How To Analyze an Apartment Deal
How To Analyze an Apartment Deal
Investing in apartments and other multifamily properties is more appealing than ever among investors who want to diversify their portfolios and build their wealth for the future. Because of the increased demand, prices can be high. Before you make a large investment into an apartment deal, it’s essential you do extensive research on the building and what your expected returns will be. If you’ve never performed an apartment deal analysis before, the following gives you everything you need to analyze your next apartment deal.
Why You Should Consider Investing in Apartments
There are many benefits associated with investing in apartments, which include:
- More control – You can effectively control every decision about your rental property after making this investment.
- Better cash flows – Apartments can generate monthly income in the form of rents, which must be collected by yourself or a third-party property manager.
- Tax benefits – Like all real estate, apartment investments come with ample tax advantages, which means that owning an apartment will reduce your taxable income.
- Ability to increase appreciation – The property value relies on your ability to boost the net operating income.
- Economy of scale – Owning an apartment building instead of multiple single-family homes make it easier to obtain rent payments. Payments come from an individual location.
Calculate the Cap Rate
Before delving into the exact calculations on how to analyze an apartment deal, let’s discuss cap rates. These rates represent the expected rate of return that the property will have based on its income. When cap rates reduce, the value of the property increases. If you own a property and cap rates are dropping, this is great for the value of your investment. A calculation to refer to is:
NOI / Value = Cap Rate
If your property has a net operating income of $60,000 and is listed at $600,000, the cap rate could be set at 10.
How to Identify NOI and Cash Flow to Determine Value
To calculate the net operating income for the property you’d like to buy, use this following formula:
NOI = Total Income – Total Operating Expenses
Your property’s total income involves the rental payments and fees you collect. These fees can include overdue payment fees and pet fees. Operating expenses can involve but are not limited to:
- Vacancies – Around 5-10% of your rent
- Taxes – County and city
- Maintenance costs – Around 3-5%
- Repairs – Around 3-5%
- Insurance – Speak with a broker
- Management – Rates can differ
- Professional fees
- Utilities – Speak with utility provider
The next step in analyzing an apartment deal is to calculate the possible cash flow. Make sure that you take your mortgage terms into account. Another equation to keep in mind is:
Cash Flow = NOI – (Mortgage Payment + Any Reserves for CapEx)
Your CapEx reserves are meant to be set aside for larger expenses. If you expect to replace the apartment’s roof in 10 years and believe that it will cost $20,000, you should add $2,000 per year to your CapEx reserves. The ideal cash flow for an apartment investment is one that allows for double-digit returns.
Identify Options for Increasing Value
An apartment’s value is based on financial operations.
Value = NOI / Cap Rate
The property’s cap rate involves a multiplier that determines the amount the market will pay to obtain specific returns. You should focus on increasing the property’s NOI to alter its value. You can increase net operating income by:
- Boost income by raising rents and charging pet fees
- Decrease expenses by having energy-efficient systems installed and by fixing any leaking pipes or faucets
Determine Your Preferred Purchase Price
Once you’ve identified the expected NOI and cap rate, you can determine what the property is worth and what you’re willing to pay. With these calculations in hand, it should be easier to avoid overpaying. A property’s purchase price equals the NOI divided by the cap rate.
Analyzing an apartment deal requires precise calculations. While these calculations are only estimates, they give you the information you need to make a confident investment decision that’s backed up by data. Remember, local market conditions can vary, so you’ll have to consider that as well.