Apartment Cap Rates

September 28, 2020

Any apartment building you buy is an investment, and knowing how to get the most out of your investment is important. Most professional real estate investors will use apartment cap rates to find out what their return on investment will look like, and if you’re savvy enough you can even figure out an estimate before you even buy the property you’re looking at. Renting out multi-family homes can take a lot of math to make sure that you aren’t going to lose a lot of money on a property every year. Let’s look at what a cap rate is, how to calculate it, and how you can use this information to maximize your profits.

National Multifamily Cap Rate 2020

  • According to the CBRE, Q2 of 2020 the average cap rate dropped two basis points. During the COVID pandemic the entire multifamily structure was threatened by the loss of jobs and the inability for people to pay their rents.
  • The quarterly average between 2018 and 2020 shows that the cap rates dropped throughout the United states from region to region. For example, the Midwest dropped from Q2 2018 from 7.13 to 6.65 in the second quarter of 2020. For the entire nation the quarterly average of the second quarter of 2018 was 5.72 where it dropped to 5.55 in the second quarter of 2020.

What is a Cap Rate?

The first thing we should take a look at is exactly what a cap rate is. If you’re a veteran landlord, you probably already know all about cap rates and exactly how to find them. If you aren’t and this is your first time hearing about them, you’ll probably need a bit of an explanation to make sure that all of our readers are on the same page. If you don’t know about it yet, that’s perfectly ok. There’s a learning curve and definitely a lot to learn about this topic.

Cap rates, short for capitalization rates, is a term that is used in the world of commercial real estate. It’s usually used to indicate the yearly return on your investment on a piece of rental property. The cap rate is a percentage, so it will allow you to find out an estimate of the percent of return on investment you’ll get that year.

It’s an incredibly powerful tool for getting estimates on how much money you can make from a property, but it’s far from perfect. It leaves out a lot of details that are important for determining how much income the property could actually generate, including potential increased cash flow from property renovations, leverage, and a lot of other things.

That being said, it’s still a good thing to know about when getting into your investment property because it lets you know if the property will be able to make you money right off after you purchase it, rather than after you put in a good amount of time, effort, and money into it. Most landlords and property management companies will make improvements to their properties because it can yield them more revenue anyway, but if you’re buying your first property that you intend on renting, you might not have the time to wait around until you can finish renovating an entire apartment complex.

How to Find The Cap Rate of a Property

It’s time to bust out your pencils and paper, or calculator at the very least, because it’s time to do some math. Many people will use spreadsheets for this information because you can program functions to run the numbers for you, then you can get a whole lot more information on one screen very quickly. That also makes things a little easier if math isn’t your strong suit, which is the case for many people. It’s a good thing that you don’t need to be a math genius to make money on real estate, leave that to the stock investors.

The first thing that you’ll need to get your cap rate is the net operating income, or NOI for short. You can find this by taking the expected annual income for the property and subtracting what it costs to actually operate the property. That includes things like snow removal, utilities, maintenance, upkeep, and even property taxes. After you’ve done that, you’ll have the first thing that you’ll need to find out what your cap rate for that property is for that year.

Once you have your net operating income, you’ll need the current value of the property. As the owner of the property, this should be relatively easy to find. A lot of people just use the purchase price because that’s what they paid for the property and that will give you the truest estimate of your return on investment based on what you paid for the property yourself. Once you have these two numbers, you’re ready to move on to the actual equation. It’s a pretty simple equation, so don’t worry too much. All you’ll want to do is divide your net operating income by the value of the property, and that’s your cap rate.

Just to make sure that you understand, let’s look at an example. Hypothetically, you recently purchased a property that is worth $1,000,000. Every year, you can expect a net operating income of $100,000. You would take your net operating income, $100,000 in this case, and divide it by the value of the property, $1,000,000. Well, $100,000 divided by $1,000,000 comes out to exactly 10%, so your cap rate on this property would be 10%.

Many people would recommend trying to get the property’s current value for this equation because using what you paid for the property can make this equation a lot messier. For example, let’s say you inherited a property and the NOI is $100,000. What’s $100,000 divided by 0? Considering you can’t divide by 0, that’s where your equation would end. A question with no answer, which is great for philosophy students but not for people trying to figure out their cap rates.

Getting Your Cap Rate to Make Your Life Easier

Cap rates are just an estimate of the percentage of your return on investment, so what you could actually get could be much higher or lower depending on a lot of factors that aren’t taken into account in the equation. Regardless of that, it’s still a good way to get a general feel of how much of your investment you can expect to get back from your property in a normal year. You can also use it as a benchmark to try and beat if you have the skills and tools to do so.