Anyone who wants to get into real estate investing will usually start with the simplest option. While you have a lot of options to choose from, single family homes are the usual go to, because they are usually the most affordable for first time investors. In addition to single-family homes, you have duplexes, apartment buildings, office buildings, strip malls, etc. Similarly, there are many a multitude of ways to invest: real estate flipping, wholesale dealings, buy-and-hold, and everything in between.
Why not start with apartment buildings? Unlike single family homes where value is simply based purely on market demand, apartment buildings are valued by the cash flow and expenses. The value of an apartment building is calculated by a value formula: Purchase Price= Net Operating Income (NOI) / Capitalization (CAP) Rate.
CAP rate? What the heck is a CAP rate? Well,. mathematically speaking, CAP = NOI / Purchase Price. The CAP rate is the ratio of a property's net operating income to its purchase price. , the CAP rates of properties will be within a narrow range. As a general rule, the higher the CAP rate, the higher the risk. Inversely, the lower the CAP rate, the lower the risk. Plus, the lower the cap rate, the more of an effect changes in the NOI will have on the value of the property.
The ability to affect the CAP rate is what makes apartment buildings more lucrative. In a 20 unit building, raising the rents just $10 per unit will increase the gross income by $2400 per year. As an example, if the CAP rate it 5%, and the NOI goes up by $2400, that could raise the building's value by a whopping $48,000! ($2400 NOI / 5% CAP rate)
This ability to make small changes in rent with increases, or decreasing expenses over many units is what makes multi-family the best choice for those looking to create value in their property portfolio!