Multifamily property gets its value from the Cap Rate and the NOI. The Cap Rate, or capitalization rate, is divided by the NOI, or Net Operating Income, to determine the valuation of the property. A Cap Rate is a metric used to determine a potential return on investment of a property.
A Cap Rate is an important metric to know when looking at apartments. Cap Rates fluctuate all of the time and are based on each sub-markets and market conditions. The Cap Rate is an inverse number that can often confuse people. If a Cap Rate is LOWER, the value of the property will be HIGHER. If the Cap Rate is HIGHER, the value of the property will be lower.
Another important note is the Reversion Cap Rate. A Reversion Cap Rate is a forecasted Cap Rate at the time of sale or refinance, typically 3-5 years down the road. While we do not know what the Cap Rate will be with our projections, we tend to come with a higher Cap Rate than what the industry forecast shows. We do this to be conservative in our underwriting.
Let’s look at a couple of examples:
Cap Rate: 5%
Property Value: $20,000,000
Cap Rate: 4%
Property Value: $25,000,000
The industry standard in Reversion Cap Rates (the Cap Rate when a property is projected to sell) is to add 10 basis points for each year of ownership. If a property is purchased with a 4% Cap Rate and we plan to hold for 5 years, the Reversion Cap Rate would be 4.50%. We, however, take it a step further. We use professional 3rd party data to determine the Reversion Cap Rate and still will add 25-50 (0.25-0.50%) basis points on top of that. This goes along with our conversative underwriting.