A Multifamily Deal Paying Me 10% Cash on Cash

Since 2022, finding a multifamily deal with solid cash flow has been challenging (to say the least).

The math just doesn’t math! To generate meaningful cash flow at the time of purchase, the going-in cap rate needs to be higher than the interest rate. Furthermore, to really find a positive leverage scenario, your cap rate needs to be higher than the debt constant.

Debt constant: The annual debt service (interest and principal amortization) expressed as a percentage of the original loan amount. It represents the annual cost of debt financing relative to the loan amount. The loan constant is calculated by dividing the annual debt service by the total loan amount. 

To help illustrate this, picture your home mortgage. It is comprised of an interest payment and a principal payment which combined is your total monthly mortgage payment. Let’s say you have a $300,000 loan at 6% interest and a standard 30 year amortization. Your debt constant is going to be about 7.19%, because you're paying down some of the principal each and every year along with the 6% interest.

For instance, purchasing a property at a 6.5% cap rate with a debt constant of 6% creates positive leverage and likely strong cash flow—especially if there’s an opportunity to boost NOI further.

However, in most markets across the country, it’s tough to find this kind of positive leverage spread. Cap rates are generally between 5.25% and 6%, with interest rates ranging from 5.5% to 6.5%, depending on the daily fluctuations in treasury yields.

And those fluctuations can be quite volatile!

With that in mind, one of my first investments was in a tertiary market in Upstate, NY. We entered the deal with a strong year-one cash-on-cash return of around 7%, which is excellent compared to the typical 3-5% year-one returns seen with popular Sunbelt properties.

Thanks to bringing in professional management and the lack of competition for quality apartments in the area, we’ve been able to increase rents by $150 above projections while maintaining occupancy around 97%. Now, about 2.5 years into the project, we’re already meeting our year 10 NOI projections. Things are progressing well, and we’re currently earning a 10% return on our cash, with a clear path higher double digit cash flows.

This 10% return, of course, doesn’t account for any equity we may realize when we sell the property. The millions added through increased NOI will hopefully be realized at the time of sale.

I’m convinced that our on-site property manager could easily hold an executive role at D.O.G.E. He’s incredibly cost-conscious, even when it’s not his money being spent. He might be one of the most impressive property managers I’ve ever worked with.

What competitive advantages do investors have in markets like this?

Reduced Competition: One of the key advantages of investing in tertiary markets is the reduced competition compared to primary and secondary markets. Larger institutional investors and big investment firms typically focus on bigger cities, leaving space for smaller, more professional firms to outcompete the mom-and-pop owners who dominate these markets.

Hands-on Management and Local Expertise: As mentioned earlier, a hands-on approach to management is highly valued by tenants in underserved markets where housing options are limited. Tenants often appreciate clean, functional, and safe living spaces so much that they’re willing to pay higher rents in exchange. At the complex I mentioned earlier, we've seen little resistance to rent increases because of this.

Reduced Operating Expenses: Lower property taxes, insurance costs, and other operational expenses in tertiary markets can significantly boost cash flow.

Higher Cap Rates: While tertiary markets come with some risks, these perceived (and real) risks push cap rates higher than in primary markets, which can lead to greater cash flow potential.

We’ll dive deeper into the risks of tertiary markets in another article, but with the right acquisition strategy and management, I see these markets as a solid fit for part of my LP portfolio.