If you are a real estate investor in the areas of North Dallas, Plano, University Park, Southlake or this general region, you should know that this area has been touted as the hottest in the national real estate market for 2017. It is due to the cost of living and the prices for rentals, the diversity of industries and the strength of the job market.
What it means to an investor is simple: this is a perfect spot for real estate investing of any kind, but most especially rental properties. Common logic dictates that one of the safest investments in residential real estate is the multi-family property. This is due to a simple fact – it is rarely going to be at risk for 100% vacancy. With an apartment building, you can still count on solid monthly income with a few vacancies or tenants late with rent. With a single-family home, this same scenario (vacant or late on rent) means 100% vacancy.
Naturally, this does not mean that every single multi-family or apartment building is the best deal or choice for your investment goals. In fact, we have three metrics that are more likely to help you find amazing apartment building deals than just basic assessments.
The Cash on Cash Return
How much cash will you get back each month for your investment on the apartment building? This is the cash on cash return. It is the amount of money after every possible expense has been considered. You divide this by the total amount invested.
As a simple illustration: a property has annual cash flow of $30k. You invested $200k into the purchase. That means that you divided that $30k by $200k invested to find your cash on cash return is 15%.
What is a good return? Experts say that a property with 90% occupancy should yield a cash on cash return of nothing less than 12%.
The Risk Level of the Apartment Building
Typically, this is known as the debt service coverage ratio and it is going to often reveal whether or not you can get financing to make the investment. The debt service coverage ratio looks at the NOI or net operating income versus the annual debt service (interest and principal) you must pay.
As a simple example, you have a building with a net operating income of $40k, and its debt service each year is $30k. The debt service coverage ratio is figured by dividing the NOI by the debt services, and getting a 1.3 ratio. Most banks want to see at least a ratio of 1.25 to be comfortable with the amount of risk in such an investment. The safer level is 1.5.
The Cap Rate
Finally, you need to know the fair market value of the apartment building. That means knowing is NOI as well as the cap rate. The NOI, we already know is the amount of income after all expenses (but usually not including debt service). The cap rate is a multiplier used on the NOI to figure the value of the building.
It is a strange and bit confusing concept, and represents the return on the apartment building if you bought it with 100% cash. You calculate it as a ratio by dividing NOI by the value or price of the building. However, you might often receive the cap rate from your broker, and hear it in terms of the typical cap rate for buildings in a specific area of North Dallas or Plano.
You will usually want a cap rate of 8% or more. You can then use that to determine the fair market value for any apartment building. You do this by dividing the NOI by the cap rate. So, the building that has an NOI of $40k and a cap rate of 8% would be worth $500,000. If it is much lower or higher than area comparables, you need to understand why before making the investment.