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Multifamily Investment Cap Rates

The capitalization, or cap rates, of income-producing properties, give us a quick peek into the financial condition of a property, but they also provide us with insight into overall market trends. 

Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More.

What Is the Cap Rate

The capitalization rate, or cap rate, is one of the most basic and commonly used metrics when studying an income-producing property. The simple formula gives us essential information about a property’s performance in relation to its value or purchase price. 

To find the cap rate, divide a property’s net operating income/current market value (NOI/current market value=capitalization rate). 

Net operating income is simply the income minus the expenses.

What We Learn By Analyzing Cap Rates

Cap rates reveal some essential characteristics of a property: risk and price.

Lower cap rates indicate that a property is less risky but more expensive. As such, investors hold different views as to what cap rates they want to see for their investment strategy. 

Many investors pursue properties without the lowest cap rates in search of a bargain that can be improved to create significant gains in appreciation in just a few years. Alternatively, others buy the low-cap rate, expensive properties, knowing that the low-risk investment with steady income and modest appreciation outperforms the stock market.

Multifamily Cap Rates

After learning about the existence of and factors contributing to cap rates, the next question for most people is, “What is a good cap rate for a multifamily property?” Of course, the answer is not simple, but the question is astute. Knowing a good cap rate for a certain type of property in an area gives you an idea as to whether it’s well-priced and how its performance tracks with the value.

As with most things, real estate cap rates vary based on region and asset class. However, on average, multifamily real estate as a whole has lower cap rates than a buyer would find with other types of income-producing property, like office or retail properties. The lower cap rates stem from the overall lower risk of multifamily properties. h

Generally, cap rates between four and ten percent are considered typical and a sign of a promising property. According to a recent study, the average multifamily cap rate in the United States is 6.38 percent.  

When analyzing cap rates, keep in mind the more similar the properties, the more accurate the cap rate comparison will be. 

Cap Rates by Asset Class

First, only compare the cap rates of assets of the same class. Asset class is a four-tier rating system that encompasses the age, condition, location, and quality of a property. 

Class A properties are less than ten years old, have the best amenities, and are most desirable. These characteristics all reduce the risk of owning a multifamily property; by signaling reduced repair expenses, continual demand, and high rents. As a result, class A properties generally have the lowest cap rates.

The scale goes down to class D, which includes buildings 30 years or older. Besides being older, class D properties are in poor condition with many critical repairs needed, may be located in abandoned or highly undesirable parts of town, and face challenges collecting regular and adequate rent each month. As you may imagine, these buildings generally reflect higher cap rates due to low net operating income.

Cap Rates by Location

Asset class considers the location of the property based on its demand within a city or market. Multifamily cap rates also vary based on the property’s city and region. Fortunately, we have good data to work with.  

CBRE compiles and issues significant cap rate data we can use to contextualize many multifamily markets in the United States. As of the third quarter of 2021, the Pacific West had the lowest average cap rate, 5.88 percent, and the highest rate was in the Midwest at 6.82 percent. 

CBRE also provides market-specific cap rate data for multifamily urban and suburban markets across the country in its biennial report. It overwhelmingly captured that in nearly every market, cap rates compressed compared to 2019 despite the tumult of 2020 and the pandemic.

The report is beneficial for getting a glimpse of a “good” cap rate for a particular market. For example, what’s good in Albuquerque (4.5-5 percent) is not what’s good in Phoenix (3.2-3.75 percent), demonstrating that two Southwest markets 400 miles apart have very different metrics.

Final Thoughts

Cap rates are just one preliminary data point to consider when searching for and comparing multifamily properties. As with any formula, the results can be skewed by the person calculating them or by the unique features of a property. Use it as a stepping stone for the much more conclusive due diligence process. 

Life Bridge Capital is a leading real estate syndication company. We offer our investment partners the opportunity to leverage shares of multifamily rental properties into a passive monthly income. Learn More.

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