Commercial Valuation Confusion

[Bethany Fannin]

I am relatively new here, and I am in the process of reading Brandon Turner’s The Multifamily Millionaire vol. I (it’s also credited to Brian Murray, but it seems that Brandon has mostly written vol. I and then Brian might be more involved with the writing of vol. II).

In Chapter 9: The Multifamily Millionaire Model, Turner explains how you can use the cap rate formula to increase your ability to make wealth.

He explains cap rate and how it is related to NOI and property value, which all made complete sense to me and was incredibly interesting (I love numbers).

However, he starts to talk about how you may sometimes overpay for a property because you are not necessarily worried about what the property is worth today but about the “long-term play.” This is what he says verbatim:

Notice that, based on a 5 percent cap rate, the property is worth only $1,228,600. Then why would you consider paying $1.3 million for this property - $70,000 over value? Because of the long-term play. You know the property can be improved. You don’t care as much about today’s value, because today’s value doesn’t tell you about the property’s possibilities. Some investors might think you were crazy for buying this deal for more than it was apparently worth. You’re not worries because you didn’t buy it for today.

This doesn’t quite make sense to me, because why would I pay someone else for the value that I am going to put into the property? Perhaps it is different when it comes to commercial real estate versus residential, but if you are going to renovate a SFH or even a MFH, you wouldn't pay more for it because you plan to improve it - if anything you pay less?

When I searched the BP Forums for "commercial valuation" and "commercial value-add" I saw some information about people finding deals where the seller wanted to sell a commercial property for when it was "Stabilized" - but this seems slightly different than making improvements that go beyond filling vacancies.

Obviously I have far less experience than Brandon Turner! And, to be honest, I am not even in the process of looking for a 4+ unit property (yet), which is what this section is referring to, but it drives me nuts when I read something I cannot understand.