How to calculate price for Multi Family property

32 Replies

I am looking to get into buying a Multi Family property and have couple properties in the pipeline, need to know how exactly to calculate the price to make an offer, please advise!!

@Sunny Kapila

Q: Nine times out of ten, what is the most important thing to an investor?

A: Cash flow

Q: How do you determine cash flow?

A: Income – Expenses = Cash Flow.

What numbers do we need to know?

  1. Gross Income (monthly)- This is simply what amount of rent you expect to receive
  2. Monthly Expenses
    1. Mortgage
    2. Taxes
    3. Insurance
    4. Property Management Fee: If you are not going to manage yourself
    5. Utilities
    6. Vacancy
    7. Repairs
    8. Contract services

3. Monthly Gross Income – Monthly Expenses = Net Income. If the number is positive, Congratulations, keep going. If the number is negative, turn back.

4. Calculate Returns - There are two important numbers that you will need to focus on.

A. Cap Rate: This simple number tells you if you are buying a good deal.

Net Annual Income / Purchase Price = Cap Rate

(Note about Cap Rate: This is simply giving you a percentage number. Simply put, the higher the percentage, the better a deal. You have to decide how low you will go.)

B. Cash-on-cash Return: This number is the how much you are receiving on your actual investment. If you purchased the property with cash, this return will be the same as Cap Rate.

Net Annual Income / Total Cash Investment = Cash-On-Cash Return

@Sunny Kapila

Tell us more about the properties. Is it a duplex, triplex, fourplex, or 5+ unit apartments?

@Jared Carpenter  

So how do you calculate the price (which is the OP's question :-) )? 

Cheers... Immanuel

@Immanuel Sibero

it's mentioned it in my response, towards the end, " Net Annual Income / Purchase Price = Cap Rate" rearrange the equation

@Jared Carpenter

So I rearrange the equation:

     Purchase Price = Net Annual Income / Cap Rate

I take Net Annual Income and I need to divide it by Cap Rate. But Cap Rate = Net Annual Income / Purchase Price. So How do I calculate Cap Rate?? Cap Rate formula needs Purchase Price but I don't have Purchase Price because that's what I'm trying to calculate...

Does it seem like a vicious circle to you?

Cheers... Immanuel

Thx. Guys for the great information. Cheers 

@Immanuel Sibero - You determine the Cap Rate by researching the specific market.  Talking to brokers, other investors, lenders.  The Cap Rate can vary significantly by market and class of property.

@Greg Scully

Correct! That was the point I was trying to make. I was trying to lead the poster to it instead of just pointing it out to him. Not sure if it was effective... lol

As you explained, when calculating a price the cap rate is derived from the market (i.e. brokers, other investors, lenders, information sources, etc.) and NOT from some formula by rearranging variables internal to the property. Within this context, cap rate is more of an external gauge of investor sentiment, attitude, or appetite if you will, in a given market. This is one of the so many misconceptions and confusion surrounding cap rate.

@Sunny Kapila

I still don't know if the you're looking at residential or commercial MF. All the above information might not even be relevant to you.

Cheers...  Immanuel

@Sunny Kapila

Excellent! At least we know all the discussion in this post is relevant. I can't count how many times an investor posts a valuation question on a potential "multi family" property and everyone just jumps to NOI and cap rate discussion and later finds out that the investor is looking at a duplex...

I suggest searching on apartment syndication right here on BP. There are lots of very seasoned, prominent apartment syndicators offering free advice on apartment underwriting on BP. Best wishes to you Sunny!

Cheers... Immanuel

please correct me if I am wrong here. I like to look at unlevered cash flow the property will produce and use gordon growth model to come up with a NPV, which is the intrinsic value today. The discount rate I use is cap rate plus my premium.  This is similar to stock valuation - my background - method and would like to know if anyone in real estate uses this method to value.

@Kevin Im

Interesting question! I had to look up the gordon growth model ... lol.

Based on the definition of the gordon growth model, in theory real estate uses the same method because it values the asset based on income (NOI). The flaw is that generally only one year's worth of NOI is used but this is besides the point. Note that I'm referring to commercial real estate, there is a submarket of residential assets that are valued differently (i.e. based on buyers' emotion). So within the commercial real estate space cap rate can be viewed in the same way as a discount rate or a dividend rate in stock.

Seems to me though there are more than just one valuation methods in stock (i.e. not just the gordon growth model). I know this because I trade stocks and never heard of the gordon growth model... LOL. But the point is, in commercial real estate there is only one way that investors value the asset, and that is using the cap rate which calculates the intrinsic value of the asset (consistent with the gordon growth model). So I guess it's fair to say that real estate always trades at its "intrinsic" value (i.e. the only one valuation method there is). This brings me to my next comment - in theory, if you attach a premium on top of cap rate as your required ROR then you will always be priced out of the market because real estate always trades at cap rate. In other words, you will always be underbidding.

Again it's an interesting subject, I would love to see other comments...

Cheers... Immanuel

I am sure you know the concept of gordon growth model just not heard the name formally. It is used by all of the buyside and sellside research analysts.  Although, each company may put different weights to it. 

OP, I apologize for hijacking your thread but I believe it is related to your valuation question. I have background in equity arb hedge fund as a generalist. When we look at REITs or any others, we project the free cash flows and present value them to come to the current valuation. Now, my thinking is if we do this for REITs, would it be any different for single CRE?

Originally posted by @Greg Scully :

@Immanuel Sibero - You determine the Cap Rate by researching the specific market.  Talking to brokers, other investors, lenders.  The Cap Rate can vary significantly by market and class of property.

But, in the end, this is basically just a target metric correct? I believe i just went over this during a meetup. Different markets have different cap rates so our goal or target comes from a certain market. But, actually figuring out the cap rate comes from a calculation, correct? We are then using that calculation to see if it hits the target goal, right?

@Jeffrey Grieshop

Say I found a 20-unit apartment complex in Coldwater, OH I'm interested in buying. I have determined that the apartment is located in a working class part of town, say a solid C class property. As the OP was asking, my next dilemma would be "what's the value of this 20-unit apartment?" I need the answer because I plan to make an offer.

I would then call a couple of commercial multifamily brokers who are active in the area (or maybe local lenders in the area). I would then ask them what is the prevailing market cap rate for a C class apartment in the area where the 20-unit complex is located. Let's say they would tell me the prevailing market cap rate is 8%. This means there have been recent sales of C class apartment complexes in the area (i.e. the "comps") and the average cap rate of those sold comps was 8%.

So I would request T12 from the seller and figure out the NOI of the 20-unit apartment I'm interested in. Let's say NOI was $100,000. I would estimate the value of the apartment to be 100,000 / 8% which equates to $1.25M. Now that I know a reasonable estimate of the value of the apartment, I can now make an offer (assuming the numbers meet my underwriting guidelines). Notice I have done nothing with cap rate beyond just asking for it. Within the context of the OP's original question ("What's it worth?"), I don't need to do any calculation or work out a formula or set a certain target cap rate to achieve.

Hope I'm understanding your question.

Cheers... Immanuel

@Immanuel Sibero thank you very much for the details. It provided some clarity.

Where I guess I get a little confused is here we start with a cap rate. We did the same during the meetup. However, when I have been using BPs rental calculator, it seems like I "find" the cap rate. I input all of the variables and then a cap rate is spit out. 

As an investor, I have been looking in the Coldwater area for duplexes and triplexes. Should I therefore have a good indication of Coldwater's cap rate for duplexes and triplexes? Then, when I do my rental property analysis on BP's, I would be looking for prospective properties to exceed Coldwater's cap rate, right?

@Jeffrey Grieshop

I have never used the BP calculator. If it spits out cap rate then I wish it wouldn't... lol... or at least it should come with a disclaimer like "object appears more useful than it really is".... okay BP j/k.

The cap rate you're referring to is what some BP members call "property cap rate". The cap rate that I described (also the one pointed out by @Greg Scully ) is the "market cap rate". Both are calculated the same way (they are after tall the same "cap rate") so they're defined as NOI/(Value or Price). The difference is "property cap rate" is the cap rate of a specific property that you either already own or are considering owning. Market cap rate is a blended or average cap rate of several random properties that have sold recently in the area.

Property cap rate is often used as a metric to measure performance, which is what you were suggesting in your first post (i.e. somehow setting a target cap rate). It is also used as a performance metric to compare different properties to determine which is the best.

The other cap rate (i.e. market cap rate) has nothing to do with performance. It's a value/risk metric. It's a measure of the strength of investor sentiment/demand for real estate in a particular market. So this is the cap rate that you can't calculate nor can you control. As pointed out before, you get this rate by asking for it.

If you pulled up forum discussions regarding cap rate on BP, you'd find many experienced investors saying that cap rate is not a performance measure. In this case they are referring to the MARKET cap rate because it truly is NOT a measure of performance. However, this doesn't stop investors from using PROPERTY cap rate as a performance measure.

So you can certainly use property cap rate as a performance measure and use it to compare duplexes, apartments, even SFRs, but IMO there are other metrics such as CoC or IRR that are far superior that practically render property cap rate insignificant.

So should you calculate and evaluate cap rate of duplexes and triplexes? Sure, many people do it. But remember cap rate gives you a metric based on one year. If your hold time is one year it may be ok, but what if you plan to hold for 5, 10, 15 years? Would you make your decision based on metric that measures only ONE year?

Cheers... Immanuel

@Sunny Kapila Look at the market and determine what you can get for rent per unit. Ideally, look for rents that are for similar buildings to your target and also recently signed as those are the best determinants of what your building will get. This gives you potential rent.

Then, look at market vacancy rates and apply that to your rents. ([1-vacancy rate] x potential rent = rental income).

Next comes expenses. In general, your expense ratio will be 40-50%. If you don't know and/ or have the time or resources to figure out what your expenses will be, use 50% to be safe as this assumes you will incur more expenses than average. Multiply your rental income by .5 and you arrive at your net income, or net operating income (NOI).

Multiply your NOI by a cap rate. The easiest way to find an applicable cap rate is to ask a broker that often is involved with your target asset class and describe your target. This gives your a general price, but remember that this price has your assumptions baked in to it.

One thing to remember too is if you have to finance the property, to ensure your NOI per month is above your loan payment per month. That difference will be the cash going in to your pocket.

@Sumny Kapila

Also please note that my explaination is very general as for the purposes of this post. If you need a more granular description please don't hesitate to reach out.

Just to add to the above, average vacancy is 8%, assume 10% to be safe.

The important thing here is to realize that the more conservative your assumptions, the less you will be willing to pay, the less risk you have in your deal, and

less sellers will be willing to sell you their property and vice versa. It is up to you to determine your risk tolerance and balance that with what sellers are asking. That is the real hard part.

@Sunny Kapila hey sunny they have a calculator on this site. Good luck! 😉

@Sunny Kapila how I determine price for my clients normally is by doing a discounted cash flow analysis for the deal which might be a little to advanced for most investors on here but it's worth looking into. It's the most common way institutional investors valuate real estate and in my opinion the most accurate. The key metrics in a discounted cash flow analysis are the (IRR) internal rate of return and (NPV) net present value of an investment.

@Jeffrey Grieshop - Keep in mind that duplexes and triplexes are considered residential property.  Residential values are determined more by sales comps than Cap Rates.  You may look at Cap Rates for your own evaluation, but the market will look at the property value through a comparative analysis.

@Immanuel Sibero @Greg Scully thanks for your time and information guys! Immanuel, I have read it twice and may reread it twice more :). Greg, I am familiar with comps and have done some. I got the "needed" and "wanted" comp information from one of Turner's videos, good stuff.

Create Lasting Wealth Through Real Estate

Join the millions of people achieving financial freedom through the power of real estate investing

Start here