How buyers value an apartment building
Houses are priced mostly by comparing them with similar homes that sold nearby. Apartment buildings of five units or more are priced mostly by the income they produce. A buyer is paying for a stream of rent, so the question becomes: how much net income does the building generate, and what return does the market expect on that income?
That return is the capitalization rate, or cap rate. It reflects the local market, the age and condition of the building, the tenant base and the level of risk a buyer sees. Dividing net operating income by the cap rate turns one year of income into an estimated price.
The formula, step by step
The calculator works through the same sequence an underwriter would:
- Start with gross annual rent: the rent roll for all units over twelve months.
- Subtract the vacancy allowance: gross rent multiplied by your vacancy percentage.
- Add other income such as laundry, parking, storage or pet fees. The result is effective gross income.
- Subtract operating expenses, entered either as a dollar amount or as a percentage of effective gross income. What remains is net operating income (NOI).
- Divide NOI by the market cap rate, written as a decimal. That is the estimated value.
- The calculator repeats the division at your cap rate minus 0.5% and plus 0.5% to show a range, and divides value by your unit count if you enter one.
A worked example
Take a 20-unit building with $300,000 in gross annual rent. A 5% vacancy allowance removes $15,000. Laundry and parking add $15,000 back, so effective gross income is $300,000. Operating expenses run 40% of that, or $120,000, which leaves NOI of $180,000.
At a 6% cap rate, $180,000 ÷ 0.06 gives an estimated value of $3,000,000, or $150,000 per unit. At 5.5% the same income supports about $3,270,000; at 6.5% it supports about $2,770,000. Half a point of cap rate moves the value by roughly half a million dollars on this building, which is why the range matters as much as the single number.
Reading your results
Treat the estimate as a starting point for conversations, not a final price. The cap rate you enter carries most of the weight, so use one drawn from recent sales of comparable buildings in your area, or ask a broker what similar properties are trading at. A lower cap rate means a higher value and usually reflects a newer building, a stronger location or more stable income. A higher cap rate reflects more risk or more work ahead for the buyer.
Price per unit is a useful cross-check. If your result lands far above or below what similar buildings have sold for per unit, revisit your expense figure and your cap rate before relying on the number.
Mistakes that inflate or deflate the estimate
Most gaps between an owner’s estimate and a buyer’s offer trace back to a few inputs.
- Using asking rents or pro forma rents instead of rents actually being collected.
- Entering zero vacancy. Buyers will apply a vacancy allowance even to a full building.
- Leaving out expenses the owner handles personally, such as management or routine repairs. A buyer will budget for them.
- Using last year’s property tax bill when a sale will trigger a reassessment in your state.
- Subtracting mortgage payments. Debt service is not an operating expense and does not belong in NOI.
- Picking a cap rate from a different market or a different class of building.
