My husband and I are looking to expand our rental portfolio and move up to the big time and purchase an apartment building. We currently own 10 rental houses in Phoenix and manage those properties very well ourselves and have a great positive cash flow on these properties. Our problem is just plain understanding all of the terminology like, cap rate, and other definitions that would tell us if the deal is a good one. What would be the advice you would give me in looking at and undertstanding the numbers on the executive reports of these building complexes? What income should I look for monthly/yearly or how do I determine a good deal? I know that sounds very basic for someone already successful in this business, but the apartment business is much more detailed.

Ellen:
Well with 10 rental houses you should know enough to figure out whether a property produces enough cash flow to repay the debt and leave some kind of a return on your investment. If you have had the houses for a while you have also benefited from the appreciation that most markets have experienced in the last few years so you must be feeling good. Now the cap rate sounds tricky, but really isn’t. Capitalization is an appraisal process to covert income streams to value. I did an article about six years ago about it and you can find it at http://www.loanuniverse.com/capitalization.html if you want, but in a nutshell you can understand it easier by the following example:

”If you have a building that makes you $100,000 in rental income, you adjust this gross income by the expected rate of vacancies… Then you deduct the operating expenses you get the Net Operating Income. This number is then divided by the cap rate to give an estimated valuation of the property using the income approach”

Gross Income = $100,000
Less Vacancies = $10,000
Less Operating Expenses = $40,000
Net Operating Income = $50,000
Cap Rate = 10%
Estimated Value = $50,000 / 10% = $500,000

Off the top of my head and without any other specific question in front, the only thing that occurs to me is that no matter how hot the property is, do not use a cap rate that is substantially lower than 10%. It does not matter that market rates in other investments are very low {example CDs are paying only 2%} using a substantially lower cap rate will result on inflated valuations. If you were to use a 5% rate on the example above, you will end up with a $1,000,000 valuation.

Hope this helps.

I almost forgot make sure that you visit my page on sensitivity analysis at http://www.loanuniverse.com/sensitivity.html there you will see a real life tool that we use to determine debt service coverage for multi-tenant buildings.

I hope I'm not too late for this post.

I have a property in a large college town in Montana. It is an older 8 unit building with $44,000 in annual rents. No vac. in the past 15 years!!! Realestate is really hot here.

The expenses are about 20,000 per year max. including and that is including 2000 for possible vac. We have never had any but may now have some due to many more rental being built in this area.

Building is very sound but in need of Much TLC. It is an older building. People like to rent apts. because of the bldg. looks and style, etc.

We usually rent to college students (grad students) quite building with no problems in 30 years.

What would be a good mulitplier for this building?

I have an offer of 200,000 at 6% with $50,000 down and $1,665 for 10 years.

That gives the purchasers about a $$6,000+ net cash flow after all payments to me and expenses. (including $3000 for repairs and Maintenance) if the bldg is full.

I think that is way too low?


I have owned the bldg for 30 years and have never had exp. go over 18,000 a year including vac.

Help?

Different strokes.
Dear friend,
I have seen across the country the many apartment buildings catering to students needs rise up.
The concept, the equity positions, in these "student oriented" apartment buildings are unique to students needs. The idea is to capture the cash these students spend on living as a student.
The climate to rent to students has changed. Those landords who do not follow the change or do not add those amenities for students and simply supply them a
"rental" or a 4 plex converted to student housing will end up losing value of the investment real estate. And if you are a small fish- this can be a bad thing.
My suggestion is to find out what YOUR RATE OF RETURN is on this building. If it is acceptable to you then I would not even worry about what the other guy is receiving from buying your asset.
If you believe ( and not think ) the offer is too low. Then hang on to your belief and see what it fetches you in the next few years. And be prepared to adjust your expectations (either up or down) I already see the trend of students rejecting old style properties that need TLC for an eye pleasing, comfortable building. Remember students today can take classes without ever leaving their dorm room or house!
-just my2 cents.