Multifamily CAP exercise.

[Michael Randle]

Hello everybody,

The following is all theory and I am putting it out there for the community to correct my process not exactly the numbers.

I am doing my homework and trying to analyze 5 deals a day. Working on getting up to speed on multifamily. So obviously this involves CAP rates and unfortunately not a lot of deals that can be found on public search engines.

I did manage to track down a property in my old town of Phoenix AZ and figured it would be good to try and see what a good offer on it would be.

NOI = ~$45k (pro forma)

CAP = 4.11% (C class property)

Asking = $1,100,000

10-Unit.

I managed to see a few places to increase NOI, get it up to ~$55k.

Now I want to make an offer on this property but I do not know if the CAP rate is accurate.

I google and call brokers and it seems like class C properties are going for 5.5% cap in reality!

So in order to make a actual offer I would make an offer of NOI=$45k with a 5.5% cap rate. Therefore the counter offer is ~$818K.

I understand that in reality I would probably be closer to CAP rate of 6.2% and instead of using PRO FORMA rates I would use actual rates, and I would look at actual NOI. But besides that does my theory hold up on to how to evaluate and make a counter offer on a property?

[Daniel Akerman]

If the average cap rate in the area is 5.5%, and you’re comfortable purchasing at that cap rate, then you’d want your purchase price to be around $818k. That means your initial offer would likely be lower than that and you’d negotiate up.

If you are comfortable with purchasing at 4.5% cap (below the average), it means you’ll be “overpaying” for the property initially. But if you’re comfortable doing that and getting it to perform better to hit the 5.5% market average, then that’s a viable option.

It’s really not as complex as some here make it out to be. Cap rates are simply a good comparative tool for comparing commercial/multi family properties in the same area, given that you know what the average for the area is.

More important is making sure that NOI is being calculated correctly, because if it’s not, then you won’t get an accurate cap rate. The formula is (Gross Revenue x Occupancy Rate) - ALL expenses = NOI. I find that many people, including MOST real estate agents, either don’t take into account occupancy/vacancy rates, or leave out some expenses (taxes, insurance, management, utilities, repairs, etc) and the NOI figure is therefore wrong.