hi to all, I have been searching for my first deal and i might have found but would like some insight. I have found a 29 unit apt. for sell @1,150,000 (asking price) they say the EGI is 176,400 and the yearly NOI is just under 88,000 is this goog if I am correct i would say that the building would be worth 1.7 million, your opinion is greatly welcomed. ???
islander,
Just a quick calculation shows that if you borrowed all of the money at 8% interest, the interest alone would be $92,000 per year. I am sure that the EGI that they list is considering 100 percent occupancy. Sometimes they will allow for some vacancy in the description, but I am sure that if you were to look at their books that they have not performed as well as they say that you can. When you sell a property such as this, the proforma usually maximizes income and reduces expenses to show that you can maximize income. It is your job to find out all of the problems that the property has and look at the last 2 years of income and expenses to determine if this is a true picture of what you could make from this property.
Wilson
thanks wilson, did i figure the property value right if the actual EGI is 176,400 the building would be worth 1.7 million?.. because 170,000 would be 10% of 1.7 million ???
islander,
Your numbers are a little off.
If you require a 10% capitalization rate, then you would estimate the property value from the NOI, not the EGI. At a 10% cap rate and with an NOI of just $88K, your cap rate formula would put the property value at $880K.
If the 10% factor you are referring to is really a Gross Rent Multiplier (GRM) of 10.0, then your estimate of the property value is equal to the EGI times the GRM. In my experience, a property in my market does not usually cash flow when the GRM is higher than 6.5, though it may differ in your local market. Since I would want a positive cash flow, I would use a GRM no higher than 6.0. In this case, a GRM of 6.0 and an EGI of $176K suggests that the maximum value of the property to me is about $1,056K.
If the seller did the same GRM arithmetic then added his real estate agent’s 9% sales commission, I can easily see how the seller came up with a $1,150K sale price.
Please note that the CAP RATE and GRM calculations are just quick and dirty estimators – screening filters, if you will. A detailed cash flow analysis is really needed before you make a business decision to purchase this property.
ok that makes sence i have not heard of the GRM and I think I got lost on the EGI and on the NOI… will using the NOI to get an estimate of the value hurt any when trying to get an idea of what the property is worth or do most Multi Fam owner use the GRM?.. and as an investor do you budget about 50% on operations or is that to high ???
Cap rate formula forces you to get good estimates of YOUR operating expenses, so the calculations may result in a truer picture of the property’s potential.
However, for one to four family properties, the value of the property is usually set by the comparable sales in the marketplace.
When the property is a larger multiplex, then GRM and Cap Rate calculations can be used to initially screen potential properties to filter out those that will obvious fail to meet your investment criteria.
A 50% operating expense factor is a good starting point when you are operating in a vacuum. As you examine the property operation, you will get truer estimates of your cost components. As you get more accurate estimates of your operating expenses, your NOI becomes more accurate.
Once you know the NOI, then look to the cost of financing. If your NOI is less than 125% of your debt service, you will have some difficulty in making the property cash flow through vacancy periods and when faced with unplanned repair expenses.
Download the free Cash Flow Analysis Spreadsheet from the Real Estate Forms section on this site to get a better idea of what I am talking about for one to four unit properties.