Three Tips You Absolutely Need To Know Before Purchasing an Apartment Building
Since the recession in 2008, investing in real estate has turned taboo. If an individual was interested in purchasing in apartment building, they were immediately frowned upon by people. Why is this so? The recession caused falling stock prices, high-interest rates, and high employment rates on properties. It’s no wonder investing in real estate was a bad idea. Thankfully, it is a new day! Things in the economy are trending in a more prosperous direction! This makes potential real estate buyers have confidence before diving into the market. Even with the current turn of the economy, apartment building seekers should still be careful not to purchase overprices properties. There are three key ratio metrics for finding amazing apartment deals! This article will discuss what they are, how to use them, and what value to look for in a good deal.
1.The Cap Rate
Making an offer on an apartment building can be tempting! Especially if you see a building that seems to pass everything on your checklist! The asking prices seems feasible, but how do you know if you’re really getting a good deal? In order to answer this question, the fair market value of the building must be considered. This is figured out by evaluating the cap rate and the NOI. The cap rate, or capitalization rate, is the rate of return if you were buying the apartment building 100 percent in cash. While this is not likely to happen, it is the best way to measure the returns and the value of the building. The NOI is the net operating income. This factor represents the income after all expenses before the mortgage payment. To explain further here is an example.
You own a motorcycle that cost $5000; which includes all the expenses to maintain it. So, the NOI of the motorcycle would be $5000. A friend comes along and is willing to buy your motorcycle for the price of $10,000. In mathematical terms, the Cap Rate equals the NOI divided by value ($10,000) of the motorcycle. This means the cap rate: 5%.
2. Cash on Cash Return
Cash flow is the major key asset. As it will determine whether or not your investment in the apartment building was worth it! The formula for cash on cash returns are simple! Cash on cash return is determined by cash flow divided by the total cash. So, if your annual cash flow after expenses is $50,000 and you put $500,000 into the deal, then the cash on cash return ratio is 10%. Luckily, this key metric is pretty self-explanatory.
3. Debt Service Control Ratio
The debt service coverage ratio (DSCR) measures the ratio of net operating income to the amount of annual debt service you need to pay. Banks use this ratio to determine risk factors, if you were given a loan. The formula for debt coverage ratio: NOI divided by debt service. So, if the NOI is $5000 and the debt service is $4000, then the debt service coverage ratio is: 1.25 This answer should be used as a comparison to the bank’s minimum debt ratio coverage.
There is no doubt that the real estate market is changing for the better! The economy has come a long way from its former deteriorating state almost a decade ago. This now gives property buyers tons of options that weren’t always available. Who says that you can’t find a great deal on the apartment building? The truth is that anyone can! Once an individual uses the three key ratio metrics, then discovering amazing apartment deals won’t be problem!