To analyze a multifamily deal, start with the rent the building can really collect, subtract vacancy and every operating expense to get net operating income (NOI), then test that NOI against the price (cap rate), the loan (DSCR) and your cash (cash on cash return). The work is mostly about replacing the seller's numbers with ones you have verified. This walkthrough follows one small building through every step.
It is written for a first small multifamily purchase, roughly 2 to 20 units. When you are ready for a more detailed process, the small multifamily underwriting playbook picks up where this leaves off.
Step 1: Screen the listing and collect the documents
Most listings do not deserve an hour of your time. Two quick rules of thumb help you sort them:
- Gross rent multiplier (GRM). Price divided by gross annual rent. It ignores expenses, so it is only good for comparing similar buildings in the same area. See GRM screening.
- The 50% rule. A rule of thumb that operating expenses on small rentals run around half of gross rent, with vacancy, management and reserves counted inside that half. If a listing claims expenses of 25%, something is missing. See the 50% rule test.
If a building looks reasonable on both, ask the seller or broker for:
- The current rent roll, showing each unit, tenant, rent, lease dates and deposit
- The trailing 12 months (T12) of income and expenses
- Copies of the leases
- The property tax bill, the insurance bill and 12 months of owner-paid utility bills
- A list of capital work done in the last several years (roof, boilers, windows, parking lot)
Sellers of small buildings often have poor records. Missing paperwork is not always a red flag, but it means you verify more yourself. The post on verifying seller rent rolls covers how to check that the rents on paper are the rents being deposited.
Step 2: Build the income side
Start with gross potential rent: every unit rented for all 12 months. Use current rents for occupied units and a supportable market rent for vacant ones. If the broker's package shows "pro forma" rents, set them aside. You pay for the income the building has today, and upside from raising rents is your reward for the work and risk.
Add other income you can document, like laundry, parking or storage.
Subtract vacancy and credit loss. Even a full building loses rent to turnover and to tenants who do not pay. Rules of thumb run from 5% to 10% of gross potential rent, depending on the market and tenant base. Lenders typically apply at least 5% even when the building is full.
What is left is effective gross income (EGI).
Step 3: Build the expense side and calculate NOI
Do not reuse the seller's expenses as they stand. Rebuild each line for how you will own the building:
| Expense | How to estimate it |
|---|---|
| Property taxes | Check how your county reassesses after a sale. The seller's bill may be based on a much lower value |
| Insurance | Get a quote. Premiums have moved a lot in many states |
| Repairs and maintenance | Use the T12 as a starting point and adjust for age and condition |
| Management | Commonly 8% to 10% of collected rent on small buildings. Include it even if you self-manage |
| Utilities | Use the actual bills for anything the owner pays (often water, sewer, trash and common area electric) |
| Grounds, snow, pest control | From the T12 or local quotes |
| Administrative and legal | Accounting, software, evictions, licenses |
| Capital reserves | An annual amount per unit set aside for roofs, boilers and parking lots |
Sellers who manage their own building rarely show a management fee, and many leave out reserves. Both make NOI look higher than it is for you. Pay for management in your model because your time has a cost, and because a lender will include it when sizing the loan.
Calculating NOI
NOI equals effective gross income minus operating expenses. It does not include mortgage payments, depreciation or income taxes. Conventions differ on capital reserves: many brokers leave them out of NOI and many lenders put them in. Including them is the conservative choice, and that is what the example below does.
Step 4: Run the numbers on a six unit example
This is an example with round numbers. The 6.5% interest rate is an example rate used to show the arithmetic. It is not a quote of current rates.
A six unit building of two-bedroom apartments, each renting for $1,250 a month. The seller is asking $720,000. We analyze it at an offer price of $640,000 and come back to the asking price afterward.
| Income and expenses | Annual amount |
|---|---|
| Gross potential rent (6 units at $1,250 for 12 months) | $90,000 |
| Laundry income | $1,800 |
| Vacancy and credit loss (7% of gross potential rent) | ($6,300) |
| Effective gross income | $85,500 |
| Property taxes | $10,800 |
| Insurance | $5,400 |
| Repairs and maintenance | $6,000 |
| Management (8% of effective gross income) | $6,840 |
| Water, sewer and common electric | $5,400 |
| Grounds and snow removal | $1,800 |
| Administrative and legal | $960 |
| Capital reserves ($400 per unit) | $2,400 |
| Total operating expenses | $39,600 |
| Net operating income ($85,500 minus $39,600) | $45,900 |
Expenses are 46% of effective gross income. To line that up against the 50% rule you have to put vacancy back in, because the rule treats vacancy as part of the half: $39,600 of operating expenses plus $6,300 of vacancy and credit loss is $45,900 against $91,800 of gross potential income, or exactly 50%. That is a sign the expense side is probably complete.
Now the three return tests at a $640,000 price. The loan is 75% of the price, $480,000, amortized over 30 years at the 6.5% example rate. The payment is $3,034 a month, or $36,408 a year.
| Metric | Calculation | Result |
|---|---|---|
| GRM | $640,000 divided by $90,000 | 7.1 |
| Cap rate | $45,900 divided by $640,000 | 7.2% |
| Annual debt service | $3,034 times 12 | $36,408 |
| DSCR | $45,900 divided by $36,408 | 1.26 |
| Annual cash flow | $45,900 minus $36,408 | $9,492 |
| Cash invested | $160,000 down, $12,800 closing costs, $7,200 initial repairs | $180,000 |
| Cash on cash return | $9,492 divided by $180,000 | 5.3% |
How to read those numbers
Cap rate is NOI divided by price. It is the return you would earn buying with all cash, and it lets you compare buildings without financing getting in the way. Whether 7.2% is good depends on the market and the building's condition. See what a good cap rate looks like for context.
DSCR (debt service coverage ratio) is NOI divided by annual loan payments. Lenders on five or more units commonly want 1.20 to 1.25 or higher, because the loan is sized on the property's income more than on yours. At 1.26 this deal clears the bar with little room. The post on DSCR explained goes further.
Cash on cash return is annual cash flow divided by all the cash you put in, including closing costs and day-one repairs. At 5.3% this deal is modest. It does not count principal paydown, appreciation or rent growth, and it is the number that tells you what your cash earns in year one.
Now look at the $720,000 asking price. NOI stays at $45,900. The cap rate falls to 6.4%. The loan rises to $540,000 with a payment of $3,413 a month, or $40,956 a year. DSCR drops to 1.12, which most lenders would decline at 75% loan to value. Cash flow falls to $4,944 on $201,600 invested ($180,000 down, $14,400 closing costs, $7,200 repairs), a 2.5% return. The analysis has told you what to offer: somewhere near $640,000, and no more.
Step 5: Stress test
A deal that only works if everything goes right is fragile. Change one assumption at a time and watch DSCR and cash flow. Using the example at $640,000:
| Scenario | NOI | DSCR | Annual cash flow |
|---|---|---|---|
| Base case | $45,900 | 1.26 | $9,492 |
| Vacancy doubles to 14% | $40,104 | 1.10 | $3,696 |
| Operating expenses rise 10% | $41,940 | 1.15 | $5,532 |
| Loan rate is 7.5% instead of 6.5% | $45,900 | 1.14 | $5,628 |
In the vacancy row, rent loss rises by $6,300 and the management fee falls by $504 because it is a percentage of collections, so NOI drops by $5,796. In the rate row the payment becomes $3,356 a month, or $40,272 a year.
Each single shock leaves the building cash flow positive, which is what you want to see. Two at once would get tight. The post on sensitivity analysis shows how to test several variables together, and the multifamily calculator builds sensitivity tables from your own inputs: cash on cash across a range of prices and vacancy rates, and DSCR across a range of prices and interest rates.
Financing and property type notes
Two to four unit buildings qualify for residential mortgages, with 30-year fixed terms and qualification based mainly on your income. Five units and up are commercial loans. Expect a loan sized on DSCR, a shorter fixed period (often 5 to 10 years) with a balloon or rate reset, amortization of 20 to 30 years, and sometimes a prepayment penalty. Terms vary widely between local banks, credit unions and agency lenders, so get a term sheet early and rerun your numbers with it.
Some small buildings do not fit the standard template. If there is a storefront or office on the ground floor, the commercial lease needs its own analysis, covered in analyzing a mixed-use property. If you are looking at a duplex where one side is rented and one is vacant or owner-occupied, see how to analyze a duplex with one unit rented.
Common mistakes
- Underwriting to pro forma rents. Pay for today's income. Treat rent increases as upside you have to earn.
- Using the seller's tax bill. In many states a sale triggers reassessment, and the new bill can be far higher.
- Leaving out management and reserves. They are real costs even in years when you do not write the check.
- Trusting the rent roll without proof. Match it against leases and bank deposits, and get tenant estoppel letters if you can.
- Looking at cap rate alone. A fine cap rate can still fail the DSCR test when loan rates are close to or above the cap rate.
- Ignoring deferred maintenance. A roof or boiler at the end of its life is part of the price. Get bids during inspection and put day-one repairs into your cash invested.
Bottom line
Every multifamily analysis follows the same chain: gross potential rent, minus vacancy, equals effective gross income; minus operating expenses equals NOI; NOI against price, debt and cash gives you cap rate, DSCR and cash on cash return. In the example, a six unit building with $45,900 of NOI worked at $640,000 and did not work at the $720,000 asking price. Verify the income, rebuild the expenses yourself, stress test the result, and let the numbers set your offer.
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