The Two Must-Know Tools for Calculating the Value of an Apartment Building and Benefit From Its Appreciation
We all know the way to make money with an investment is to buy low and sell high. Although this tends to be easier in the stock market, where a centralized institution like the Stock Exchange provides the real-time price of an asset, in real estate it can be a tricky thing to know precisely how to put a price on a property.
This results in many inexperienced investors overpaying for an asset for which they’ll probably also undervalue the expenses. The best way to guard yourself against this is to get educated on how apartment buildings are valued. This will also help you understand why real estate provides an amazing opportunity for asset appreciation.
What Is a Good Deal?
As we suggested before, the only way to know if a real estate deal is good or not is if it provides a positive ROI. However, as Warren Buffet famously said, “price is what you pay. Value is what you get”.
What this means is that price and value do not always coincide. And finding that difference is what a good multifamily operator knows how to do.
So an asset is worth to the trained eye not only what it produces today, but what it can produce tomorrow. The problem is that determining the value of an apartment building accurately can take a lot of skill and experience, and also prices can be affected by many things like the general situation of the economy, the state of the building, and even the birth rates in the area.
However, there are also things that we can control and that can have an influence on the price. For example, if value add activities are performed (like repairs and improvements) the building can appreciate and give a greater return on the initial investment.
So, what are the two most common tools to calculate the value of an apartment?
Tool #1: Capitalization Rate (CAP Rate)
In order to calculate this, you’ll need to first determine the net operating income (NOI).
To do so, you have to take the total annual income and subtract all of the costs of running the building. It should exclude all the mortgage payments but include the property tax. This will give you the net operating income the building generates.
Now, in order to find the CAP rate, you divide the NOI by the price of the building. This will give you the capitalization rate, which is a comparison of the net profitability of a building to its value.
CAP rates will vary by state, city, and even neighborhood. Asset class, condition of the property, age, and surrounding apartment community values all impact CAP rates. Brokers with experience in your market will have a sense of what CAP rates are for the area you’re investing in, so be sure to rely on experienced professionals in the area when looking up CAP rates.
Tool #2: Gross Rent Multiple (GRM)
This metric is based on the idea that a higher rent equals a more valuable building. You need to calculate the annual gross rent (for example, a $7,000 rent x 12 months = $84,000). You then multiply that by the Gross rent multiple (GRM), which is a rough measure of the value of an investment property. According to Wikipedia, “GRM is the number of years the property would take to pay for itself in gross received rent”.
The GRM will vary according to the conditions of each property. If the area has greater demand, the GRM will be higher. On the contrary, Class C and D properties will have a lower GRM, meaning their value will be diminished by the conditions of the neighborhood.
Multifamily professionals prefer the CAP rate method, as GRM does not take into account the costs of operating the asset. However, it is a quick way to get an idea of the value of a property without providing the whole picture.
Although there are other methods like determining the price per door of each property, the CAP rate is the most common way multifamily brokers & investors determine the value of a property.
Now That We Know the Value, Is There Something That Can Be Done to Influence It?
There are many factors outside our control when it comes to determining the value of a property. Nonetheless, one of the things that can be done to force appreciation is to add value to the property through repairs and improvements.
This is because the CAP rate is based on the income the property generates. As income increases, the property value increases, providing a lucrative exit when it’s time to sell the property.
Skip the Property Valuations and Calculations
It takes knowledge and experience when it comes to crunching all the numbers involved in multifamily valuation. Here at Titanium Investments, we can help you get all the benefits of real estate without all the hassle of calculating the CAP rate and keeping up with the constant changes in the market. When you invest with us, you’ll have both peace of mind and cash flow, all without the work that comes with managing an apartment complex.
Put simply: you can build wealth and earn passive income in real estate while someone else does all the work. Wanna know how? Connect with us here and get expert help today.