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Cap Rate Basics When Analyzing A Multi Family Deal

Apr 4, 2008
When analyzing a multifamily deal, it's important to understand the term Cap Rate and how it can help you quickly and easily make decisions about a property. C.R. is short for "capitalization rate." The Cap rate is the return on investment on a percentage basis if you paid all cash for a property. Use this calculation to determine cap rate: (C.R.) (%) = NOI (100%) / Price. For example, let's say you have an apartment building with a net operating income of $100,000 per year and you paid $1,000,000 for the property. The Rate on your property is 10% because you are getting a 10% return on your $1,000,000.

The Cap Rate is useful for measuring the performance of different properties. Regardless of the size, price, or other variables of a property, the C.R. is a common denominator for evaluating properties. Cap Rate is a widely used term. Across the country, you can talk with commercial brokers and investors about The C.R. of the Property. However, using the Cap Rate is only pertinent when evaluating properties with five or more units. Four plexes and smaller properties do not follow the C.R. formula as much.

Once you have determined the Cap Rate on the apartment buildings you are evaluating, you can determine which properties are worth further investigation. Different investors will have different thresholds of risk, but a good rule of thumb is to look for properties with C.R. of 10% or higher. Of course, the current C.R. on a property may change if, through better management, the occupancy goes up or costs go down. This is something to take into consideration in evaluating Cap Rates.

For example, if you find a multifamily property that has a current C.R. of 9%, but through further investigation you realize that through better management or more active leasing you could drive the C.R. up to 12% fairly easily, then you can rationalize not needing the 10% C.R. before the deal is finalized. If the apartment doesn't have a 10% C.R. today but could have a 12% C.R. tomorrow, it may be a deal you don't want to pass up.

As mentioned earlier, Cap Rate is a term that most investors and brokers are familiar with, so become a C.R. expert yourself. Learn to calculate the Cap Rate on a property, and you will save yourself precious time in analyzing and evaluating properties during your search for a multifamily property.

Investors expect a larger return when investing in high risk income properties. Utilizing his strategy of evaluating the Cap rate, Lance purchased his first deal (a four-plex apartment) in March, 2003 nothing down. Over the next 2 years, he went on to purchase 50 units nothing-down on a part-time basis, while working his full-time corporate job. In July, 2005, Lance retired from his 20 year corporate career to start a full-time real estate business that acquires multifamily properties. And he now teaches others how to create faster financial freedom with apartments using none of their own money. Last year, he purchased 10 unit and 50 unit apartment buildings all nothing down. Just recently, he closed a 56 unit property again using none of his own money.
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