You want to invest in multifamily properties, but with all the apartment buildings in your city, you could spend all your time looking at them, analyzing them, and comparing them without ever getting anywhere. You need a simple, effective way to analyze buildings to save you time and help you make judicious decisions. The following three guidelines are all you need to rule out unprofitable deals and narrow in on the best.
1. Cap Rate. Cap Rate is an abbreviation for capitalization rate. It’s the return on investment on a percentage basis if you paid all cash. The formula for Cap Rate is NOI (Net Operating Income, which is simply your revenue minus your expenses) divided by the purchase price. Here’s an example: You have a property with a NOI of $50,000 per year. You paid $500,000 for the property, so the property has a Cap Rate of 10%. It’s wise to look for properties that have a Cap Rate of at least 10%.
2. Price Per Door. The price per door is simple to calculate. Just divide the price of the property by the number of units. As a general rule, if the price per door is less than $25,000, it will probably have an acceptable Cap Rate and cash flow. The price per door also tells you the class of property you’re dealing with and whether or not it’s a deal for you. However, it isn’t wise to look only at the price per door without analyzing the other two guidelines. You may miss out on some key information that could help you make a good decision.
3. Unit Mix. The unit mix is the percentage of units that are one bedroom, two bedroom, and three bedroom. A property that has more two bedrooms than one bedrooms will have higher rent or higher revenue per door. Between a property that is 80% one bedrooms and another that is 80% two bedrooms, the property with more two-bedroom units will have higher revenues and most likely a higher Cap Rate. Some people say they like to have more two-bedroom units than three-bedroom units because the three-bedrooms attract children. One bedroom units bring single people or couples. Two bedrooms are typically for roommates and small families.
Once you have collected the above information, you’ll be able to cut to the heart of the deal and weed out properties that don’t meet your needs.
15 Responses to How to Evaluate Apartment Deals in Ten Minutes
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Nice writing. You are on my RSS reader now so I can read more from you down the road.
Allen Taylor
Hello Everyone, there’s this thing with cap rates (well checking for a properties true value) that I just can’t seem to wrap my brain around and wanted to hear what some of you other investors thought about it.
OK. everyone knows that the properties value is based off its income (NOI) which I got that, and everyone knows you arrive at the cap rate by dividing NOI by the Asking Price which you get the cap rate at which the seller is selling his/her property at.
so my question is, isn’t it a flawed pratice to analyze all deals off a 10% return/cap calculation? because basically to me there is no set true value even when both you and seller agree on the income the property produces.
Example….a property generating 100K and a asking price of 1.4M equals a cap rate of 7. But if I were to come along and analyze this property off of a 10% return/cap this property would look like its 400K overpriced (so whose right).
I know behind all this its based on the risk factor (lower return less risk, higher return more risk), so with that being said what particular risk factors that make you investors feel comfortable analyzing the property/deals off of a 10% return/cap instead of what the seller is asking for?
the point behind this whole thread is that I feel alot of investors are missing out on some great deals because they’re being taught how to analyze them incorrectly, so they can’t get a true sense of a deal or trash.
thanks lance haven’t yet read all of your tutorials but i’m getting around to it and i have to say it has been very informative
This very interesting; I’ve been using the cap rate for evaluating apartments, but you have given me more tools for my tool chest. Thank you.
Thanks for the info Lance. Now in your course, do you have ranges for each guideline for each class of property, so we will know when we have a great deal?
Hi Alex,
Yes – there are ranges which vary by the class of the property – We focus on Class C & B.
Avoid Class D; D – as in “Don’t Do it”. D’s are war zones.
Each class has its own “market cap rate” which can vary by city and even submarket. The name of the game is to acquire properties at a higher cap rate than the market cap rate.
We simply the process even further by establishing 3 simple guidelines that allow us to qualify deals in 10 minutes.
Lance
Hi Chris,
Thanks for the question.
See my reply to Alex on cap rates. The objective is to buy at a cap rate higher than the market cap. That’s what creates free equity.
Free equity which we can either monetize by flipping a deal or by refinancing the property.
The cap rate also determines the amount of cash flow as our cap rate must be higher than the cost of the money funding the deal.
We may put a Class B property under contract at 8% in a 6 cap market and then flip it.
If we are in LA where the market cap is 5 then we need to find deals of cap – 6 or higher. Interestingly, a 6 cap deal in a 5 cap market can yield the same return as a 12 cap deal in a 8.5 cap market.
It all comes down to understanding the market cap rate for the area of interest – which can be anywhere in the US. That’s the attraction of multifamily. The U.S. is our territory and we can evaluate deals from our home.
Of course, the higher the cap rate we get, the better.
Lance
Do we determine the market cap rate by just looking at ASKING prices in a particular market or talking to a broker or what ???
thanks a lot lance for sharing your knowledge and clearing this up.
lance something else that bothers me is, i understand now of how you use cap rates basically as an instrument to measure up against other properties (market cap rate), i get that.
but the market cap rate number weather coming from your broker or the listing broker is this number reliable, especially to the point to say i’m gonna jump on this particular deal because the market cap is 6 and i’m getting it at a cap of say 8.
because right in commercial property closing transactions, 1- there will be less sales to look at and compare to too get a good cap rate comp, especially any new ones in some areas, 2- unless your broker or the listing broker or their companies have done the closings on those other properties how would they know what cap rate the other properties sold at, because there is no MLS system for commercial property sells, 3- how a simular proeperty was purchased (the terms) must also be a factored into the equation to see why certain properties sold for this or that, which is actually confidential info
and lance i just wanted to know what first year cash-on-cash returns to you tell you students to seek and analyze there deals off of?
Market cap rates are determined by asking local commercial brokers and appraisers.
Keep in mind that the market cap is a function of the class of apartments. So you want to ask, “What’s the market cap rate for Class C apartments in [area x]?”
Check it by asking several brokers or an appraiser. You can also get a sense by looking at the cap rate advertised on LoopNet for the area. Again for the class of property you are interested in.
Lance Edwards
In the sentence, “Between a property that is 80% one bedrooms and another that is 80% two bedrooms, the property with more two-bedroom units will have higher revenues and most likely a higher Cap Rate.” Wouldn’t it be “higher revenues and most likely a LOWER Cap Rate.”? Higher revenues (or NOI) would lead to a higher price and thus a lower cap rate. Yes?
Hi CT,
Thx for the question.
Given 2 properties of the same number of units and price, the one with more 2 bedrooms than 1 bedrooms will tend to have a higher cap rate because the average rents will be higher.
Lance
Right on the money, Lance! As an appraiser for 30 years, and just learning to buy these things, I’d like to know how you quickly verify the reported NOI and if it includes a vacancy estimate or not, and if it includes the correct expenses, along with stabilized reserves, repair costs, management, etc. Often I find that owners “under” report these things, until I have an actual historical income and expense statement, going back a few years. Even then, I have to verify what they provide me, with expense comparables. We appraisers have to research this stuff, but, in order to invest, you’ve got to have a faster method (I have a lot to “unlearn”). Thanks so much.
-Todd (alipira187@aol.com)
Hi Lance,
great summary.
what is the difference between a Class A,B,C, D and D minus apt building?
How do you evaluate the property if its totally
vacate. At the present there is no NOI. But its
in a good market and is a class C property in a class B area. Let’s say its a fourplex and they
want 140,000. How do you evaluate this property??
thats 35,000 per door.