By Noah Birk, Broker
In a business where crunching, analyzing and re-analyzing numbers is at the core of every deal, one number separates itself from the rest:
(Net Income) / (Sale Price) = Capitalization Rate
Although cap rate is the first thing the vast majority of investors coming to the South Side ask about, apartment investors (especially new ones) need to realize that cap rate usually isn't the most reliable parameter when analyzing an investment. The most important thing is to analyze return on investment and maximize your position. Too many investors simply look at the cap rate to determine the viability of the investment.
It’s never quite that simple though. As much as I’d like for every buyer to accept broker-underwriting as perfection, the fact is that every owner operates their building very differently. Some owners pay 5-10% to a third-party management company, while others personally scrub the floors with a toothbrush. When you begin analyzing the soft costs of a building (expenses other than taxes, insurance and utilities), these numbers that can dramatically affect cap rates. Determining those numbers on an individual and independent basis is essential to making savvy investment decisions.
As a broker, I’ve looked at the numbers on hundreds of buildings from a wide variety of owners. I am challenged with trying to find an average for soft costs that are estimates for both the he third-party management investor as well as the toothbrush owner. My goal is always to portray the most accurate estimates of soft costs on a given property; however, investors (especially new ones) need to thoroughly dig into these numbers themselves to fully understand how these numbers are going to play out when they take ownership of their new building, given how they intend to manage and operate the property being analyzed.
The South Side of Chicago is a real estate market primed for cash flow; but too often new and out-of-market buyers get lost in the enticing cap rates it has to offer. I strongly encourage new buyers in this sub-market to have multiple in-depth conversations with current south side owners, property managers and brokers. You need to make sure you understand how the property will operate with your individual style, what that will cost, and how that will affect the cap rate and value of your individual investment. It’s an exciting and rapidly changing era on the south side – just make sure you have all of the knowledge you need to make it a profitable one for you, as well.