The Quick Way to Generate an Apartment Value
You may be reading this because you are interested in buying apartments. Maybe you want to know how we value apartments. Whatever the reason, we’re glad you are here and hope to provide you with some insight in this article.
The truth is, we have an advantage as we look at several deals a day. Because of this, we can assign a value to those apartments quite quickly. However, we have taken some time to put together some key points about what we look at, in the hopes that it is helpful to you.
Cap Rate
The cap rate, also known as the capitalization rate, is used to determine the return rate expected on a rental property. To calculate the cap rate, you take the net operating income and divide it by the current market values.
Capitalization Rate = Net Operating Income / Current Market Value
Let’s start with how to determine the Net Operating Income (NOI), which is the total rent (including late fees, bill backs, misc. fees, etc.) subtracted by all the costs of building, vacancy reserve, property tax, utilities, repair reserves, management fees, and insurance, but not debt.
With the last deal our total annualized net income was $531,764 (after vacancy, concession, loss to lease, bad debt) plus other income subtracted by all the expenses, $323,688, which equals $208,688 of NOI.
In the geographies that we are looking at, the average cap rates usually land between 6.5 to 7 %. Based on the actual historical expenses on the last building we bought, we were actually buying at a cap rate of 3. We knew that based on our experience and the feedback from a couple of property managers that we can achieve much lower expenses effectively buying at a 6.49 cap.
In the above scenario, we would divide the NOI of $208,688 by the 6.49% cap rate and get our purchase price and value of $3,213,200. If we bought at a 7.5 % cap rate, you can see that the value of $208,688 divided by .075 (the cap rate) equals $ 3,782,507. You can observe here how just a small change in the cap rate can significantly impact the value.
Cap rates fluctuate depending on specific markets. Cap rates can also change by neighborhood in those markets as well. In better areas, cap rates will be lower. The rates generally take into account the risk in certain areas.
Price Per Door
We do use price per door or unit as back of the napkin math, to value a potential acquisition. To calculate the price per door, you take the sales price divided by the number of apartments (doors).
Price per Door = Property Purchase Price / # of Apartment
For JB2 Investments, the Oklahoma City metro is one where it makes sense for the acquisition of a sub 50k price per door. In the example mentioned above, the price per door was $45,256. The purchase price of the property was $3,213,200 and there were 71 doors. This was in our favor as the average in the area was $46,431. We are in the process of adding an extra unit, bringing the price per unit down to $ 44,628. This provides us with a great spread between the average. Keep in mind, however, that this doesn’t take into account the unit mix or expenses.
The price you are willing to pay per door is also affected by the average rents. For example, if we buy a more stable asset, we want the return on average rent to be in the 13 to 14% return per unit range. Using the above example, if you divide the average rent of $626 by $45,256 per door, you get a 13.3% return. This average return on rent is also not taking into account expenses. Better areas will usually command a higher price per door as well. Are you starting to sense a common theme here? Hopefully, by now, you are catching on.
Bringing it All Together
Ultimately, there isn’t any clean way to bring all these tools together to get a true value. So, we work with a combination of these methods to get a good range of value. The price per door method seems to be the most effective for our acquisition needs in markets where we are working.
Using these tools will give you a working range to work with. Somewhere in that range, you will find a fair value for the building or complex.