When analyzing a potential multi-family acquisition, knowing all your going-in cap rates helps inform purchase price. It may mean more wiggle room in negotiations and generally gives the purchaser a better understanding of the opportunities, especially with value-add. It also may be relevant if you plan to have key changes to ongoing expenses.
- Using raw historical data (in-place) for rent and expenses (usually a T12).
- Using historical rent with manually adjusted expenses.
- Using historical rent with all T12 expenses with a +/- percentage applied to each.
- Using stabilized assumptions for rent and expenses (usually the highest cap rate).
Historicals vs. Stabilized Assumptions
| Aspect | Using historical NOI (T‑12 / Trailing‑3) | Using stabilized / pro‑forma NOI |
|---|---|---|
| Reliability | High—documented, audit‑able | Forward‑looking, subject to error |
| Reflects | Actual current performance; impacts of loss‑to‑lease, concessions, operating slippage | Future performance after executing business plan and market rent growth |
| Risk signal | Lower perceived risk → cap rate often lower (price higher) | Higher perceived risk → investors demand higher cap rate unless growth is certain |
| Lender view | Most senior lenders size on T‑12 or in‑place caps (DSCR tests) | Bridge / construction lenders may size on stabilized NOI |
| Equity underwriting | Helpful for downside protection (“what if we miss the plan?”) | Drives upside IRR; must be stress‑tested with sensitivities |
| Valuation pitfalls | Can undervalue a property with substantial mark‑to‑market rent upside or recent CapEx | Can over‑value if market rent growth, vacancy burn‑off or expense savings are too optimistic |
| Tax & insurance resets | Usually ignored in seller’s T‑12, so buyer should adjust | Must explicitly model new taxes, insurance and payroll under buyer ownership |
Why the distinction matters in multifamily deals
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Illiquidity premium & pricing transparency
Multifamily trades are frequent, and brokers quote cap rates routinely. Knowing which cap rate you hear—T‑12 or stabilized—prevents paying “pro‑forma pricing” for sub‑performing income. -
Debt sizing & structure
Permanent agency loans (Fannie/Freddie/HUD) are constrained by DSCR and LTV tests that reference current NOI. If your purchase price implies a thin T‑12 cap, you may need more equity or bridge debt—even if your stabilized cap looks healthy. -
Return decomposition
‑ T‑12 cap drives current cash‑on‑cash.
‑ Stabilized cap underpins value‑creation IRR.
Blending the two clarifies how much of the return comes from yield vs growth. -
Exit strategy & reversion cap
Buyers often sell once the asset is stabilized. If you enter at, say, a 4.5 % T‑12 cap that will become a 6.0 % stabilized cap on your cost basis, prospective buyers at exit will see a 5.0 %–5.5 % in‑place cap—supporting a higher valuation multiple.
Best practices for analysts
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Always quote cap rates with the income basis (“We’re paying a 4.4 % cap on T‑12 and a 5.6 % on Year‑3 stabilized NOI”).
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Adjust historicals to reflect buyer reality—true property taxes, insurance, payroll, management fee, reserves.
Stress‑test stabilized NOI by:
- slower lease‑up, higher turnover;
- softening rent growth;
- expense inflation.
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Reconcile to sales comps that cite cap rates—confirm they are apples‑to‑apples (often brokerage flyers use forward‑12 NOI).
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Present both lenses to investors and lenders so risk and upside are transparent.
Key take‑aways
- Going‑in cap rates are not one‑size‑fits‑all; they vary with the NOI definition chosen.
- Historical (T‑12) caps emphasize certainty and lender support but can ignore upside.
- Stabilized caps capture business‑plan value creation yet carry execution and market risk.
- A disciplined multifamily underwriter computes both, applies realistic adjustments, and makes investment decisions on the spread between where the asset is today and where a credible plan can take it tomorrow.
