Don’t start your search for multi family homes for sale before reading this. Understand what a good cap rate is when investing in multi-family homes first.
Investing in real estate takes a lot of research and effort. After all, you need to know everything about your real estate market if you want to ensure the best real estate investments. When buying multi family homes for investment, you need to know: What is a good cap rate? But before we talk about that, let’s refresh and discuss exactly what cap rate is and why it’s important when investing in multi family real estate.
What Is Cap Rate?
Cap rate stands for capitalization rate and is a key measurement when analyzing an investment property. Cap rate is actually a simple calculation used in real estate investing which helps in making investment decisions. It’s important to note that cap rate isn’t the only metric used in an investment property analysis, but it is a key measurement. It’s typically the first metric used when evaluating real estate properties.
Calculating Cap Rate
The cap rate calculation involves cost and income relative to a certain real estate property. For example, when investing in rental properties, you’d take the annual net operating income (NOI) and divide it by the purchase price. This calculation will determine a percentage which is referred to as the cap rate. Here’s the basic cap rate formula:
Cap Rate = ( Income – Expenses) / Cost
We can apply this formula when evaluating multi family homes for sale. For example, if a particular property has a market value of $500,000, annual expenses of $15,000, and an expected annual rental income of $55,000, the cap rate would be:
($55,000-$15,000) / $500,000 = 0.08
Multiplying that final number by 100 will give us an 8% cap rate, which for a multi family home is considered good.
NOTE: Are you looking for a quick and easy way to calculate cap rate or any other important real estate metric? Consider using an investment property calculator. Mashvisor is a great place to find one! To learn more about our product, click here.
How Real Estate Investors Use Cap Rate
Cap rate can be used to represent the profitability of a certain property, neighborhood, or city. But what does this percentage actually mean? There are three main uses for the cap rate in real estate investing.
- Level of Risk: Different cap rates typically represent different levels of risk. A high cap rate implies a higher level of risk associated with this investment. Whereas a low cap rate implies a lower level of risk for this deal. It’s up to the investor to determine the right cap rate for the level of riskiness associated with the deal.
- Screening Tool: We mentioned above how investors usually first look at the cap rate of a property when analyzing investments. The cap rate is a simple tool real estate investors use to quickly compare similar investment properties when in the initial phases of their investment property search.
- Return on Investment: This function is what we can most directly understand from the cap rate formula itself. Since we’re using cost and income to evaluate a property, we should be able to conclude the profitability of that property.
Since we’ve established an understanding of what cap rate means in real estate investing, let’s now loop in multi family homes for sale.
Related: What’s a Good Cap Rate for Investment Properties?
Multi Family Homes for Sale and Cap Rates
So, what is a good cap rate for multi family homes in real estate investing? First, let’s differentiate between the different types of multi family homes and where they fall in the real estate market: commercial real estate or residential real estate?
Basically, a multi family home with four or less units is considered a residential property. A property with five or more units is considered a commercial property. It’s important to note this difference because answering the question, “What is a good cap rate?” depends on the scale of the building you’re investing in.
What is a Good Cap Rate: High or Low?
That depends on the type of property you’re talking about. The cap rate is most valuable when used correctly, i.e. when used to compare very similar properties. For example, consider a multi family real estate investment analysis. You wouldn’t compare the cap rate of a duplex with the cap rate of an apartment building. That wouldn’t be a fair or accurate evaluation. A “good” cap rate is completely dependent upon property type, location, and market conditions.
In commercial real estate, not all property types are created equal when it comes to perceived levels of risk. Multi family homes typically have the lowest cap rates within a real estate market because they are considered to provide lower risk relative to other asset types. This means that a good cap rate when evaluating multi family homes for sale typically ranges from 4%-10%. If you’re looking at multi family homes for sale in a high demand area, a 4-6% cap rate is reasonable. However, if you’re in a low demand area, you should aim for a cap rate of 10% or above.
Where to Find Multi Family Homes for Sale with a Good Cap Rate
Now that we’ve answered, “What is a good cap rate when investing in multi family homes for sale?”, it’s time for you to start the search for those properties. Where can you find these multi family homes for sale? After all, location is a huge factor behind finding profitable investment properties. But you shouldn’t start your search by asking where, rather how.
With Mashvisor’s heatmap analysis, real estate investors can find the best location for investing in multi family real estate. This is a digital and revolutionary real estate investment tool not like anything you’ve used before. By displaying data in the form of highlighted visuals on a map, investors can quickly and easily locate top-performing properties in the best neighborhoods. Say you were searching for multi family properties for sale with a high cap rate. Simply apply the filter to see which neighborhoods have high cap rate properties for sale.
So now you know what is a good cap rate, and how to find multi family homes for sale with Mashvisor. To learn more about how we will help you make faster and smarter real estate investment decisions, click here.