March 28, 2023

Adam Hoeksema

The purpose of this post is to help new and experienced multifamily developers learn the process of building a financial model that can be used to raise capital from lenders and investors. In this post we are going to assume that you are a developer, constructing a multifamily apartment complex from the ground up.

To put it simply - your goal is to:

## Multifamily Apartment Financial Model Template

Before I dive in, I wanted to mention that I will be referencing our multifamily apartment financial projection templates throughout the article to demonstrate and include a number of screenshots and a demo video as well. Our 2 templates include:

With that, let's dive in!

## 1. Identify a Location

The first step in developing a multifamily property is selecting a location. Consider factors such as local demographics, employment opportunities, access to public transportation, and nearby amenities. Your location will determine the type of multifamily complex you will build based on the zoning requirements and architectural norms of the area. Your location helps determine whether you are going to build a single story complex, or build vertically.

### How Many Apartment Units per Acre?

The University of Idaho estimates that you can achieve between 6 and 100 apartment units per acre depending on whether you are building vertically or horizontally.

- Single story duplex apartments can fit 6 to 8 apartment units per acre
- Two and three story apartment complexes can fit 20 apartment units per acre.
- Multiple story apartment complexes can fit 50 to 100 apartment units per acre.

Your location, urban, suburban or rural, will likely determine whether you are building vertically or horizontally and ultimately determine how many acres you might be able to acquire.

## 2. Determine how Many Units you Plan to Build

Once you have the proposed land identified you can plan the number of apartment units that you would like to build. Specifically this is often called your “program” which effectively means how many buildings will you build, what type of buildings, and how many units will each building have. An example of a Multifamily program could be as follows:

### How Many Units Does the Average New Multifamily Apartment Complex Have?

The average number of apartment units per new multifamily development is roughly 111 apartment units according to Fannie Mae data.

## 3. Plan your Unit Mix

Next, you need to determine the mix of unit types (e.g., studio, one-bedroom, two-bedroom) to cater to the needs of your target market. You will likely want a diverse unit mix in order to appeal to a wider range of potential tenants, thereby reducing vacancy rates and stabilizing income faster. Our Multifamily Financial Model allows you to enter in your unit mix as seen below:

### What is the Typical Unit Mix for a Multifamily Apartment Development?

The typical unit mix for a multifamily apartment development is 2 two or three bedroom units for every 1 single bedroom or studio apartment unit. This seems to be the standard rule of thumb based on multiple sources (Jake and Gino, Willowdale Equity).

The reason that most multifamily complexes have a 2 to 1 ratio of 2 bedrooms to 1 bedrooms is because typically 2 bedroom units are in higher demand; however, this doesn’t mean that this unit mix is guaranteed to be the most profitable. In fact, you can typically earn a higher rent per square foot with a studio apartment for example. If you think there is sufficient demand to fill studio apartments, those are likely to be more profitable per square foot when compared to two bedrooms.

## 4. Calculate your Gross Potential Income (GPI)

GPI is the total income your property can generate if all units are rented at market rates without any vacancies, concessions or bad debt.

### How to Calculate Gross Potential Income (GPI)

To calculate GPI, multiply the number of units by the average monthly rent per unit type.

Although gross potential income, also known as potential gross income (PGI), is an important number, effective gross income is maybe even more important.

### How to Calculate Effective Gross Income (EGI)

Effective gross income equals gross potential income minus vacancy and credit loss. In other words, your effective gross income is the total income you will actually receive after taking into consideration vacancies and the tenants that don’t pay rent for some period of time.

### What is the Average Vacancy Rate for Multifamily Apartment Properties?

The average vacancy rate for a multifamily apartment is roughly 6% according to Matthews Real Estate Investment Services.

### What is the Average Credit Loss for a Multifamily Apartment Property?

The average bad debt or credit loss for a multifamily apartment is 0.7% according to CF Capital.

## 5. Calculate your Multifamily Operating Expenses

Operating expenses for a multifamily apartment complex are typically between 35% and 45% of your effective gross income according to Bullpen. Typical operating expenses for a multifamily property include:

- Apartment Turn Costs
- General and Administrative
- HOA fees
- Insurance
- Janitorial
- Maintenance
- Management Fees
- Marketing
- Real Estate Taxes
- Salaries
- Utilities

Our model will allow you to enter in your operating expenses on a per property, per unit, or per square foot basis. You can also enter in expenses as a percentage of revenue if you prefer.

### Typical Operating Expenses for Multifamily Apartments

It is difficult to provide specific percentages for each operating expense category without knowing the details of a specific multifamily apartment complex, as these costs can vary significantly based on location, size, age, and management practices. However, here are some approximate ranges for some of these operating expenses as a percentage of the effective gross income (EGI):

- Apartment Turn Costs: 1-3%
- General and Administrative: 2-5%
- HOA fees: This is highly variable depending on the specific complex and location; can range from 0% (if no HOA) to over 10%
- Insurance: 2-4%
- Janitorial: 1-3%
- Maintenance: 5-10%
- Management Fees: 3-6%
- Marketing: 1-3%
- Real Estate Taxes: 10-20% (depends on location and tax rates)
- Salaries: 5-10% (includes on-site staff, such as property managers and maintenance personnel)
- Utilities: 5-10%

Please note that these percentages are approximate ranges and can vary based on the specific circumstances of a property. For a more accurate analysis, it would be best to consult with a property management company or a real estate investment professional who can provide tailored guidance based on your unique situation.

## 6. Calculate Net Operating Income (NOI)

In order to calculate net operating income for a multifamily apartment complex you can utilize the following formula:

**Gross Potential Income - Vacancies - Bad debt (aka credit losses) = Effective Gross Income**

**Effective Gross Income - Total Operating Expenses = Net Operating Income**

## 7. Determine a Loan Amount Based on Your NOI, Cap Rates and Debt Service Coverage Ratio

Once you have an estimated Net Operating Income (NOI) for your multifamily property, you can calculate the potential loan amount that a lender might provide.

Lenders may use a loan-to-value ratio to determine a loan amount for your proposed development. Lenders may also require that you maintain a certain debt service coverage ratio (DSCR). Based on your NOI and your DSCR, you can back into the maximum loan amount that your project can afford. Once you have a monthly loan amount, you can estimate the total loan amount that would give you that monthly loan payment. Here are 8 steps I would follow to estimate a loan amount for a multifamily development.

- Estimate Net Operating Income
- Estimate Current Cap Rates for Your Property Type
- Estimate the Value of your Proposed Property based on NOI and Cap Rates
- Estimate a Loan-to-Value Ratio that the Bank will Use
- Estimate a Loan Amount based on Property Value and LTV
- Estimate a Debt Service Coverage Ratio that the Bank will Require
- Calculate a Maximum Loan Payment you can Afford based on the NOI and DSCR
- Estimate a Loan Amount based on the Maximum Loan Payment you can Afford

There is quite a bit here, so let me try to walk through this step by step:

### 1. Estimate Net Operating Income

Again, the formula to calculate net operating income is Gross Potential Income - Vacancies - Credit Losses - Operating Expenses = Net Operating Income. For the sake of an example, let’s assume we have a property with a projected net operating income of $1 million.

### 2. Estimate Current Cap Rates for Your Property Type

Next, you need to know what the cap rates are for your type of property and location. Cap rates change as the market changes, so you will need to do a bit of research.

#### What is a Cap Rate?

A cap rate, short for capitalization rate, is a measure used in real estate to evaluate the profitability and potential return on investment of a property. It is calculated by dividing the net operating income (NOI) of a property by its current market value or purchase price.

The formula for cap rate is:

**Cap Rate = Net Operating Income / Current Market Value or Purchase Price**

The cap rate is expressed as a percentage and is used to estimate the potential return on investment of a property. A higher cap rate indicates a higher potential return, while a lower cap rate indicates a lower potential return.

#### What are Typical Cap Rates for Multifamily Apartments?

Cap rates for multifamily properties in prime locations in urban areas can be as low as 4% to 5%.

Cap rates for class B and C multifamily properties in less desirable locations can be in the 5% to 8% range.

For the sake of this example, let’s use a 5% cap rate for our proposed property.

### 3. Estimate the Value of your Proposed Property based on NOI and Cap Rates

Since you don’t know the value of your proposed property, but you do have a projected NOI and you can find the market cap rates, you can then calculate an estimate of the value of the property.

With our example of a $1,000,000 NOI and a 5% cap rate, we can take $1,000,000 divided by 5% and calculate a property value estimate of $20,000,000.

### 4. Estimate a Loan-to-Value Ratio that the Bank will Use for Multifamily

The average loan to value ratio for multifamily properties is 73% according to Lev Capital. The maximum LTV for a multifamily property that you might be able to secure is 80%.

### 5. Estimate a Loan Amount based on Property Value and LTV

Based on an LTV of 73% for Multifamily properties, and our example property value of $20,000,000, we can estimate a loan amount of $14,600,000.

### 6. Estimate a Debt Service Coverage Ratio that the Bank will Require

The other guardrail that will determine how much you can borrow is how much you can cash flow. Your Debt Service Coverage Ratio is a way to measure how much debt service you can cover based on your Net Operating Income.

#### Average Debt Service Coverage Ratio for Multifamily Properties

The average required debt service coverage ratio for multifamily properties is 1.2 according to Janover.

### 7. Calculate a Maximum Loan Payment you can Afford based on the NOI and DSCR

If we assume Net Operating Income of $1 million and a required debt service coverage ratio of 1.2 we can calculate the maximum loan payment that you can afford each month and still maintain a DSCR of 1.2.

In order to calculate the debt service amount we can afford, we can take our NOI divided by DSCR which is $1 million divided by 1.2 which equals $833,333 in annual debt service. If we divide by 12 months we come up with a monthly loan payment maximum of $69,444.

### 8. Estimate a Loan Amount based on the Maximum Loan Payment you can Afford

Next we can try to estimate a loan amount that would give us a monthly payment of $69,444.

But in order to do this we need to make assumptions about the term of the loan and the interest rate.

#### What is the Average Term for a Multifamily Apartment Loan?

The average term for a multifamily apartment loan is 30 years, but can be up to 35 years in some cases according to Janover.

#### What is the Average Interest Rate for a Multifamily Property Loan?

A common interest rate for a multifamily property loan is the 10 year treasury rate + 2%. So if the 10 year treasury rate is 3.5%, your interest rate would be 5.5%. These rates fluctuate daily, so you will need to check the current rates.

For our example we are going to assume an interest rate of 5.5% and a 30 year term with a monthly payment of $69,444. Then I did a quick trick and asked ChatGPT to calculate what my loan amount would be with those parameters and it calculated a loan amount of $10,850,000.

ChatGPT did a wonderful job explaining the process and calculation below:

*“To calculate the loan amount, we need to use the formula for a fixed payment loan:*

*Loan Amount = Monthly Payment / ((1 - (1 + Monthly Interest Rate)^(-Number of Months)))*

*where Monthly Interest Rate = Annual Interest Rate / 12 and Number of Months = Loan Term x 12.*

*Plugging in the given values, we get:*

*Monthly Interest Rate = 5.5% / 12 = 0.00458 Number of Months = 30 years x 12 = 360*

*Loan Amount = $69,444 / ((1 - (1 + 0.00458)^(-360))) Loan Amount = $69,444 / ((1 - 0.3681)) Loan Amount = $10,850,000*

*Therefore, the loan amount assuming an interest rate of 5.5% and a 30-year term with a monthly payment of $69,444 would be $10,850,000.”*

So after all of this we have 2 different loan amounts! The loan to value ratio process estimated a loan amount of $14,600,000 and the DSCR process estimated a loan amount of $10,850,000.

You should assume that you will need to take the lower of the two numbers. So we are going to move forward with a $10,850,000 loan in this example.

## 8. Finalize a Construction Budget Based on your Loan and Equity Amount

Your construction budget should include all costs related to land acquisition, construction, professional fees, and financing costs. Your total project cost should be covered by the combination of your loan and equity investments. We already know our loan amount is $10,850,000, but we need to know our equity amount.

### Average Equity Injection for a Multifamily Apartment Complex

The average equity injection for a multifamily apartment development is 25% according to Janover.

If we assume that $10,850,000 is 75% of the total project cost, then the total project would be $14,466,667. Our equity portion would be 25% which equals $3,616,667

So our construction budget can be $14,466,667.

Our model includes a Construction Budget Template tab that allows you to enter in the details and timing of construction as seen below:

## 9. Add Assumptions for Rent Stabilization

Let’s fast forward and assume your multifamily property is complete. Your multifamily financial model should include assumptions for rent stabilization, meaning how long does it take to get the property full and stabilized?

### How Long Does it Take to Fill a New Multifamily Apartment?

Let’s assume it takes 9 months from the time the property is complete to have all of the units occupied, less the normal vacancy rate that you might expect.

## 10. Calculate Potential Sales Price Based on Cap Rate

The capitalization rate (cap rate) is the ratio of NOI to property value. To calculate the potential sales price, divide your NOI by the cap rate, which is determined by market conditions and comparable properties. To be specific, the cap rate when you sell a property is called your exit cap rate. You need to be careful to assume a conservative exit cap rate because the exit cap rate will have a dramatic impact on your rate of return on the property.

As we discussed earlier, if we assume a 5% cap rate and a $1 million NOI, the expected value of the property would be $20,000,000.

## 11. Forecast Investor Returns

Finally, you will want to calculate key investor return metrics, such as internal rate of return (IRR), cash-on-cash return, and equity multiple. These metrics help investors evaluate the attractiveness of your project and make informed decisions about whether to invest. You can run different scenarios with our template to forecast IRR based on sale details as seen below:

### Typical Multifamily Investor Returns

The typical multifamily investor might expect average returns of between 14% and 18% according to ButterflyMX.

### IRR vs XIRR

Your investors might ask your for a projected IRR or XIRR. Let’s look at the difference between IRR and XIRR.

Both XIRR and IRR are financial metrics used in real estate to analyze the returns of an investment. However, they differ in their calculation methods and the way they account for irregular cash flows.

IRR (Internal Rate of Return) is a measure of the profitability of an investment, expressed as a percentage rate. It calculates the discount rate at which the net present value of all the cash inflows and outflows from an investment is equal to zero. In other words, it is the rate at which the investment breaks even.

XIRR (Extended Internal Rate of Return) is an advanced version of IRR that is used to calculate the returns on investments with irregular cash flows. Unlike IRR, which assumes that cash flows occur at regular intervals, XIRR considers the exact dates of cash flows and the amount of each cash flow.

In real estate, XIRR is generally used for investments that have irregular cash flows, such as rental properties that generate monthly rent payments, irregular capital expenditures, or other cash flows that are not evenly distributed over time. On the other hand, IRR is more commonly used for investments with regular cash flows, such as development projects with predictable timelines and cash flows.

In summary, the main difference between XIRR and IRR is that XIRR is more precise and takes into account the timing and amount of each cash flow, whereas IRR assumes that cash flows are evenly distributed over time. As such, XIRR is more appropriate for analyzing investments with irregular cash flows, while IRR is more suitable for investments with regular cash flows.

## Conclusion

I hope this has been helpful to you as you think through the process of building a financial model for a multifamily apartment complex. If you have any questions please feel free to reach out, we would love to help!