Appraising Commercial Apartments

General Real Estate Investing
21

Scott,

The last time I heard this much wrong with anything, Ann Coulter was speaking.

Purchase Capital Contributed x Interest = Rate That is WRONG. If you would like to know the correct formula, refer to Sean’s post. The band of investment method may not be “actively prescribed to” by loan officers but it certainly is with investors.

Not to play the semantics game but determining a cap rate from comparable properties is called the “market extraction method”, not “comparable sales approach”. Debt to equity ratios plays a quiet role in all property valuation, in the band of investments method, it simply shows how a cap rate is derived from backing into it using MORE precise individual information.

It’s blantantly obvious that you are not familiar with income capitalization and have a dyslexic elementary education in it.

22

I don’t know what to say to the fact that you give this advise to your customers, except that you are doing them a great disservice.

I know, and I am also very aware of the 3 different approaches to value you are speaking of. Except you left out one and its called, “Highest and Best Use”.

I am not going to speak on band of investments except to say that you might want to read up on it. I do not think, “band of investments” is the best approach to capitalization but, I do think it is the best way to acquaint a beginner with the process.

As far as NOI/Value = Cap this is a true statement on your part if you have actuals and that ratio meets your needs as an investor when you evaluate it.

Lets talk about cap rate derivation. There are three main ways to calculate a cap rate. Those are Band of Investments, mortgage equity analysis, yield capitalization. Of these three I prefer yield capitalization because it incorporates NOI growth, property growth, amortization and selling expenses and it’s an easier calculation than mortgage equity analysis.

Also remember that NOI/Value is an extraction method and not derivation method.

23
I'm trying to determine the equity, which you said you care about. "What I care about is how much cash flow and equity I will actually get with a building" by Property Manager. But how do you determine the equity not just for you but also for the lenders, if not the way we have discussed?

Iron Range,

I have looked at literally hundreds of properties in my local area. I know the market value of property in my area. For example, I know that duplexes in my area have a market value of $80K to $90K, depending on the condition and exact location. Therefore, when I buy one for $45,000, I know that I’m buying it at least 44% below market value. Likewise, I know 6 unit buildings sell at retail between $190K and $240K. I paid $88,500 for my last 6 unit building. Did I buy at a discount? Yes.

That’s basically what Sean is saying when he says ask appraisers in your area and get the average unit price. That’s what I’m doing, except I trust myself more than an appraiser - after all, I’m spending my money (credit), the appraiser isn’t spending his.

You don’t have to know the cap rate to get the loan. What you tell the bank or HML is irrelevant. They will order their own appraisal. If you know the values in your investment area and buy at a steep discount, then the appraisal will come back fine. I don’t need any hocus pocus to determine the value of a property.

Mike

24

Property Manager,

I should have specified in the beginning that I’m not looking for anything useful like cash flowing a property. I just want to know what an appraiser does when they go through a commercial property. That way I don’t pay money for an appraisal that comes back at 72% of market value, only to have the HML’s so no thanks. To me the most important thing is the cash flow (Money In Vs. Money Out). For myself, I’m running the numbers to see what the deal looks like.

I’m not really concerned about knowing the cap rate for my area, except for the fact that I need an appraisal to come in at 65% or below in order to get the loan through. So I will have to learn the cap rates in the areas because I only want to pay for an appraisal if it has a chance to come in at 65% or below.

I need to cash flow a property, but to get a loan through I should probably try to focus on what an appraiser does. But it sounds like there isn’t a specific method that any one appraiser uses.

25

Comparable sales approach or market approach are the common terminologies—boy are we splitting hairs…

Although the BOI method gives the impression of accuracy, it falls short in “accurately” depicting the following components:

  • Equity Accumulation
  • Costs up and above of nominal equity
  • Changes in value and annual income during the lifetime of the investment
  • Expenses incurred as result of selling
  • Holding period

While it is possible to calculate all of these variables, the true rate of return is hidden. Do either of you know why?

Do you really believe that this is a cakewalk for a beginner making significant value decisions for the first time?

How can you advocate a system that is based upon both the financing and equity components being infinite (that mortgage payments will last forever and that the property will never be sold)?

The bottom line is that the BOI method is grossly flawed and hence not recognized as a defacto means of evaluating income properties (It was an early attempt before the advent of both computers and the income captilization method).

You are both free to use BOI, OPP, QRS or whatever makes you feel holier then though, but I will continue to use the same formulas used by those that have the money (the banks). Call me bonkers, but I’ll take the universally prescribed to principals (that get projects funded) over the abacus and crystal ball anyday.

I respectfully agree to disagree and leave you two to carry this torch without me.

Regards,

Scott Miller

26

The appraisers all should be using the same methods, but if you hire 5 appraisers to appraise a property, I guarantee that no two will come in the same. That’s because an appraisal is only someone’s opinion of value, not a factual calculation.

The problem with this entire cap rate voodoo, is that everything is a variable. Who gets to decide exactly what the cap rate is for an area? Who says what the NOI is for a given property? We know that NOI = gross rents minus operating expenses, but whose numbers are you using? Does the seller give you the NOI? Do you use a percentage of gross rents as operating expenses? Does the mortgage broker or the appraiser get to determine the expenses or the gross rents?

On Friday, I met the seller and the appraiser at the buildings that I am currently buying. The appraiser asked what the rents were for the building. She didn’t ask to see leases or any documentation. The seller could have said anything within reason and the NOI was based on these numbers! Garbage in, garbage out!

Mike

27

I guess so far the only thing we’ve truely established is that appraisers and cap rate are worthless. So if you were a worthless appraiser then what would be your method in appraising a commercial apartment? I don’t care if the method is worthless, I only care that the result will be close to what an appraiser would say.

If you could use the numbers given in the above example that would really help. Also I would be interested in knowing the unknown variables that I may have to know depending on the area? Thanks!!!

28

Scott,

Seems like you did some research to try to figure out what you were talking about. However, it has occured to me you think “income capitalization” is nothing more than the simple direct cap formula and everything else is something strange, exotic, unreliable and seldom used or accepted.

Under the category of the “income capitalization approach” there are 3 subcategories;

Direct Capitalization - Capitalization rates
Yield Capitalization - Discount rates
Debt Equity Analysis - Annuity rates

Under each subcategory, there are several methods and technique for determining each rate. I won’t go into the last 2 because mortgage brokers are apparently easy to confuse. :kiss

Widely understood Methods of Direct Cap:

  • Band of Investments
  • Market Extraction
  • Land Residual
  • Building Residual
  • Capital Recapture and Return

Direct capitalization as a whole provides a snapshot of the property. To say the BOI method is bad because it doesn’t account for;

[i]- Equity Accumulation

  • Costs up and above of nominal equity
  • Changes in value and annual income during the lifetime of the investment
  • Expenses incurred as result of selling
  • Holding period[/i]

is like saying direct capitalization is garbage entirely. You frown on looking into a crystal ball or estimating the future, then frown on the BOI method because it doesn’t provide the above. Which direct capitalization method are you familiar with that breaks down any of what you listed? Maybe you can rewrite appraisal textbooks and teach those dumb old MAI’s a lesson.

I would not make a purchasing decision based solely on direct capitalization no matter where the cap rate came from. Cap rates are quick qualifers that if you know how to use and apply to your situation, do what they are intended for from the prespective of an investor.

You must not do a lot of commercial loans or look at the narrative reports…

29

Let the fight go, everyone here knows the three of you are knowledgeable, you’ve all proved that many times over.

Can you show us how an appraiser would evaluate the 16 unit deal listed earlier? Using the example with numbers will help Vs. just using terms and definitions.

Thanks!!!

30

I’d let a fight go if I was dead, out of bullets, or when there are no more enemies. This, is not a fight. If Scotts factually incorrect comments went uncontested, readers might think it was correct.

The subject of income capitalization cannot be covered in any level of detail in a forum. An appraiser would make the judgement on which method to use given the situation. There is no short answer. When I order an appraisal for a commercial property, I have the appraiser apply several techniques so I can look at the property from different angles.

An easy way for YOU to evaluate a property before you decide it’s worthy of putting it under contract is direct capitalization. The band of investments method will give you a cap rate based on your financing situation and return requirements. I can’t see your example in the “Topic Summary” so I can’t show you how it works.

31

That’s funny, it sure seemed like a fight. A cat fight anyway. :biggrin

32

EZLOAN, EZLOAN you did not read my last post before you did your research. :banghead
I stated that yield capitalization is the preferred method by meself and many REITs across the country for that matter. Yield capitalization does take into account the things you listed, and thats why its preferred. It is also very technical and not for beginners who don’t understand the six functions of a dollar and how they are applied to real estate.

BOI is a good method for a quick evaluation that with a little knowledge of the market can be very useful. Is it widely used in appraisal?..No The reason is simplicity and documentation. It’s easier to explain your value decision based on past sales than assumptions your making about the market. Which, is what an investor does with value. Appraised value and investment value are not the same. Appraisers try to explain the market while investors (buyers of real estate) make the market decisions. Market extraction is the preferred method for appraisers MAI and alike if the data is available. If the data is not available they will use other methods to arrive at a market value…ie Cost & Income

Mikes approach makes sense Iron. The reason it does is because where he likes to buy. We can not give you a real idea of value without knowing your market. Look at sales in your market and that will tell you all you need to know.

10 units @ 100,000(market value) = $1,000,000

NOI = 100,000

Cap = .10(within market range via sales)

I want an equity position of 20% and I have 5% of my own. I also want a total return of 13.33% and an equity return of 15%. With that said, I would need to buy it for $750,000. I need to buy it at $750,000 because $100,000/.13333333 = $750,000.

Does it meet my equity return requirement?

Remember BOI, well here it is applied. I have a mortgage interest rate of 8.00% and a mortgage constant of 9.262%. You now have debt service a year at $69,463 on $750,000 and a CFBT of $30,537 a year for a total return on equity of $30,537/$250,000 = 12.21% or your return on invested equity $30,537/$50,000 = 60.07%.

BOI = .09262(.75) + .1221(.25) = .06947 + .03053 = .10

I had to change the last part of this post because I was way off on my analysis. I apologize for the misinformation, I was tired last night when I wrote it. If I made any other mistakes please correct me but, I think we are fine.

33

oy…
this topic is too broad. why don’t you educate yourself on the basics of commercial RE investing before posting stuff like this? try this book… it helped me a lot:

http://www.amazon.com/gp/product/0071422579?ie=UTF8&tag=xanga04e-20&link_code=as3&camp=211189&creative=373489&creativeASIN=0071422579

34

Basics? Listen genius I know the basics. I was asking for a quick formula that others use to get a reasonably close estimate of what an appraiser would come up with. I’m not looking for a complicated system so I can become an appraiser. I buy at great discounts, so I have never cared how/why an appraiser does their thing. I only care about “Cash in Vs. Cash out” and maybe a rough estimate on what it is worth. I know my market so I can easily estimate 1-4 unit properties, but it is a little tricker when you’re looking at estimating larger apartments. I recently started using a HML for large apartments. As you “may” know most HML are real particular on what the appraiser thinks. I don’t care what an appraiser thinks, only the cash flow (which by the way is all that really matters). But I don’t want to have pay for an appraisal just to have it come back at 70% when I need it below 60% (role in closing costs).

Thanks for the link, I’ll take a look.

35

The fundamental difference between this argumet is the difference between an investment’s future value and current value.

Appraisers give an opinion of value for a given property in the present tense. Their value of what it is worth today. Yield capitalization gives you an idea of what the future value of the property may be. It’s really a totally different, and to an investor, more important way to value properties.

Here’s an example.

Lets say you’re buying Gold on the mercantile exchange. Lets say today it closes at $700 an ounce. That $700 an ounce is what an ‘appraiser’ would say. He would give you the value right now. However, chosing to invest in it really has to do what what it will be worth tomorrow not today. So if it’s worth $800 tomorrow it’s a great investment, if it’s worth $600 it’s a terrible investment. So the bottom line is one method is used for lenders (of which I am one) to determine to lend on a property today. The other method is used by investors to determine if it’s a good value tomorrow.

Do not use the method that lenders use to compute whether something is a good investment or not. Our profit points are far different than investors. Lenders work in a vacuum and investors work in context. I say that to people all the time and after a few moments of explanation they usually get what I mean.