We’ve owned and managed older apartments for years, and we’re currently looking to buy more.
justin0419 is describing very well how to value small units and houses. It’s very good conservative advice. We want to find the 2% deals he’s finding!!! :banghead
However, the larger the number of units the more important it is to gauge value by CAP rate (capitalization rate). That is, of course, we take the net operating income and divide it by the sale price, to get the CAP rate. This is effectively the cash-on-cash return if we paid all cash for the project.
A capitalization rate of 5% would mean that the property pushed off a 5% pre-tax profit, after all expenses, on an all cash deal. Simple, eh?
Another way some (smaller) unit investors gauge value is to use a Gross Rent Multiplier. This means of course, dividing the sale price by the annual gross scheduled rent (GSI). The lower the number, the better the deal (theoretically).
Comparing pro forma operating data with actual operating data will tell us how much upside or downside potential there is in the deal. This also applies to CAP rate analysis.
Then there’s the “replacement cost” method of valuation. We’ve never used that to establish a value on an existing, project regardless of whether it was under-performing, or not.
However, unless the project is being demolished, or we’re needing to determine land value, or the amount of insurance coverage we need, the “replacement cost” valuation method is useless to determine.
We think the best advice regarding valuation is first knowing the average market CAP and even the GRM for a given neighborhood. These averages are influenced, at least, by price point, size/number of units, neighborhood, building type/construction, and liability/distribution of utilities.
For example an 80-year old 20-unit walk-up style building with a flat roof, common utilities, and enclosed hallways is going to have a MUCH higher operating expense than a 50-year old, 20-unit building with off street parking, separate utilities, pitched roof, and open hallways/stairs.
The older building will by default require much more management and maintenance such as vacuuming interior hallways, annual repairs of a flat roofs, boilers …all with effectively uncontrollable consumption of common gas, electricity and water, etc.).
As a result most investors want a much higher return in order to run the risk of investing in this type of project.
I don’t need to go into an analysis on a newer building. The returns are usually less since there is more demand for them, because they are less of a management and maintenance burden (theoretically).
Meantime, the “best valuation method” we use is, “He who cares least, wins.”
How can I get a copy of your presentation?