How to Calculate the Pro Forma Cap Rate for a Multifamily Property
Calculating the pro forma cap rate for a multifamily property is a vital step in assessing the potential return on investment. The pro forma cap rate uses projected financial figures to estimate future performance. Here’s a step-by-step guide on how to calculate the pro forma cap rate:
![Closeup shot of an unrecognisable businesswoman calculating finances in an office Closeup shot of an unrecognisable businesswoman calculating finances in an office](https://media.gettyimages.com/id/1330234595/photo/closeup-shot-of-an-unrecognisable-businesswoman-calculating-finances-in-an-office.jpg?b=1&s=2048x2048&w=0&k=20&c=Odf58Xx0qw5XzE5bumr21_F7pJb2YAEqN05GitP9fXU=)
#### Step 1: Project Gross Rental Income
Estimate the total rental income you expect the property to generate annually. This projection should consider factors like current rental rates, market trends, and expected occupancy rates.
- **Projected Gross Rental Income = (Monthly Rent per Unit x Number of Units) x 12**
#### Step 2: Estimate Additional Income
Include any additional sources of income the property might generate, such as:
- Parking fees
- Laundry facilities
- Storage rentals
- Late fees
- **Total Additional Income = Sum of all additional income sources**
#### Step 3: Calculate Effective Gross Income (EGI)
Subtract the projected vacancy and credit losses from the total projected income (gross rental income + additional income) to get the Effective Gross Income (EGI).
- **Effective Gross Income (EGI) = Projected Gross Rental Income + Total Additional Income - Vacancy and Credit Losses**
#### Step 4: Estimate Operating Expenses
Project all the operating expenses associated with managing and maintaining the property. Common operating expenses include:
- Property management fees
- Maintenance and repairs
- Property taxes
- Insurance
- Utilities
- Administrative costs
- **Total Operating Expenses = Sum of all operating expenses**
#### Step 5: Calculate Net Operating Income (NOI)
Subtract the projected operating expenses from the Effective Gross Income (EGI) to determine the Net Operating Income (NOI).
- **Net Operating Income (NOI) = Effective Gross Income (EGI) - Total Operating Expenses**
#### Step 6: Determine the Property's Market Value or Purchase Price
Determine the estimated market value or purchase price of the property based on comparable sales, market trends, and property appraisals.
#### Step 7: Calculate the Pro Forma Cap Rate
Finally, calculate the pro forma cap rate by dividing the projected Net Operating Income (NOI) by the property’s market value or purchase price.
- **Pro Forma Cap Rate = (Projected NOI / Property Market Value or Purchase Price) x 100**
![African American Accountant Or Auditor African American Accountant Or Auditor](https://media.gettyimages.com/id/1338373163/photo/african-american-accountant-or-auditor.jpg?b=1&s=2048x2048&w=0&k=20&c=Bx8_kH4b1EkUDPf3FEU_HmC5duc67H9nIQOHPRgN3LM=)
### Example Calculation
Let’s say you’re evaluating a multifamily property with the following projected figures:
- **Monthly Rent per Unit:** $1,200
- **Number of Units:** 20
- **Annual Additional Income:** $10,000
- **Vacancy and Credit Losses:** 5% of Gross Rental Income
- **Total Operating Expenses:** $100,000
- **Property Market Value:** $3,000,000
1. **Projected Gross Rental Income:**
- Monthly Rent per Unit x Number of Units x 12 = $1,200 x 20 x 12 = $288,000
2. **Total Additional Income:**
- $10,000
3. **Effective Gross Income (EGI):**
- Gross Rental Income + Additional Income - Vacancy and Credit Losses
- Vacancy and Credit Losses = 5% of $288,000 = $14,400
- EGI = $288,000 + $10,000 - $14,400 = $283,600
4. **Total Operating Expenses:**
- $100,000
5. **Net Operating Income (NOI):**
- EGI - Total Operating Expenses = $283,600 - $100,000 = $183,600
6. **Pro Forma Cap Rate:**
- (Projected NOI / Property Market Value) x 100 = ($183,600 / $3,000,000) x 100 ≈ 6.12%
![Piggy bank with calculator Piggy bank with calculator](https://media.gettyimages.com/id/611086620/photo/piggy-bank-with-calculator.jpg?b=1&s=2048x2048&w=0&k=20&c=rckBm9XulUfj5RmJmkod9gVQiPsJR-eUsfVzDzhq5OM=)
### Conclusion
Calculating the pro forma cap rate for a multifamily property involves projecting future income and expenses to estimate the Net Operating Income (NOI) and then using this figure to determine the cap rate. This process helps investors assess the potential return on investment and make informed decisions.
For expert assistance in evaluating multifamily properties and securing favorable financing, consider consulting Atlantic Commercial Lending, a licensed commercial mortgage brokerage with NMLS ID #2429887.