Demystifying multifamily cap rates, NOI, and investing basics

Rick M. Bean of Rose City Commercial Real Estate writes insightful articles about real estate investing. HIs post about the basics of investing is particularly valuable:

As there is a mix of investment sophistication levels on this site I have opted to interject a review of the basics. For you institutional investors…hang on we’ll have some information that we think you’ll find valuable in…later posts.

What is NOI?: Net Operating income

What does it measure?: Measures the revenue generating capacity from operations.

When is it important?: Two times: When you is sellin’…and when you aint. On a more serious note, NOI is the source of payment for debt service, and cash flow distributions to the owners.

Why it’s important: It provides a way to measure the revenue producing capabilities of an asset excluding debt service considerations.

What’s the formula?: Current Revenue – Current Expenses (Exclude debt service, capital expenses.)

Example: Current Revenue, June 2009: $100,000.

Current Expenses, June 2009: $ 35,000.

NOI, June 2009 $65,000.

What is a Cap Rate?

The capitalization rate is what the yield as a percentage of the initial investment would be in year one if you acquired the property all cash.

Why it is important: First “sniff test” investors use to check out an available commercial property.

What is the formula? NOI/Sale Price = Cap Rate

Example: $65,000/$812,500= 8%.

What is NOI Multiplier?

How much each dollar of NOI would contribute to value if property was for sale.

Why we care: Knowing how much each dollar on NOI is worth helps us evaluate the impact of incremental increases in revenue and expense. (Great for rehab/repositioning!)

What’s the formula? Sale Price/NOI = NOI Multiplier

Example: $812,500/$65,000= 12.50 (Each dollar of NOI creates $12.50 of value.)

NOI, CAP, and NOI Multiplier Problems

A Portland Multifamily investment Property X had the following revenues in 2008:

• Rent $122,500.

• Extraordinary gain: harvest lumber on property $25,000.

• Pet rent $300.

Property X had the paid the following in 2008:

• Utilities, taxes, management fees, etc. $48,000.

• Cap Ex: Completely rebuild lower parking lot $19,000.

• Re-stripe upper parking lot $125.

QUESTIONS 1 & 2 are based on the information above.

1. What was NOI? ANSWER: $74,675 Note: The lumber revenue and parking lot expense were not operating related and were thus excluded from NOI.

2. What is the asset worth if we assume a 6.9 Cap% ? ANSWER: $74,675 / .069 = $1,082,246

QUESTIONS 3 – 4 are based on repositioning an 18 unit property we are buying for $1,200,000 at an 8 cap with a 5.9 % loan. Current Annual NOI is $96,000:

3. How much is each dollar of NOI worth? ANSWER: $1,200,000/$96,000 = $12.50.

4. How much more would the property be worth if we could raise the rents in 10 of the units $10/month? (Assume that a year has 12 months, all the units are increased at the same time for the full year…and that we could do this without increasing expenses…without any change in turnover.) Answer: 10 units X $10 X 12 months equals a $1,200 increase in Annual NOI. Multiply by $12.50 = $15,000 increase in value!

via Demystifying multifamily cap rates, NOI, and investing basics - Rose City Commercial Real Estate.

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