When you begin to compare methods of valuing residential versus commercial property, you’ll quickly find out you’re dealing with apples and oranges. Appraising an apartment complex, for example, can get difficult, but once you get the hang of it, you’ll be able to find good deals in a snap.
To value an apartment complex, calculate its capitalization rate, or cap rate as it’s often referred. In essence, a cap rate is the rate of return expected on an annual basis if the property was paid for in cash. It’s the ratio between Net Operating Income (NOI) and the property value.
To illustrate, if you anticipate a $100,000 rate of return per year on a $1 million property paid in cash, then you’d have a 10 percent cap rate. NOI is calculated by subtracting expenses from estimated gross rent. So, if your complex is bringing in $100,000 in rent and you subtract, say, $30,000 in expenses like property tax, vacancies and maintenance, for example, you get a $70,000 NOI.
Choosing the right cap rate is crucial to return on your investment. Often, rates range from 5 percent all the way up to 10. If you take an apartment building with an NOI of $50,000 and it’s on the market for $1 million, that’s a cap rate of 5 percent. That same property with a 10 percent cap rate would generate a return at half that amount, so choose wisely. Use MyNOI’s investment calculator or local cap rate tool to discover the cap rates in your area.
Gross Rent Multiplier:
Calculating the gross rent multiplier (GRM) is another way to value an apartment complex. It’s measured by taking the price of a property and dividing it by the potential gross income.
So, for example, if your property garners a gross rent of $100,000 per year, and you apply the average range in value for an apartment complex at about 10 times gross rent, you’ll calculate an average valuation of $1 million. The calculation helps investors quickly weed out bad deals, but excludes detailed analysis related to cost, unlike the cap rate.
Rental Costs vs. Size:
Finally, if you’re an investor intending to revamp your complex and plan to eventually rollout a slew of new rental rates and functionalities for the space, rental costs may not be at the forefront of your investment decision. What you can do in this case is value an apartment complex based on its size, or unit capacity.
Study your market and compare — some spaces can sell for several hundred dollars per unit, while others can swoop low.
So, before you leap forward into a new investment, grab a calculator and be sure you’re getting the best deal out there. It could make all the difference.
Stefanie Donahue is a freelance writer based in Bellingham, Washington. She’s a well-versed communicator with an extensive background in journalism and media production. Her writing draws from the insight of industry experts to uncover best practices for real estate investors.