Investor · H, NE · Member since 2015 · 54 posts · 17 votes
Hi, All. I've been looking for a multifamily property, and finally came across one that seems to work. All 4 units are rented for a total income of $2,235($26,820/year), with overall expenses of $7,630. So Net Income is right at $19,000 without accounting for interest. I plan to cut back on expenses as I will begin to mow and clean the hallways myself. I'm wondering what kind of return one looks for on mutli family. This property has a rough cap rate of 8.75, which is decent.
With some minor improvements, and eliminating expenese, I don't see why I can't get the cap rate above 9 or maybe even to 10. Any suggestions or input would be great! Thanks!
This is awesome. Even better would be if @Brandon Turner and @Joshua D. were to invite @Account Closed and @Account Closed on to a podcast to hash this out. Better yet - let's settle this once and for all. Give them some gloves and headgear and setup the camera!
I get what you are saying, I just don't agree. Cap rate is tide to purchase price not value of the asset. If all of the sudden, all investors required a cap rate of 20% then it doesn't matter that I cut expenses, the value of my property on the open market just went down. But, assuming rents stayed the same, I am still getting the 11% cap rate because of what I purchased it for.
and explain it to them. Since their students will go on to run the largest banks and hedge funds in the country. They certainly need to understand they have been teaching it all wrong.
and explain it to them. Since their students will go on to run the largest banks and hedge funds in the country. They certainly need to understand they have been teaching it all wrong.
1. You link provides no identifying or contact information.
2. I believe the example you gave doesn't assert what you think it does.
3. Why can't you explain your process in your own words?
. Since their students will go on to run the largest banks and hedge funds in the country. They certainly need to understand they have been teaching it all wrong.
This explains so much of the failure of the banking industry. Too big to fail?
I get what you are saying, I just don't agree. Cap rate is tide to purchase price not value of the asset. If all of the sudden, all investors required a cap rate of 20% then it doesn't matter that I cut expenses, the value of my property on the open market just went down. But, assuming rents stayed the same, I am still getting the 11% cap rate because of what I purchased it for.
You don't "get" cap rate. It is just the measure of what you paid for a NOI at one point in time. If the cap rate goes to 20% in your market then the value of your NOI is $55,000. That is dictated by the market. Oh, and you lost $45,000.
@Account Closed and @Account Closed and @Account Closed
I think the disconnect is, I think cap rate is a function of noi/purchase price and the value of a property is a function of the cap rate that investors are willing to accept in a given market at a given point of time.
@Account Closed The author's name is Edward H. Marchant. He teaches at the Harvard Kennedy School. Since you would never believe anyone I personally know, I thought I would let his words explain it to you.
Here is the issue with Bob's understanding. He thinks Cap Rate means "Market Defined Sales Capitalization Rate." It can also refer to a Performance Capitalization Rate. It can also refer to a Projected Capitalization Rate.
Bob only accepts one use of the Capitalization Rates. That is determining the value of the property.
Investors use it to compare how good multiple potential deals are. Bob does not like that and says it is wrong.
Using it is certainly an oversimplification of the evaluation process but it is a good starting place.
Here is the issue with Bob's understanding. He thinks Cap Rate means "Market Defined Sales Capitalization Rate." It can also refer to a Performance Capitalization Rate. It can also refer to a Projected Capitalization Rate.
Bob only accepts one use of the Capitalization Rates. That is determining the value of the property.
Investors use it to compare how good multiple potential deals are. Bob does not like that and says it is wrong.
Using it is certainly an oversimplification of the evaluation process but it is a good starting place.
Please define your three made up terms and provide a mathematical example of their use to a real estate investor. Geez, even tho I am an EXPERT I'm here to learn.
Investors use it to compare how good multiple potential deals are. Bob does not like that and says it is wrong.
Well mainly it is a waste of time to do "what if" calculations. So how can you use it to compare multiple deals AND how does that process identify is the deal is "good"? NO ONE on this forum has stepped up to this challenge. Are you investor enough?
@Account Closed That is why I included the link. I thought I would save everyone the $80,000 - $90,000 in cost for one year at the Harvard Kennedy School.
@Account Closed That is why I included the link. I thought I would save everyone the $80,000 - $90,000 in cost for one year at the Harvard Kennedy School.
Which would obviously be a waste of money when you can't even state in your own words what you learned from that link and instead of making your point you keep trying to explain mine when I have no trouble stating my point.
It doesn't feel like we are going to meet on common ground on this topic. That's ok, though. I would just end with;
1. purchase price has nothing to do with the actual value of a property. People purchase property for more than it's worth all the time. others purchase property at a discount to it's actual value, all the time. Based on that I would say that purchase price and value of the asset is NOT THE EXACT SAME THING.
2. ... never mind this not all that interesting. I think we have all made our cases clearly and we just disagree.
I really don't want to get involved in this hot mess of an argument, but it looks like I've been dragged in so I'll clarify my position. I'll start by saying I'm far from the smartest person on this forum. :)
I agree with @Account Closed, if you know that investors in your area will generally deploy capital (invest money) at a 7% Capitalization Rate, for example, you're $19,000.00 NOI would make the theoretical Value $271,428.57. If you increase the NOI to $20,000.00, you would increase the theoretical Value to $285,714.29. Etc. I would tend to think about it in those terms rather than increasing the Capitalization Rate of a building that I own. It makes more sense to me to think of it in terms of overall Value of the property. I hope that makes sense.
You can look through similar recently-sold properties and calculate the prevailing Capitalization Rates in your area to get an idea for what to plug in as your anticipated Capitalization Rate for the purposes of the formula above. Investors in your area may also know off the top of their heads what the general rates are, but I would err toward calculating myself. It will also help you to assess whether or not the building you are thinking of buying is valued appropriately. What you are looking for is essentially an average of the Cap Rates, trying to eliminate any obvious outliers. Good luck!
guys, decreasing expenses = increasing NOI. If you increase NOI, you raise the VALUE of the property. It does not change the cap rate.
The cap rate is the cap rate. It doesn't change overnight
If you increase rents or decrease expenses, you are raising the NOI, divided by the same cap rate, you have just increased the value of your property.
Where do you get this official Cap Rate from? Should I take the listing agents word when he/she provides it to me? I think the answer to the last questions is "no" so please enlighten me on where, for specific neighborhood and property type in that neighborhood, I can find the official Cap Rate?
guys, decreasing expenses = increasing NOI. If you increase NOI, you raise the VALUE of the property. It does not change the cap rate.
The cap rate is the cap rate. It doesn't change overnight
If you increase rents or decrease expenses, you are raising the NOI, divided by the same cap rate, you have just increased the value of your property.
Where do you get this official Cap Rate from? Should I take the listing agents word when he/she provides it to me? I think the answer to the last questions is "no" so please enlighten me on where, for specific neighborhood and property type in that neighborhood, I can find the official Cap Rate?
A cap rate comes from a cap rate comp that is a closed sale that has been analyzed by an independent third party. The cap rate comp will provide the expenses and income. You need to see all this to utilize it correctly. You are not going to get this information from a listing agent.
This has certainly been entertaining to read through.
I want to thank Michael for the article. Performance vs. Market cap rate. Here is an example from a property I am currently in the process of closing on.
NOI is $70k for the current owners. Market cap rates are 10% for a traditional purchase. That being said they are listing it for $700k. However, after further evaluation of their financials a number of investors believe the NOI is more appropriately $60k. At a 10% cap rate this purchase price should be $600k. It is agreed upon that when evaluating the property under a traditional 80/20 loan under the current financing market to value this scenario the market is willing to pay 10% cap for a purchase of $600k.
Nothing earth shattering above. Ok.
So I look at the property and 80/20 LTV is out of my reach. I'm young and don't have that kind of cash and no investors are willing to work with me. Plus the owners aren't willing to move on their price point. So I work out a deal for an owner financing structure that gives me a large portion of my debt to be financed at a 2% interest rate. Given my lending environment is significantly different then the rest of the market I am willing to pay an 8.6% cap rate. This puts my purchase price at $700k.
However, if I decide to sell I know that under the current financing environment the market will only pay me a 10% cap for my property and I will loose $100k. So if I want to get $700k I need to increase my NOI from $60k to $70k, my performance cap rate (NOI/total asset cost(purchase price)) will increase from 8.6% to 10%, and then I can sell at the market cap rate of 10% cap for $700k.
So, here is my summery.
Market Cap rate is what is used to define the market price of your asset. The rate is set by the market. Performance cap rate is used when measuring the performance of property on your purchase price. Each cap rate has a different purpose. Technically speaking(according to the Harvard article) the correct formula is the performance cap rate. However, investors often use the market cap rate as a way to value properties based on what they are willing to pay. Please see the two different formulas below.
Cap Rate Formula: Performance Cap Rate= NOI/Purchase Price
Valuation Using Cap Rate Formula: Purchase Price=NOI/Market Cap Rate
1. purchase price has nothing to do with the actual value of a property. People purchase property for more than it's worth all the time. others purchase property at a discount to it's actual value, all the time. Based on that I would say that purchase price and value of the asset is NOT THE EXACT SAME THING.
From the CA revenue and taxation code.
, the words "full value," "full cash value," "cash value," "actual value," and "fair market value" mean the price at which a property, if exposed for sale in the open market with a reasonable time for the seller to find a purchaser, would transfer for cash or its equivalent under prevailing market conditions between parties who have knowledge of the uses to which the property may be put, both seeking to maximize their gains and neither being in a position to take advantage of the exigencies of the other.
@Account Closed: So does the same rule apply to residential 4-units or less apartment complexes because I believe this only goes for the commercial properties as I read in the link you'd provided? The Bigger Pockets Rental Property Calculator indicates this as well, by saying the following for the Cap Rate input field:
"The Cap Rate (Capitalization Rate) is a unit of measure primarily used in commercial real estate and multifamily properties with 5+ units. The Cap Rate is used to compare the return on investment between multiple different properties. If you are analyzing a residential property with fewer than five units, leave this field blank."
This is awesome. Even better would be if @Brandon Turner and @Joshua D. were to invite @Account Closed and @Account Closed on to a podcast to hash this out. Better yet - let's settle this once and for all. Give them some gloves and headgear and setup the camera!