Using Cap Rates To Value Multifamily Rental Properties

When potential buyers seek financing to acquire a multifamily rental building in an urban area, the obvious first question is the value of the underlying asset. Prospective borrowers and lenders determine this value using different methods, but a widely accepted method is to use a capitalization rate.

Use of a cap rate allows parties to efficiently evaluate whether the asking price for a property is justified by the income it generates. As contrasted with the other traditional approaches to valuing real property, such as the cost approach and the sales comparison approach, using the cap rate method does not require the same level of time-intensive research on replacement costs, depreciation, and comparable sales. When using this approach, however, prospective borrowers need to be mindful of certain issues that make multifamily rental buildings in urban areas particularly difficult to value.