Commercial Real Estate

Determining the Value of an Apartment Building Investment Using Cap Rates

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67 Articles Written
due_diligence_apartment_buildings
Determining the value of an apartment building investment is one of the greatest difficulties that many new commercial real estate investors face. Most people who invest in apartments have some experience investing in other types of real estate, typically residential homes or duplexes and triplexes. The issue that new investors face is the fact that [...] View the full article: Determining the Value of an Apartment Building Investment Using Cap Rates on The BiggerPockets Blog. This content is Copyright © 2017 BiggerPockets, Inc. All Rights Reserved.

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    Joshua Dorkin
    Replied over 11 years ago
    This is a fantastic post, Ted! Welcome to the team. I think you’re going to help a LOT of people with your articles.
    rick marnon
    Replied over 11 years ago
    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.
    rick marnon
    Replied over 11 years ago
    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.
    Anonymous
    Replied over 11 years ago
    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!
    Anonymous
    Replied over 11 years ago
    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!
    DrJohn
    Replied over 11 years ago
    Good post!
    Chad Fisher
    Replied over 11 years ago
    A great follow-up post to this would be to explore different cap rates in different US cities and why there is such variety.
    Jim
    Replied over 11 years ago
    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
    Joe
    Replied over 6 years ago
    Jim, thank you for the details and explanation. Joe.
    John B.
    Replied over 11 years ago
    Ted! Bravo to you for breaking it down financial concepts you are my Wharton School of Finance for the day.
    eugene
    Replied about 11 years ago
    See http://www.incomeanalysis.com/boi.htm for the correct Annual Mortgage Constant derivation as per Jim’s comment.
    Jeffrey D. Smith
    Replied over 9 years ago
    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.
    Gayla Huerta
    Replied over 7 years ago
    Who do I contact for newly available $4.7mil 73 unit apt complex next to UTPA University Texas Pan American? (Gated, surveillance, no vacancies, good CF & NOI) Any directional info appreciated. Gayla
    William Turner
    Replied almost 6 years ago
    Debt Yield: DY = DCR * AMC How do you determine your AMC#?
    William Turner
    Replied almost 6 years ago
    Debt Yield: DY = DCR * AMC How do you determine your AMC#?
    Jim Young
    Replied over 5 years ago
    I would think you would want to know whether the Cap rate includes paying a manager or not. Big difference.
    Ayodeji Kuponiyi Investor from King of Prussia, Pennsylvania
    Replied over 4 years ago
    Helpful Post!
    Renata Millet-Rigali
    Replied over 3 years ago
    I couldn’t find a site where it would help me calculate the value of an apt complex. Help.