In the dynamic world of multifamily property investments, overlooking crucial factors like property tax reassessments can lead to substantial financial setbacks. Let’s dive into a real-life example illustrating how failure to underwrite property taxes properly can drastically impact cash flow and property valuation.
Imagine an investor eyeing a multifamily property and analyzing its potential profitability. They scrutinize the tax bill, which stands at $100,000, and project a 3% annual increase for the next five years. Assuming taxes would remain at $100,000 in Year 1 and climb modestly thereafter, they move forward with the investment.
However, shortly after acquiring the property, the tax assessor conducts a reassessment, resulting in a staggering increase to $175,000 in Year 2, with subsequent 3% annual increments. This unforeseen spike catches the investors off guard, severely denting their financial projections.
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Over five years, the miscalculation translates to a staggering $301,000 shortfall in cash flow. But the repercussions extend beyond immediate cash flow woes. In Year 5, when the investor plans to sell the property, the inflated tax burden distorts their anticipated income. This leads to an overestimation of Year 5 income by over $78,000.
Now, let’s examine the impact on property valuation. Let’s assume properties like this one are typically selling at a 6% cap rate. The higher property taxes significantly deflate the property’s value, compared to the investor’s initial underwriting. The miscalculation results in the property being worth a staggering $1.3 million less than initially projected ($78K/6%).
In sum, this single oversight proves costly for all involved parties. The investor faces a staggering $1.6 million reduction in cash flow and profit, highlighting the critical importance of meticulous underwriting in multifamily investments.
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This example underscores the imperative for investors to conduct thorough due diligence, incorporating potential tax reassessments into their financial models. Had the investor been aware of a potential Year 2 property tax reassessment, they would have correctly lowered their purchase price. By anticipating and accurately accounting for such reassessments, investors can safeguard their returns and mitigate unforeseen financial risks in the multifamily property market.
