Multifamily Investment Analysis
Hi,
I've been looking at some multifamily deals on market recently. I understand that cap rate is a good way to determine if its a good deal. My question is if the investor was looking to buy out the current tenants, do repairs, and then get higher rents how would you factor all of this into determining an offer price?
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#2 Land & New Construction Contributor
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#2 Land & New Construction Contributor
- Developer
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CAP rates are really only relevant upon exit. What matters at acquisition is the NOI, the returns it will generate during hold period and potential to increase it for sale or long term hold. You do not need to get rid of tenants to renovate. You do it as units turn over or with tenants in place depending on the scope. You can offer existing tenants the option to upgrade their unit for the increased rent while they still occupy the unit.
Hi @Account Closed,
Your current rent, new rents, occupancy, rehab budget, etc should all be included in your analysis. Most analyzers include these inputs. If you are looking at 2-4 units the calculations are a little different because you are more subject to market values and your loan/appraised value will be related more towards similar properties nearby that have sold recently.
Good luck!
Carmen Dettloff
Cap rate is not really a good way to tell if something is a good deal. A good deal is a bit more complicated than the cap rate. Your price should be based on your business plan and anticipated returns with said plan. With your plan, what price would you need in order to produce your desired returns at your desired risk level?
When we buy apartment buildings and gradually fix them up, we do so as the tenant base is rotated through. Units come vacant as tenants move out, and if we believe the market will bear higher rents, then we renovate.
Done in that way, the process can take a few years depending on your rate of turnover. You need to know how long those units will be vacant, and factor that vacancy into your calculations. It's really a matter of calculating how much income you're foregoing when the units are down and factoring that into your gross income calculation.
@Account Closed,
You don't buy out existing tenants to do repairs and renovations. Why would you? You renovate empty units first, then rent them out. For existing tenants, you either don't extend their lease and they move out or increase their rent upon lease renewal and then ... they move out. If they don't move out, your new rent is probably still below market.
This process is called "turnover" and should be in your business plan. Depending on the building size, it may take a year of more to complete full turnover cycle.
As for your offer price, it should be based on your expected profit. I.e., if you expect your NOI to be $120K/year and future market cap rate is assumed to be 6%, your future value would be $2M. If your desired profit is $400K, then the most you should pay is $1.6M and that includes your capex budget.
@Account Closed I would be happy to help with your UW. You need to make sure you are using an accurate model. Let me know if I can help 👍
Here's how I recommend using cap rate. Be sure you have accounted for all of the actual income and expenses for the property you want to buy, including things that are often unreported like property taxes. Calculate your NOI from that, then look for a source of market caps for that area and property type. Divide your NOI by the market cap to get a price. Then adjust up or down based on other factors like the condition of the property but that at least gives you a negotiating position when talking to the seller.
How you want to improve it, what are market rents compared to this property, and how hot is the area will help you figure out how high or low to go. You may be looking at units in terrible condition with rents half what the market will pay. Then what you're suggesting, buying out a tenant just so you can get started on renovations sooner, might make sense. If rent is $400 because the units are in bad shape and market is $800, you can let them stay another 10 months until their lease ends, which costs you $4000 in opportunity cost, or pay them something a lot less than that to leave now. If the difference isn't that big, maybe renovate when their lease ends.
@Max Kibler you should put together an underwriting model to evaluate your business plan. Take the time to do it right and make sure the numbers work
#2 Land & New Construction Contributor
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#2 Land & New Construction Contributor
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CAP rates are really only relevant upon exit. What matters at acquisition is the NOI, the returns it will generate during hold period and potential to increase it for sale or long term hold. You do not need to get rid of tenants to renovate. You do it as units turn over or with tenants in place depending on the scope. You can offer existing tenants the option to upgrade their unit for the increased rent while they still occupy the unit.
@Account Closed I recommend you analyze the deal for cash flow. You will need to estimate the time it will take for repairs and how the long the units will be vacant. You will basically have 0 income during the renovation time, which is particularly critical if you are paying hard money or taking on bridge debt. You will need to have adequate capital to cover these costs or only do one or two units at at time as recommended above. Using your estimate of post-renovation rents and the cost of renovations and down payments, you can determine the cash on cash return. The amount of return you are comfortable with at the time of post-renovation will determine what price you are willing to offer.
#5 Multi-Family and Apartment Investing Contributor
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#5 Multi-Family and Apartment Investing Contributor
- Cincinnati, OH
@Account Closed. I am echoing others. Based on what you outlined, you need to build a discounted cash flow model to determine your value.
A cap rate ultimately is only valuable to a core/core+ asset, where there is little to no upside available. The further you get into value add and opportunistic deals, the less the cap rate matters. The extreme example of this is a development deal, where I buy a piece of dirt. There is no rent, only the potential that I could build something and maybe lease it up. But going in, my cap rate is 0%. $0 income/purchase price.
For a DCF model, start at the end, and take your stabilized NOI and what market cap rates are to get a sales value, or what you want to be returning from a cash on cash basis. Then start backing out your costs to get there until you arrive at your purchase price you can pay to achieve those returns.
@Colby Fryar good points. Cash flow analysis is very important and is one of the main reasons we invest in multifamily
@Nick B. makes good points, that's how I would proceed.
But I'm thinking you want to know what you should pay in order to get a good return upon completion of your plan?
I would try to estimate expected cost of doing all this and add it to the purchase price. Then take the expected (new) net income, divide it by the purchase price + expected cost to get your future cap rate.
Let me know if you have any specific questions, otherwise good luck!
I second the advice to revisit your model, make sure you numbers and calculations are correct and then start doing a sensitivity analysis on turnover costs and vacancy during those turnovers. You can do it quickly or slowly, and you need to see how much your financials can handle before they break.
