How to value a mostly vacant multifamily

Question

I’m looking at a group of four 8-plexes on the MLS in Illinois. #1 has 5/8 units occupied, #2 has 2/8 units occupied, buildings 3-4 are vacant. Based on the numbers provided, the four buildings are collectively losing $10k a year.How would you come up with a valuation with a negative NOI? If all units were rented at $550 (I don’t know the unit specifics), half going to expenses would yield a 6% cap rate at the asking price of $400k per building. Given the industrial city and location, I would think something closer to 7-8% would be more appropriate.I don’t know if the vacant units are habitable or not. Many questions to answer but I’m starting with valuation based on what I know.Thanks!Dave

Brad Hayden · Answer

@Dave CarterDave, good advice from both Lucas & Mike. Mike's method of using the stabilized value minus costs to get a price is a good start, but another consideration will be how the lender values the property if you plan to use financing. The lender will require an appraisal which will include valuation through income capitalization, replacement cost, and sales comparables. Income capitalization will basically be ignored due to the negative NOI so that only leaves replacement cost and sales comps. Traditional banks are unlikely to finance a project with negative NOI so that leaves private non-bank lenders. Lender amount, rate, & terms will look at current property value, but they will place significant consideration on your investment plan, the projected future value, and your experience with this type of project.You need to be able to answer the following questions - in detail:• What is your investment plan; how will you increase the value? Is it as simple as increasing rental rates, reducing expenses, reducing vacancy, or addressing other economic factors; or will it require repositioning with different tenants; or perhaps adaptive reuse to a different purpose; or …? How much will it cost, how long will it take, and what impact will it have on current tenants, operations, and cash-flow? • Does it need minor repairs, major renovations, or other capital improvements? How much will it cost, how long will it take, and what impact will it have on current tenants, operations, and revenue? • Equity - How much skin do you have in the game? Will you bring in partners and/or 3rd party investors? How will they get paid? How will you get paid?• Will the local market support your plan? “Build it and they will come” was a great catchphrase for a movie, but local market realities may not be so forgiving. Occupancy trends, population trends, employment trends, competition, traffic patterns, economic development programs and priorities, zoning, and permit filings are some of the factors that may impact your plan and the future value of the property. • What is projected future value? Based on your plan and your projection of future market conditions, what will it be worth 2-5 years down the road? • What is your exit strategy and timing?Hope this helps. Let me know if you have additional questions.

Mike Davis · Answer

@Lucas Miles has provided great advice. Also, if the vacant units are habitable and you get the property, offer a lower introductory rent for the first month or so to give you time to update the units that way you are generating income.However, remember to qualify the tenants at the higher rent you will be charging in the near future and not the intro rent special.

Lucas Miles · Answer

@Dave Carter myself and a partner recently closed on a portfolio of multifamilies that had low occupancy rates and rents that were significantly below market rate. At closing monthly income was about 20k/month, once stabilized we are estimating 50k/month. We approached this from a once stabilized what will the portfolio be worth (NOI and cap rate), and what will be our rehab budget be to stabilize the portfolio (rehab + operating losses). Then can figure out how much you can pay from there. Rehab budget is hardest to predict, with that high of vacancy I'd guess there is some major issues at the property. If its listed on the MLS you should be able to walk vacant units before getting anything under contract to get an idea for the property. Depending on your experience, obtaining financing from a bank could be a challenge, many banks (even local portfolio lenders) may not lend on a highly value add project like this. See if you can work with an agent to setup a meeting with the owner to see if there are any seller financing the seller would be interested in.