What criteria do you use for multifamily?

Question

This is kind of an embarrassing question but I'm trying to find an article or blog that lists decent ranges to consider on certain criteria when evaluating multifamily (i.e., cash on cash return, CAP rate, etc).

Does anyone have a link to a pertinent article?

Thanks!

Does anyone have a link to a pertinent article?

Thanks!

Michael Le · Answer

Like @David Thompson said, if the cap rates are low because the property is under-managed and bringing in low income and spending too much on expenses, then it's a potential opportunity. If the cap rate is low because the property is overpriced then that's another situation. You have to look at the situation holistically because any single number can be and will likely be misleading.

Tracey Williams · Answer

@Lee Greene Thanks for sharing the link to the blog, it's very helpful.

To be honest, I am still struggling understating the DSCR, I appreciate all your contributions

Tracey.

Cory Brown · Answer

Great info, and exactly what I was looking for.  Thanks everyone!

David Thompson · Answer

Cory,

We look at a lot of deals in MF space.  I would say CoC and IRR range from 8-10% to 18-20% in large growth markets.  You start looking at secondary and tertiary markets and returns can go up but also risks w/less diverse industry and other growth drivers that may be lacking.  I like Michael's explanations in his link w/the exception of shopping by cap rates.  Cap rates are one of those not well understood.  I've written about this before.  You can make a killing in value add MF buying at 6 caps with conservative underwriting and exiting a bit higher cap while getting your clock cleaned just by making buying at 8 or 9 cap your top criteria and not knowing what you are doing.  Don't shop by cap rates as your major criteria based on only buying above and below a certain cap rate.  Use is as a reference guide in comparing local properties and helping in calculating the FMV of properties based on the NOI/cap rate equation.

Lee Greene · Answer

Michael Blank just posted a blog on BP yesterday that discusses three metrics to evaluate when analyzing apartment deals.  He talks about rules of thumb for cap rate, CoC, and DSCR.

https://www.biggerpockets.com/renewsblog/amazing-a...

Jonathan Twombly · Answer

@Cory Brown, I'd actually approach this question from another direction.  You should start with your own expectations of the financial return that you need to generate from the property to make it worth the risk of owning the property.

Some investors will require an IRR of 20% to make the deal worthwhile.  Others are happy with an IRR of 10%.  It all depends on how risky they perceive the deal to be and whether that risk is acceptable for them.

I personally look for deals that are yielding cap rates of 7%-8% or higher, which usually translates into IRRs in the mid-high teens or better.  (Of course, in this market, it's tough to find cap rates this high, which is why I'm not investing much these days.)  Other investors, say insurance companies that need to place cash and need to do it safely, are happy with a 3% cap rate if they think it's stable and the asset is a safe one that is unlikely to lose value.

The real issue is when cap rates are unusually low on assets that don't historically support those cap rates (like 5-6% on C property in suburban markets), because as soon as interest rates rise for good, those cap rates will rise accordingly, and you will have lost a lot of value that will take years to recover on an rent growth/NOI growth basis at higher cap rates.One thing to note, as @Kurt Bender mention is Debt Coverage Ratio (DCR) or Debt Service Coverage Ratio (DSCR).  This is the number of multiples of debt service the NOI is.  So, for example, if the debt service is $100,000/year and the NOI is $150,000/year, the DCR/DSCR is 1.5x.  Lenders usually require at least 1.25x to give a loan.  What I've been hearing from mortgage brokers recently is that deals are falling out because investors are adding leverage to deals at low cap rates to increase returns, but as they add leverage, the DCR requirements grow and loans are being denied because the deals don't support the DCR requirements on the lenders' underwriting.  So this is one metric you need to keep a close eye on.

Kurt Bender · Answer

@Cory Brown,

CAP rates vary by market, and cash on cash returns are going to vary based on the amount of leverage and terms of the debt. Other metrics we use in our underwriting are: gross rent multiplier, expense ratio, levered IRR, equity multiple, DCR, etc.

Are you looking for an evaluation article for a local market in Ohio?

What criteria do you use for multifamily?

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