How Much Should You Be Spending on Multifamily Apartments?

multifamily tips Nov 14, 2021

What should you be paying for multifamily apartment buildings?

When looking at the multifamily investing market, there are several factors to consider.

Without researching your area, prices depend on the location, and it's hard to know how much a fair price is.

We'll take a look at some of the factors that will help you make this decision!

Income Approach (Capitalization Rate)

This approach takes the income for an investment property - minus expenses and determines what a reasonable price is to pay for it based on the capitalization rate.

Net Income Equals =

Gross Rental Income (the money that tenants pay you every month)

(MINUS) Operating Expenses (repairs, insurance, property taxes, etc.)

The income approach calculates the Net Operating Income and then multiplies it by Capitalization Rate to arrive at an investment value.

The Danger of Using the Capitalization Rate Approach

Be careful when using the income approach because so many factors determine what markets will do over time and how they'll affect your investment value.

What if builders are building a new shopping center in the neighborhood?

What if everyone has started to rent homes because they can't afford to buy them anymore and apartment demand drops dramatically.

Many different factors can affect the value of your investment, so make sure you account for all of these!

Seller's Market Approach

This approach is for people to sell their investment properties and price them based on what similar investments have sold for recently.

The key here is to have many comps in the area.

Using this approach, you can compare your property with other properties that are selling.

You can also determine if your price is reasonable or not.

For example, if all the multifamily investments around you sold for a 5.75% cap rate, you should also price yours at a similar number!

Of course, it's not that easy, but it's a beautiful start to get an idea of what price is acceptable.

Be Careful When Using The Seller's Market Approach

The seller's market approach is also risky because the real estate market can swing in both directions.

Like we saw with capitalization rates, it would be wrong to assume that apartment values will always increase and only price your property higher than what similar properties sold for.

Although this seems logical, you could end up pricing yourself out of a profitable deal.

This method looks solely at replacement costs or what you'd have to spend if you wanted to build an identical multifamily apartment building on vacant land.

So, if you were buying a property for $1,000,000 and had to spend $250,000 on renovations compared to spending $2,000,000 to build an identical building, then this method would state that acquiring the older property and renovating it could be a better return on investment than building new.

The danger of using the replacement costs approach is that sometimes some unusual features or amenities add to the value of a property, and you're not accounting for them in your calculations.

For example, there is a fantastic feature on the property that would be very costly to replicate. In addition, someone has maintained this particular building over the years, making it much more valuable than others in its class who haven't received such TLC.

Using the Replacement Cost Approach is Useful Sometimes

The Replacement Cost Approach can be helpful when trying to determine if an investment property needs renovations or not because you could compare how much it would cost to build a new one vs. fixing up your current building and what ROI each option provides.

Of course, this method works best for vacant multifamily buildings or where you could demolish the existing structure and replace it with a new one.

Marcin Drozdz

The information contained herein is for general guidance on matters of interest only. This information contained herein is not intended to provide you with any advice on financial planning, investment, insurance, legal, accounting, tax, or similar matters and should not be relied upon for such purposes. www.marcindrozdz.com is not a financial or tax adviser. You should assess whether you require such advisers and additional information and, where appropriate, seek independent professional advice. www.marcindrozdz.com, its subsidiaries, and affiliates are not responsible in any manner for direct, indirect, special, or consequential damages however caused arising from your use of the information contained herein.

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