While most of my active real estate efforts go towards rehabbing/flipping houses, I’m a huge fan of investing in apartments. I’ve done some passive investing in the past (invested in other people’s projects) and am always on the looking for great apartment deals to add to my portfolio.

Why do I love apartment investing so much? It’s all about what I call the ** Golden Ratio**…

You may have heard references to the Golden Ratio in mathematics and architecture, but that’s not what I’m referring to here. I’m referring to the other Golden Ratio – the one that applies to income-producing real estate investments. You probably won’t see it referred to as the Golden Ratio anywhere else, but this is what I call it, because it’s worth so much.

The Golden Ratio in apartment investing is about 10 to 1 (10:1). This is the ratio between the amount of extra value you get out of your apartment investment for every extra dollar of income your property brings in.

**In other words, for every $1 of extra income your property produces, the value of your property increases $10!** Let’s take a look at why that’s the case…

If you have ever studied some basic financial analysis of income producing properties, the value of a property is directly proportional to the amount of net operating income (NOI) it produces:

**Price = NOI / Cap Rate**

(This is just a rearrangement of the Cap Rate formula: Cap Rate = NOI / Price)

So, if a typical property has a cap rate of about 10% (which is a pretty realistic average), then for every $1 of NOI the property generates, the property is worth $10.

For example, let’s say a property with a cap rate of 10% has an annual NOI of $1000; using the formula above, the property is worth about $10,000 (Price = $1000 / 10% = $10,000). Now let’s say that same property is able to increase its annual NOI to $1100; now its price increases to $11,000 (Price = $1100 / 10% = $11,000). That extra $100 in income translates to an extra $1000 in property value (a 10:1 increase).

And remember, when we talk about NOI, we’re talking about the total income after expenses. So, for every $1 you can shave off expenses, you get the same $10 increase in property value. For example, if you can cut your annual property taxes by $500, your property value will have just increased $5000.

Pretty cool, huh? Now you know why I love apartments…

## 5 Comments

When you say price are you referring to cash down?

One could also calculate this using cash on cash. Then the formula would appear:

Value = NOI / cap rate

Where your starting value is the amount of cash you put down rather then the full purchase price, or cash down plus value of the mortgage…

Hi Eric –

I probably should have defined my terms better (or used better terms :))…sorry about that…

When I said “Price” above, what I was referring to was the “value” or the “price the property could be sold for.”

Cap Rate refers to the rate of return that would be expected if there was no financing involved (purchase for 100% cash). So, I’m not sure you could apply any Cap Rate formula to determine a cash-on-cash return.

To determine a cash-on-cash return, you’d need to determine your cash flow (NOI – Debt Service), and then divide by the cash investment. This would account for the financing terms (the debt service) and allow you to determine the actual return YOU would get on the deal as opposed to the theoretical return that a 100% cash investor would get (the Cap Rate number).

Does that make sense?

Perfect sense. Thanks for the detailed response. Forgot to include the debt service in there… I’m young and new :).

How did you get into real estate investing? Did your career start in real estate? And if so, were you a Realtor?broker?syndicate?developer?

J… great article and when you throw in the power of leverage the returns only accelerate.

Keep these great articles coming!

Pete

Thanks J,

You’re right and I’d found this ratio myself through running the numbers on so many apartment buildings… it’s easy to see where shaving expenses here and there can increase the value of one’s buildings!

Of course the other ratio I like to use is the good ol’ 80/20 rule: 80% of the lawn mowers you pick up at bank-owned houses don’t work and 20% do! Lol….

Richard 🙂