What's a good cap rate for an 11 unit apartment in the Midwest?

[David Kuhlke]

Hello BP,

I'm looking at a deal, and I need help determining what qualifies as a "good" cap rate for small apartments in the Midwest.

Here are the details:

11 unit apartment

Asking price: $1.4 million

Monthly rent total: $12,000

Taxes: $2,250 per month (2% of property value annually... I am estimating here on taxes. Using the non-owner occupied SFH rate)

Insurance: $935 per month (estimating $85 per door) 

Property management (10%): $1,200 per month

Vacancy (5%): $600 per month

Repairs (10%): $1,200 per month

Cap Ex (5%): $600 per month 

Annual NOI is $58,260

This leaves me with a cap rate of 4.24% for current asking price (NOI/Price)

Is that good? I have read in an apartment investing book, written in 2005, that a normal cap rate is 8-12 percent but I don't know if the "normal" has changed since 2005 for this kind of investment. I feel like this property is overvalued. If I want a 7% cap, the property should be worth $832,285 (NOI/Cap Rate)

Thoughts?

David

[Anthony Vicino]

Great question, @David Kuhlke.

Unfortunately, it's not really the right one.

Cap rates are tricky and they trip up new and old investors alike. I've written a couple articles on the topic if you feel like doing a deeper dive, but here are some high-level things to keep in mind.

1) There is no such thing as a good cap rate.

A 3% cap rate is not necessarily better than a 10% cap rate. Investors who say things like, I only buy at a 10cap, fail to fully comprehend the cap rate, what it's for, and, more importantly, what it's not for.

You can make money at any cap rate. The key lies in the business plan and intended execution. The entry cap rate on a value-add multifamily is largely irrelevant because you're going to go in there from day one with the expectation of increasing the value and thus skewing the cap rate.

The question isn't: What's a good cap rate for this area?

Instead, the question is merely: What is the current cap rate for this asset class, in this area, at this particular point in time?

You mentioned the book you read is from 2005. Go ahead and throw it out the window where cap rates are concerned. Which leads to point number two.

2) Cap rates move constantly

You need to have a finger on the pulse of a market to have any hope of gleaning the appropriate cap rate. This can be done through googling different industry reports, talking to brokers, and auditing recent transaction histories.

You'll likely get some fluctuation in numbers depending on the source. Which leads to point three.

3) There is no definitive cap rate

Ask ten investors in a market and you'll probably get ten different answers.

Who's right?

They all are.

Who's wrong?

Again, they all are.

Doesn't really matter.

What matters is whether or not the asset can deliver the expected returns at the purchase price you're paying.

And finally,

4) Cap rates are hyper-local

The midwest is a big place. The cap rates for Class A new build in downtown Chicago are different than a Class C in boondocks Wisconsin.

Cap rates fluctuate even on neighborhood levels, so you'll need to be way more specific than just midwest, unfortunately.

For what it's worth, where we operate (Minneapolis and Saint Paul, MN) cap rates could be anywhere between low 4 up to high 6 percent. Just depends on the building and area.

Would be happy to hop on a call and discuss further, @David Kuhlke! Good luck