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Multifamily Deals: Understanding Cap Rate Basics

When analyzing a multifamily deal, it is important to understand the term Cap Rate and how it can help you quickly and easily make decisions about a property. Cap Rate is short for capitalization rate. The Cap rate is the return on investment on a percentage basis if you paid all cash for a property. Use this calculation to determine cap rate: Cap Rate (%) = NOI (*100%) / Price. For example, let us say you have an apartment building with a net operating income of $100,000 per year and you paid $1,000,000 for the property. The Cap Rate on your property is 10% because you are getting a 10% return on your $1,000,000.

The Cap Rate is useful for measuring the performance of different properties. Regardless of the size, price, or other variables of a property, the Cap Rate is a common denominator for evaluating properties. Cap Rate is a widely used term. Across the country, you can talk with commercial brokers and investors about Cap Rates. However, using the Cap Rate is only pertinent when evaluating properties with five or more units. Fourplexes and smaller properties do not follow the Cap Rate formula as much.

Once you have determined the Cap Rate on the apartment buildings you are evaluating, you can determine which properties are worth further investigation. Different investors will have different thresholds of risk, but a good rule of thumb is to look for properties with Cap Rates of 10% or higher. Of course, the current Cap Rate on a property may change if, through better management, the occupancy goes up or costs go down. This is something to take into consideration in evaluating Cap Rates.

For example, if you find a multifamily property that has a current Cap Rate of 9%, but through further investigation you realize that through better management or more active leasing you could drive the Cap Rate up to 12% fairly easily, then you can rationalize not needing the 10% Cap Rate before the deal is finalized. If the apartment does not have a 10% Cap Rate today but could have a 12% Cap Rate tomorrow, it may be a deal you do not want to pass up.

As mentioned earlier, Cap Rate is a term that most investors and brokers are familiar with, so become a Cap Rate expert yourself. Learn to calculate the Cap Rate on a property, and you will save yourself precious time in analyzing and evaluating properties during your search for a multifamily property.

Article Source: http://www.bo-knows.com

Lance Edwards is living proof of his mantra that you don't have to "graduate" from single family to multifamily - you can start with multifamily; using none of your own money and not dealing with tenants and toilets. For FREE information, visit www.ApartmentWealthMachine.com.

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