Comments on: Determining the Value of an Apartment Building Investment Using Cap Rates http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/ Learn, Network, Invest Sun, 12 Feb 2012 02:59:04 +0000 hourly 1 http://wordpress.org/?v=3.3.1 By: Jeffrey D. Smithhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-78711 Jeffrey D. Smith Thu, 11 Feb 2010 18:31:43 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-78711 I determine the cost of financing as the Annual Mortgage Constant (AMC), the highest allowable Loan to Value ratio (LTV), and a safe Debt Coverage Ratio (DCR).Lenders are tightening their guidelines and requiring the Debt Yield (DY) to be at least 11.5%, some as high as 15%. The DY is the NOI divided by the loan amount, which I call the Present Value (PV). The PV is simply the value times the LTV ratio.Rather than trying to squeeze financing into a purchase price, I calculate the Maximum Allowable Offer (MAO) according to the derived Capitalization Rate (CAP). I calculate the required CAP rate from the structure and cost of financing.Debt Yield: DY = DCR * AMC Cap Rate: CAP = DY * LTV Maximum Allowable Offer: MAO = NOI / CAP Return on Equity: ROE = (DCR-1)*AMC*LTV/(1-LTV) Debt Coverage Margin: DCM = 1/DCR Cash Flow Margin: CFM = 1-DCM Leverage to Yield: LTY = ROE/CAP = CFM/(1-LTV)Real estate is a borrowed money business. The value of income property is determined by the structure and cost of financing that is available to the buyer at the time of purchase. The current value has no correlation to what the seller originally paid for the property or the current debt on the property.Two cents worth. Your mileage may vary. I determine the cost of financing as the Annual Mortgage Constant (AMC), the highest allowable Loan to Value ratio (LTV), and a safe Debt Coverage Ratio (DCR).

Lenders are tightening their guidelines and requiring the Debt Yield (DY) to be at least 11.5%, some as high as 15%. The DY is the NOI divided by the loan amount, which I call the Present Value (PV). The PV is simply the value times the LTV ratio.

Rather than trying to squeeze financing into a purchase price, I calculate the Maximum Allowable Offer (MAO) according to the derived Capitalization Rate (CAP). I calculate the required CAP rate from the structure and cost of financing.

Debt Yield: DY = DCR * AMC
Cap Rate: CAP = DY * LTV
Maximum Allowable Offer: MAO = NOI / CAP
Return on Equity: ROE = (DCR-1)*AMC*LTV/(1-LTV)
Debt Coverage Margin: DCM = 1/DCR
Cash Flow Margin: CFM = 1-DCM
Leverage to Yield: LTY = ROE/CAP = CFM/(1-LTV)

Real estate is a borrowed money business. The value of income property is determined by the structure and cost of financing that is available to the buyer at the time of purchase. The current value has no correlation to what the seller originally paid for the property or the current debt on the property.

Two cents worth. Your mileage may vary.

]]> By: eugenehttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-59032 eugene Mon, 04 Aug 2008 20:16:45 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-59032 See http://www.incomeanalysis.com/boi.htm for the correct Annual Mortgage Constant derivation as per Jim's comment. See http://www.incomeanalysis.com/boi.htm for the correct Annual Mortgage Constant derivation as per Jim’s comment.

]]> By: John B.http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-58148 John B. Sat, 05 Jul 2008 18:14:45 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-58148 Ted! Bravo to you for breaking it down financial concepts you are my Wharton School of Finance for the day. Ted! Bravo to you for breaking it down financial concepts
you are my Wharton School of Finance for the day.

]]> By: Jimhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-56033 Jim Mon, 14 Apr 2008 19:44:57 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-56033 Ted:Actually, a 7.99% interest rate on a 30-year mortgage yields a mortgage constant of 0.087968, not 0.0799 as stated in the example. The mortgage constant is derived by calculating the periodic payment to repay $1 over the specified life of the loan (in this case 30 years) at the specified interest rate (in this case 7.99%), then multiplying this monthly mortgage constant by 12 (due to 12 payments in one year). If you have an HP12C calculator, input the following (on a monthly basis) 7.99% interest rate converted to monthly figure of 0.66583%, 30 year mortgage = 360 pmts, -$1 for PV and $0 for FV. Solve for PMT, which yields 0.007330676. Then, multiply by 12 for an annual indication of the mortgage constant (0.087968). The cap rate developed using your weighted average band of investment technique would actually be 0.092, or 9.2%. Capitalizing the $150,000 by 8.0% rather than by the 9.2% rate significantly overstates the value ($1,875,000 at 8% cap vs $1,630,000 at 9.2% cap). The reason the mortgage constant is higher than the interest rate on the loan is due to the compound nature of the interest the borrower pays over the life of the loan.Jim Ted:

Actually, a 7.99% interest rate on a 30-year mortgage yields a mortgage constant of 0.087968, not 0.0799 as stated in the example. The mortgage constant is derived by calculating the periodic payment to repay $1 over the specified life of the loan (in this case 30 years) at the specified interest rate (in this case 7.99%), then multiplying this monthly mortgage constant by 12 (due to 12 payments in one year). If you have an HP12C calculator, input the following (on a monthly basis) 7.99% interest rate converted to monthly figure of 0.66583%, 30 year mortgage = 360 pmts, -$1 for PV and $0 for FV. Solve for PMT, which yields 0.007330676. Then, multiply by 12 for an annual indication of the mortgage constant (0.087968). The cap rate developed using your weighted average band of investment technique would actually be 0.092, or 9.2%. Capitalizing the $150,000 by 8.0% rather than by the 9.2% rate significantly overstates the value ($1,875,000 at 8% cap vs $1,630,000 at 9.2% cap). The reason the mortgage constant is higher than the interest rate on the loan is due to the compound nature of the interest the borrower pays over the life of the loan.

Jim

]]> By: Chad Fisherhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55778 Chad Fisher Sat, 05 Apr 2008 05:27:27 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55778 A great follow-up post to this would be to explore different cap rates in different US cities and why there is such variety. A great follow-up post to this would be to explore different cap rates in different US cities and why there is such variety.

]]> By: DrJohnhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55361 DrJohn Mon, 17 Mar 2008 22:42:58 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55361 Good post! Good post!

]]> By: Anonymoushttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55034 Anonymous Wed, 05 Mar 2008 05:18:08 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55034 Great post Ted. I used to buy apartment buildings in my area for an 8% to 10% cap rate, but now that our local economy has heated up they are going for 4% to 5%. NOI is the same but higher prices are up pushing the cap rates down. Now rents have to play catchup! Great post Ted. I used to buy apartment buildings in my area for an 8% to 10% cap rate, but now that our local economy has heated up they are going for 4% to 5%. NOI is the same but higher prices are up pushing the cap rates down. Now rents have to play catchup!

]]> By: rick marnonhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55008 rick marnon Tue, 04 Mar 2008 13:14:27 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-55008 this is a huge part of analyzing commercial real estate investments. i learned this a while back when i started looking at making a investment into an apartment building. great post for the potential invester. this is a huge part of analyzing commercial real estate investments. i learned this a while back when i started looking at making a investment into an apartment building. great post for the potential invester.

]]> By: Determining the Value of an Apartment Building Investment Using Cap Rates | The Long List of Odysseus Medal Nominees | Realtors and real estate, mortgages, lending, investmentshttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-54994 Determining the Value of an Apartment Building Investment Using Cap Rates | The Long List of Odysseus Medal Nominees | Realtors and real estate, mortgages, lending, investments Tue, 04 Mar 2008 01:22:31 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-54994 [...] Determining the Value of an Apartment Building Investment Using Cap Rates, by Ted Karsch. [...] [...] Determining the Value of an Apartment Building Investment Using Cap Rates, by Ted Karsch. [...]

]]> By: Joshua Dorkinhttp://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-54993 Joshua Dorkin Tue, 04 Mar 2008 01:07:30 +0000 http://www.biggerpockets.com/renewsblog/2008/03/03/determining-the-value-of-an-apartment-building-investment-using-cap-rates/#comment-54993 This is a fantastic post, Ted! Welcome to the team. I think you're going to help a LOT of people with your articles. This is a fantastic post, Ted! Welcome to the team. I think you’re going to help a LOT of people with your articles.

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