There is a misconception out there that evaluating real estate deals is a time-consuming and arduous task. Nothing could be further from the truth!
Analyzing apartment deals and making money on apartments is all about the numbers. More specifically, it is all about the revenue and expense numbers. With that in mind, you can easily assess a deal in 10 minutes.
Apartment values are based on the numbers and the Net Operating Income (NOI). The more net operating income you can generate, the more money you will have to put in your pocket every month and again when you refinance or cash them out.
However, you have a large degree of control over the revenue and the expenses of an apartment. You have the ability to estimate the value up front but you can also predict the value of your property even if you desire to make changes.
There are three simple questions to ask when evaluating a deal:
1. What is the Cap Rate?
2. What is the price per door?
3. What is the unit mix?
Once you have the answers to those three questions, you will know whether you should move forward with the deal. Let us examine each of those questions more closely.
What is the Cap Rate?
This is an abbreviation for the capitalization rate. This is the return on investment on a percentage basis if you paid all cash. The formula for CapRate is your NOI divided by the purchase price.
For example, if you have a property that has a NOI of $100,000 per year and you paid $1,000,000 cash for the property, your Cap Rate is 10% because you are getting 10% return on your $1,000,000. The golden rule in evaluating deals is to look for properties that have a 10% or higher Cap Rate.
What is the price per door?
Price per door equals the price divided by the number of doors (or apartments). As a general rule, if it is less that $25,000 per door, then it is a candidate because it will most likely have a good Cap Rate and it will most likely have cash flow. Your general rule of thumb is that you go with less than $25,000 per door for an apartment building. This figure does include any rehabilitation costs.
What is the unit mix?
The unit mix is the percentage of units that are one bedroom, two bedroom, and three bedrooms.
A property that has more two bedrooms than one bedrooms will have higher rent or higher revenue per door. It is better to have a property with more two and three bedrooms than one-bedroom units because the rent per apartment will be higher on average. Generally speaking, two bedrooms are easier to rent.
The answers to these three questions reveal a lot of things. The Cap Rate tells you about the cash flow of a property. The price per door will tell you the class of property you are dealing with and the unit mix will tell you about marketability and revenue stream.
These answers allow you to assess within 10 minutes whether a property is worth pursuing.