Please, critique my math for Multi-Unit Investment

[Anna L.]

I wanted to start investing in multi-unit properties(5+), and before I jump in, I need to understand the basic math behind this type of investment.

I want to try with classic strategy of buying a value-add property, where I can increase the rent and decrease the expenses after acquisition. Basically, the goal is to do BRRR and pull as much cash out as possible after refinance.

Can you please look at the math example that I put together and critique it? Is it directionally accurate?

The biggest unknown for me right now is how the bank evaluates the property value after the increase of NOI. Do they use the same Cap Rate and that's how the value increases?

I know I missed the closing cost and the cost of potential rehab or expense related to efficiency improvement. So, anything that you can add from a real life example is highly appreciated.

FYI - my example is hypothetical, but I would love to hear from you if those numbers are even close to realistic in B-C type neighborhoods. 

Thank you!

[Scott Skinger]

@Anna L. Talk to brokers, other investors and analyze enough deals that you start to get a feel for what the cap rate in your area is. I'm very inexperienced (couple of months) with all of this as well and I can say that I have a lot more comfort in understanding market cap rates (in my area, Chicago and suburbs) after actively analyzing deals, getting feedback from brokers and talking to other investors. Two things to keep in mind:

1. There is a big difference in market cap rate depending on the building quality type, age, size, location and sub-location. So in the city of Chicago for a 40 unit well rented apartment in a nice area the cap rate might be 4%. While in a far reaching suburb, a 10 unit older building might be more like a 10% cap. Keep in mind, cap rate is ultimately just a guideline and the exact cap rate (and therefore price) on the building is negotiable.

2. Exit cap rate (what you are going to be able to sell the building for) is incredibly important to keep in mind. We may be at the top of the market right now (or not) but when you start modeling returns when you buy an apartment building the exit numbers are just as important as the acquisition numbers. For example, if you overpay for a building today (say you buy a building for a 7% cap price when it should have been a 8% cap) and the demand for multi-family goes down...or even stays the same, you are going to have a tough time getting the returns you modeled if the cap rate is 9% when you want to sell. Long story short, of course "buy right" but also be conservative about the exit. When I model an investment I like to assume that my exit cap rate is going to be approximately 1% lower than my buy cap rate. If the returns still look solid with the higher cap rate at exit, then I start digging deeper.