There is a saying in real estate that you make your profit when you buy and get your cash when you sell. When deciding whether to invest in houses or apartment buildings, be aware of the differences when it comes to creating value. Investors are looking for a good return on their money. Make sure you keep this goal in mind and don’t get caught up with other aspects of real estate.
One broker said that apartments are real estate and houses are feel estate. The difference is that the value for apartments is based on numbers. The value of single family houses is based on a number of subjective attributes like wallpaper, carpet, paint, location, and many other factors you can’t control.
Apartment values, on the other hand, are based on the numbers and the net operating income. The more net operating income you generate, the more money you can put in your pocket when you refinance or cash out. Multifamily real estate investors have a larger degree of control over the revenue and expenses of their real estate than investors in houses. Apartment investors can estimate the value up front and even predict the value of the property if certain changes are made. For instance, if the owner of an apartment building raises the rent by $10, he can know exactly how much money will be coming in each month.
Single-family investors have to play more of a guessing game. An investor could spend several thousand dollars replacing carpet in the hopes of increasing the value of the home only to discover that the next potential renter hates carpet. The value of upgrades is subjective, and it’s difficult if not impossible to predict what will really add value and attract tenants or buyers.
Clearly, investing in apartment buildings offers a much greater degree of control and security than investing in single-family housing. If you like to be able to predict success based on numbers and follow through to that success, multifamily real estate is right for you.
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.
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