- 1. What Is Real Estate Cap Rate?
- 2. Cap Rate Calculation Formula
- 3. Advantages Of Determining A Multifamily Property’s Cap Rate
- 4. What Is A Good Cap Rate For A Multifamily?
- 5. Which Factors Influence Multifamily Cap Rates?
- 6. BFPM Can Help You Invest
If you are thinking of investing in a multifamily property, understanding the importance of cap rate when evaluating a potential acquisition is absolutely critical to your success. Knowing the capitalization rate of the real estate can help you manage investment risks and avoid high-risk, low-return investments.
What Is Real Estate Cap Rate?
A cap rate or capitalization rate is a key metric that real estate investors use to analyze and objectively compare potential investments. It is used by multifamily real estate investors to indicate the expected return on their investment in real estate. This rate is determined by taking the property’s expected net income and dividing it by the specific property’s asset value and is expressed as a percentage. An investor uses the multifamily cap rates to determine their potential ROI before investing capital in a property.
Cap Rate Calculation Formula
Wondering what is a good cap rate for rental property? Here’s the formula that can help you figure this out:
Cap Rate = (Income – Expenses) / Cost
Simply put, gross income minus operating expenses, divided by the purchase price is the capitalization rate for a specific real estate.
Advantages Of Determining A Multifamily Property’s Cap Rate
Following are three major advantages of knowing a property’s capitalization rate:
Risk Analysis: Cap rate is responsible for determining the ideal risk/reward ratio. Potential ROI is more significant at higher cap rates, but so are the risks. Lower cap rates are less risky, but not a wise investment.
Calculating Potential Return On Investment: Ultimately, the most important advantage of cap rates is that they allow you to estimate your best-in-class financial return based on the information available.
Investment Review: When evaluating multifamily investment potential, the multifamily cap rate can be used as a benchmark metric to compare different properties.
What Is A Good Cap Rate For A Multifamily?
A good cap rate for multifamily is anywhere over 4% and under 10%, depending on where you are in the market cycle, geographic location, property condition, and the balance of supply and demand of rental units in a particular region. A higher cap should usually be expected in areas with low demand for rental properties. Having said that, know that each situation is different. Cap rates are important, but they should be seen as part of the bigger picture, not as the sole indicator of an investment’s likely success or failure.
Which Factors Influence Multifamily Cap Rates?
Following are some of the crucial factors that influence the capitalization rate of multifamily real estate:
A look at the designated markets and current available inventory allows investors to better understand their potential position in the market and better understand the risk-reward equations of multifamily investment.
Location has a huge impact on cap rates for multifamily real estate. Properties closer to employment, entertainment and lifestyle options can demand higher rents due to higher resident attraction. Properties within such bustling areas have a reduced investment risk as they experience high-demand and constant cash flow.
Properties are divided into three categories based on their age. For example, Class A is less than 10 years old, while Class C is 30+ years old. Older properties typically have higher maintenance costs and can cost a lot in a given year thus increasing costs and lowering the cap rates.
Rate of employment
Multifamily cap rates also depend upon the current employment rate. Positive employment data in the market is highly correlated with cap rate compression, which can be a positive feature. This could be an indication that prices are rising and that some investors see real estate investments in this area as less risky compared to other investment options.
High household incomes generally result in a lower cap rate. Afterall, the creditworthiness of residents, landlords and buyers reduces the risk in a market.
BFPM Can Help You Invest
While many would like to access assets with different risk/reward profiles and shorter return periods, entry points seem to be out of reach for some. BFPM provides a convenient way to invest in multifamily homes; our experts know how to study the dynamic real estate market before making recommendations. Feel free to book a quick 15-minute consultation call if you want to know how we can help you optimize your property and maximize your profits.