Jonathan Cronin walks through net operating income as the key metric for evaluating apartment deals. He shows how to calculate NOI from market rents minus a 50% expense ratio, then apply a cap rate to find the property's stabilized value and your maximum offer price.
Questions this video answers
Market rents; unit mix; expense ratio (speaker recommends 50% as a conservative assumption); renovations needed (total dollars).
$1,200 per month.
32 units.
50%.
$38,400 per month (spoken).
Hey, what's up guys? So today I want to talk to you about the most important factor that you need to be looking at. The most important number that you need to be looking at in buying apartments, especially when it comes to using investors, but really just in, in total, like in overall. And so basically I want to break down in this video exactly how I determine whether a good deal, whether a deal is a good deal or a bad deal, and how to get the time wasters off your desk. But first, let's tackle that point. I'm gonna share my screen here in a second and walk you through the exact formula so you can understand what your deal looks like in that life. Okay, but number one, what is the most important metric? Now I feel like I get so many people who, you know, I, I see teaching on, on, on these types of things. And here's some people say it's the interest rates, right? Interest rates are most important. Well, that's true there. It is extremely important because when you get into these deals, it's definitely a financing game. You need to understand how to make the deal work with the current financing. But, and if it's high interest rates, it could literally say whether it's a good deal or not just based on interest rates. Right? And that's what we've currently been facing in the market. But at the same time, if the deal is good enough and the price is low enough, we can still have high interest rates. Right? So at the end of the day you could say, well, to solve that, you just need to learn how to find really good deals, how to go through a lot more leads, how to reach out to more people, how to get more off market deals. And the other people, you know, you may say it's the price or the cap rate or you know, I think Grant Cardone says it's the number of units. And, and you know, by the way, the, what he really means in that is, is that one of the greatest factors in creating appreciation, right? And, and hedging against downturns is a number of units. But you can still have a very unprofitable large property. So today, so the number one metric you need to focus on is going to be your noi. And the cap rate is right with that. But we need to know, just like any business out there, it's valued based on your net operating income, okay? It's normally a multiple of your net operating income. In apartments, it's your net operating income divided by your cap rate. So we're going to talk about that for A second. We're going to break this down for just a few minutes. And basically, your noi stands for net operating income. It's income minus your expenses equals your net, your profit or your net operating income. This is before debt, before capex capital expenditures. And this is how apartments are valued, just like a business. Okay, so I'm going to share my screen. I'm going to walk you through a scenario so you can have a context for what I'm telling you. Okay, so what's needed to really understand the value of a property? First, need the market rents, because we're valuing a property based off of what we feel like we can get in the near future. And then we back out a discount to really understand what we can pay today based off what we can raise the rents to, based off what we can renovate the property to. That's how we're valuing the property. So only four things needed. Market rents, unit mix, expense ratio, or just assume 50% to be conservative, you know, and then once you go into a deeper analysis of the property, you feel like you may be in the right ball game as far as price. Then we can get a little bit more granular and a little bit more accurate on the expenses. But 50% is a good conservative number. Renovations needed. Okay, so those are the four metrics needed. Okay? Market rents, unit mix, which is unit mix is just how many? Two, one. Two bedroom, one bath, one ones, all that stuff. But you could just say a total of 32 units. Okay, and then how many renovations? All right, and you also would like to know your market cap rate, and you can find that out on Google. You can talk to a commercial mortgage broker, you can talk to a bunch of people to find that number. But let's just suppose market rents for a Particular property is $1,200. Unit mix is 32 units. Expense ratio is 50%. Renovations needed is 160. Now, here's the calculation. Here's how we find out what is our maximum allowable offer. It's all centered around this noi. Okay? You need to know what kind of profit you're getting and then what kind of market cap rate. So $1200 a month times 32. That gives you $38,400 per month times 12 months in a year. All right, you got 460,000, which is represented right here. That's your gross potential rent. Okay? Now what you need to do is back out your expenses. So you're going to, minus your 50% in expenses, you got $230,000 an NOI. Okay. That now we can determine if you, somebody said if you can just give me the noi and the address, I'll tell you what it's worth. Okay. And that's very true because you can look up as far as renovations, how do you determine renovations? You can look at reviews, you can look call the plays, you can, you can call around the area, you can look on Google photos, you can do all kind of stuff. Now the noi next step is divided by the cap market cap rate. And again I already told you how to get that. If you want to know more of how you can find out the cap rate in the market, you let me know. It's not the property cap rate. Just because the seller says it's a cap rate of this much doesn't mean that's the market future value cap rate you could sell this for in the Future. Okay, so $230,400 divided by. Let's just suppose it's a 7% cap rate in the market. We're at a stabilized value fixed up value of 3.2 and 1. Then we want to back out a discount because we're not buying it for. We're not buying it based on the price in the future. We're buying it based on right how it is right now, but the opportunity. So we need a discount to be able to make sense of our time investing in this and taking this deal down. Right. So 3.2 times 78% total cost basis all in cost basis is going to be 2.5. So this is what more likely the loan would be around. If you have one loan. Okay. And then all that's left is to take that total cost basis, subtract your rental cost which was 160,000 and you got 2.4 million. That is what you're going to offer the seller. And we do more videos on how to make sense of the how to negotiate with sellers and we'll do some more in the future. But I hope that helps. Just get. I just wanted to jump on here and give you a quick overview of the most important metric being your NOI and how to factor that in why it's so important. So guys, I hope that helps. Didn't have a whole lot of time today but let us know what other topics you'd like to be covered and we'd love to help you out. Otherwise would love to talk soon. God bless.
