Testing a 12-Unit Apartment Price Against NOI, DSCR, and Cash-to-Close
An investor is under contract to buy a 12-unit apartment building for $1,650,000. The rent roll shows 12 units at $1,150 per month; market vacancy and collection loss is 6%; laundry income is $4,800 per year; operating expenses are $71,000 per year. The buyer’s appraiser uses a 7.0% capitalization rate. The buyer plans a 70% loan-to-value loan at 6.5% annual interest with 25-year amortization, 2 discount points, and $18,000 in closing costs. The lender requires a minimum debt service coverage ratio of 1.25. The buyer has $600,000 in cash and wants to know whether the deal works before the financing contingency expires. The property has no other income, and the expense figure includes no capital reserve.
1. Compute net operating income, the value indicated by the 7.0% cap rate, and the cap rate implied by the $1,650,000 asking price. What do the numbers show?
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Gross potential rent: 12 units × $1,150 × 12 months = $165,600.
Vacancy and collection loss: 6% × $165,600 = $9,936.
Effective rental income: $165,600 − $9,936 = $155,664.
Effective gross income: $155,664 + $4,800 laundry = $160,464.
Net operating income: $160,464 − $71,000 operating expenses = $89,464.
Indicated value at 7.0%: $89,464 ÷ 0.07 = $1,278,057, rounded to about $1,278,000.
Implied cap rate at the asking price: $89,464 ÷ $1,650,000 = 0.0542, or 5.42%.
The asking price is about $372,000 above the income-indicated value, and the buyer would be accepting a 5.42% return when the market supports 7.0%. That is a material pricing gap, not a rounding difference. The NOI is also optimistic because it contains no capital reserve for roofs, HVAC, or turnover.
2. Compute the monthly loan payment, annual debt service, and DSCR at the contract price. Does the property meet the lender’s 1.25 requirement?
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Loan amount: 70% × $1,650,000 = $1,155,000.
Monthly payment at 6.5% annual, 25 years (300 months): use the amortization factor for 0.065 ÷ 12 = 0.0054167 and 300 periods. The payment factor is about 0.006752 per dollar of loan.
$1,155,000 × 0.006752 = approximately $7,799 per month.
Annual debt service: $7,799 × 12 = approximately $93,588.
DSCR: $89,464 ÷ $93,588 = approximately 0.956.
The property does not meet the 1.25 requirement; it does not even reach 1.00. Annual NOI falls about $4,100 short of debt service before any capital reserve. The lender will reject this loan as structured, and the buyer would have negative cash flow even if approved. Adding a capital reserve would make the shortfall larger.
3. What maximum purchase price would produce a 1.25 DSCR using the same loan terms? How does that compare with the income-indicated value?
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Maximum annual debt service: $89,464 ÷ 1.25 = $71,571.
Maximum monthly payment: $71,571 ÷ 12 = approximately $5,964.
Maximum loan amount: $5,964 ÷ 0.006752 = approximately $883,300.
Maximum price at 70% LTV: $883,300 ÷ 0.70 = approximately $1,261,857, or about $1,262,000.
That is close to the $1,278,000 income-indicated value. The lender’s DSCR constraint is slightly tighter than the 7.0% cap-rate valuation, which is common when debt is priced at 6.5% with 25-year amortization.
Cash to close at the contract price: down payment $495,000; points 2% × $1,155,000 = $23,100; closing costs $18,000; total $536,100. The buyer has $600,000, leaving only about $63,900 for reserves. At the DSCR-supported price, the down payment would be about $378,600 plus points and closing costs, leaving a much safer reserve. The contract price fails both the income and the debt tests.