How to work out your maximum offer on an apartment building

The short version

1. Find the net operating income (NOI) today from the rent roll and the T-12, adjusted for what changes when you buy.
2. Estimate the NOI after your renovation and lease-up.
3. Divide that NOI by a cap rate to get the value after the plan.
4. Subtract the renovation budget, closing and loan costs, lost rent and the profit you need.
5. What is left is your maximum offer. Then check it against the loan and a worse case.

Step 1: net operating income today

NOI is the rent and other income you collect, minus the costs of running the property, before the loan payment. Start from the T-12 and the rent roll, checked as in How to analyze a rent roll. Then fix the lines that change when you buy:

• Property taxes are often reassessed after a sale. Use the tax on your purchase price, not the seller's bill.
• Use a real insurance quote for you, not the seller's policy.
• Include a management fee even if the seller manages the property alone.
• Set money aside each year for replacements, often called reserves.

Step 2: income after your plan

Stabilized NOI is the income once the work is done and the units are leased. Base any rent increase on listings of renovated units nearby that you checked yourself, not on the marketing package. Raise expenses too where the plan adds them, such as a new amenity to maintain.

Step 3: value from NOI and a cap rate

The cap rate is NOI divided by price. Turn it around and value is NOI divided by the cap rate. Get cap rates from recent sales of similar buildings in the area, through a broker or appraiser. Many buyers use a cap rate a little higher than today's for the future sale, so the plan still works if the market softens.

Step 4: subtract what it takes to get there

Everything you spend between buying and stabilizing comes off the value, along with the profit that makes the work worth doing:

• The renovation budget, with its allowance for surprises. How to estimate renovation cost per unit shows how to build it.
• Closing costs, loan fees, and the cost of reports and inspections.
• Lost rent while units sit empty for work.
• The profit you require, as an amount or a share of the value.

Worked example

Example a 40-unit building. Every number below is made up to show the arithmetic. The renovation budget is the high end of the example in the renovation cost guide.

In this example the maximum offer is $3,322,584, about $83,065 a door. If NOI today is $240,000, that price is a going-in cap rate of about 7.2%. An asking price above your maximum is not a reason to stretch the inputs. It is a reason to negotiate or walk away.

Step 5: check the loan

Your lender sizes the loan on its own tests, such as a share of the price (loan to value) and how many times the NOI covers the loan payment (debt service coverage). If the lender will lend less than you planned, you need more cash, and your real maximum may be lower. Your lender will also want a scope of work and budget, covered in Renovation scope of work and draw schedule.

Step 6: test a worse case

Change one input at a time and see how far the maximum moves: a sale cap rate half a point higher, rents a little lower, an interest rate a point higher, or a renovation that runs over budget.

Example the same building at a 7.5% cap rate. Value falls to $4,200,000, the 15% profit becomes $630,000, and the maximum offer falls to $3,067,584, which is $255,000 less.

If a small change wipes out the deal, the margin is too thin. For a fuller answer, model the hold year by year with the loan, and solve for the highest price that still meets your target return. That is what a deal model does.

Common mistakes

• Using the seller's taxes and insurance instead of yours.
• Pricing the renovation as one number per door without walking the units.
• Using the same cap rate for buying and selling.
• Leaving out lost rent and the cost of the loan.
• Starting from the asking price and working forward.

How DoorWalk does it

DoorWalk does this math in code from your own inputs. The renovation budget comes from your walk, priced from a cost table by market. Rents and expenses can come from the rent roll and T-12 you upload, each value showing the page it came from, and you confirm them. The deal summary then shows the highest price that still reaches your target return, starting from a 15% assumption you can change to 12% or 18%. A stress test runs the deal with the interest rate 1 point higher, rents 5% lower, the sale cap rate 0.5 point higher, the renovation 20% over budget, and all four together, and shows the highest price that still works if everything goes worse.