Multifamily is currently one of the most booming sectors of commercial real estate, attracting lots of investors daily. However, before acquiring a multifamily property, there are many things to take into account, such as the property’s capitalization rate. So, what is a good cap rate for multifamily?
What Is a Good Cap Rate for Multifamily?
A good cap rate for multifamily investments ranges between 4% – 10%. On a general scale, multifamily units have one of the lowest rates among the several types of commercial real estate investments. Hence, they are termed low-risk properties.
Property capitalization rate is a major metric used to determine how long it would take to recoup expenses on a property. However, it does not consider factors such as future cash flows from property upgrades and the time value of money, and so should not be used solely to determine whether or not to purchase a property.
How Do You Calculate Cap Rate for Multifamily?
To determine the capitalization rate of a property, the formula is Capitalization Rate = Net Operating Income / Current Market Value, where the net operating income is the potential yearly income yielded by the property -mostly from rent payments- minus all the expenses and taxes incurred for managing the property.
The current market value of a property is the present value of the property when compared to the current market rates. Dividing a property’s NOI by its current market value goes on to show potential returns as well as potential risks. Basically, a higher rate signifies more risk, while a lower rate signifies lower risk.
What Factors Affect the Cap Rate of Multifamily in Northern Kentucky?
When defining what a good cap rate for multifamily units is, it is vital to take note of the specific property type. It goes without saying that the rate of a duplex or garden apartment cannot be compared with that of a high-rise apartment or condominium.
In Northern Kentucky, here are a few factors that determine what the capitalization rate of a multifamily building will be:
Property Location
The location of a property is a vital factor to consider in determining how much the property is going to yield because it affects both the potential yearly income and expenses. Multifamily properties situated near metropolitan areas with booming economies like Cincinnati and Northern Kentucky are more likely to be rented all year round and at good prices too.
Such properties also offer lower investment risks because of their steady income generation and lesser expenditure, thus resulting in lower cap rates.
Market Conditions
The overall movements and dynamics in the market determine several variables such as demand, supply, and of course, capitalization rate. Properties tend to have lower rates when the market dynamics are strong and vice versa. This is because the market conditions favor the value appreciation of different properties, including multifamily units.
On the other hand, when market conditions are unfavorable, property acquisition is bound to come with increased risks, higher expenses, and lower income potential, leading to poor value appreciation of properties and, ultimately, higher rates.
Inventory
The number of properties available for sale has a significant impact on the capitalization rate of a multifamily property. Low inventory rates culminate in high demand and competition for the limited properties available. This, in turn, drives up the prices of properties, resulting in property appreciation and lower cap rates.
Interest Rate
An increase in interest rates simply means an increase in the cost of procuring mortgages, signifying that buyers have to pay more than usual to own properties. Higher interest rates could significantly contribute to higher rates, and in the same vein, lower interest rates could significantly contribute to lower rates for multifamily properties.
The profits generated on a property purchased with a high-interest rate will appear smaller when compared to a similar property purchased with a lower interest rate because the property owner may end up using a significant part of the profits to offset the mortgage on the property.
State of the Property
Properties that are new, equipped with modern facilities, and located in urban areas tend to attract more tenants and investors than older, outdated properties. This results in a lower capitalization rate for the former -thanks to its potential for a steady income and pricey market value- and a higher rate for the latter.
Another reason for this is that properties in bad conditions usually require more renovations and maintenance than newly built or upgraded properties. These costs cause the owner to have a higher expenditure that may lead to a higher rate.
Is It Better to Have a Higher or Lower Cap Rate?
Cap rate is usually taken as a measure of the risks associated with investing in a property. Typically, a property with a higher cap rate has more risks associated with it than a property with a lower rate. However, does that mean that they should not be purchased? No, it does not.
You should not base your decision to invest in a property solely on its rate because property capitalization rate can change based on the varying levels of income generation and current market evaluations. Here are some other property metrics and features to consider before investing in a multifamily property:
- Internal Rate of Return (IRR)
- Previous Return on Investment (ROI)
- Loan-to-Value Ratio (LTV)
- Gross Rental Yield
- Equity Multiple
- Price-to-Rent Ratio (PRR)
- Cash-on-cash
If you are still unsure about whether to buy a property after examining its metrics, you might want to consult the services of a professional real estate company like Si Vales Valeo Real Estate. We will help you to navigate the market and create strategies to help you make profitable decisions, even in seemingly unfavorable market conditions.
Related Questions
Should I Buy a Property With a High Cap Rate?
The decision to purchase a property with a high capitalization rate should be made based on your risk profile. You could also consider other metrics aside from property rate before making your decision.
What Is the 50% Rule?
The 50% rule in real estate states that an investor should allocate half of the total income generated by a rental property to operating costs when determining profitability. The rule is developed to help property owners avoid underestimating expenses or overstating the potential profits of a property.
Conclusion
The goal of every investment is to yield returns, and the cap rate is an avenue to determine the yield potential of the property. This article provides information that will help investors understand how to calculate the cap rate and know the factors that may affect the yield potential of their property.
