Multifamily property

Multi-Family and Apartment Investing
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Multifamily property

Rikard Lorén
Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes

Hello !

So I have a question, I listening to Ken Mcelroy and he says: to get a value of a building, take the net operating and divide it with the going capitazilionation rate.

So, on one building here, I did it and:

Price: 4,3 Million

Income: 434 000 /year

expenses: 75 000/ year

434 000-75 000= 359 000

so: 359 000 ( net operating ) divided by 6% ( capitalitation rate ) = 5 983 333

So: If we say that the net income is correct, and the cap rate, does that then mean that the seller COULD sell it for 5 983 333 and is loosing money but he don't know it ? and then thata if I bough it, I would make a profit of 5 983 333-4 300 000= 1 683 333 million ?

SO Question: If the numbers are correct, income, cap rate and expenses does that mean that the building is worth atm 6 million and the seller is making a loss, selling it for 4,3 million and COULD sell it for the 6 million instead ? or I'm missing something ?

//Rick

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Joel OwensBusiness Member
Moderator
Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
12y

The valuation is crap.

No way you have gross income of 434,000 and expenses of 75,000.

75,000 / 434,000 is the seller saying the property runs at 17% costs including property management, operating expenses, and vacancy. That's not going to be the case with apartment buildings.

If you self manage and the place is brand new and you defer everything with repairs then you could say maybe 40% to 45% costs but then you are buying a job with PM work. If you are buying a building where landlord pays utility go 60%. If not I typically use 50%.

You have to know what operating costs should be and run your projections off of that not what some seller who is trying to sell you a bill of goods is telling you.

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    *Edit*/another question:

    So, I was checking with the numbers and came up with that the price: 4 432 098

    with a cap rate of 8.1% ( this means that if the correct cap rate was 8.1 instead of 6% )but what does that mean ? woulden't the building be more worth if the cap rate is higher ? I mean: what does this 8.1-6=2.1% mean ? if the building is growing in value 2.1% more, woulden't it be more worth ? or is it cuz of the cashflow ? Could someone explain this please :) Thanks!

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    *Edit* OR:

    If someone just could explain for me how the numbers work when u are trying 2 figure out the value of a building and what it does mean if u get higher numbers than the asking price or lower, cashflow and so, would be GREAT, this was the last edit, sry for confusion, thanks!

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  • Steve Smith
    Beverly Hills, FL · Member since 2013 · 388 posts · 62 votes
    12y

    @Rikard Lorén ken McElroy also said "TRUST BUT VARIFY" he also warns about believing what is said by sellers and realtors

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    Yeah I know, but when I say, "if the numbers are correct" then I have in my mind went there and varified it ( if we play with the though ) :)

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    1,a: hm, well then I guess I have to researsh a little about the rule, so u mean that I should save 50% of the income 2 pay the expenses and repair and so ? Iand then I would "lay on the safe side" becouse I got some buffert for that costs?

    1,b: but is it really fair to tell the seller, "hey! I predict that ur property is worth ****** becouse I need 50% of the income for repairs and expenses" I mean, to me, it sound more fair to come up with a price that is calculated right now, not with a 50% marginal, I don't see how I can get a true price on the building that way... u get what I mean ?

    2. cap rate = the value that the building increases with each year, right ? Or I'm totally lost here ?

    3.I don't really know, I have 2 research some more I guess, thx so much for the answers Jeffrey!

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    12y

    The valuation is crap.

    No way you have gross income of 434,000 and expenses of 75,000.

    75,000 / 434,000 is the seller saying the property runs at 17% costs including property management, operating expenses, and vacancy. That's not going to be the case with apartment buildings.

    If you self manage and the place is brand new and you defer everything with repairs then you could say maybe 40% to 45% costs but then you are buying a job with PM work. If you are buying a building where landlord pays utility go 60%. If not I typically use 50%.

    You have to know what operating costs should be and run your projections off of that not what some seller who is trying to sell you a bill of goods is telling you.

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  • Joel OwensBusiness Member
    Moderator
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    12y

    Rikard are you actually looking at buying an apartment building or just going through theory solving to get better at valuation??

    You will evaluate slightly differently buildings of various sizes and vintage builds. Regular renters, tax credit, section 8, assisted living, student housing etc. will have tweaks to them for valuation.

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  • Dan Brewer
    Lender · Lenexa, KS · Member since 2013 · 119 posts · 80 votes
    12y

    An easy way to understand cap rate is to consider it as the rate of return an investor wants on his money. For example, If a property has an NOI of $100,000, and the investor wants a 10% return on his money, then the property would be worth $1 million to him (100,000/.10). If a second investor is looking for a return on his investment of 5%, then a property providing a $100,000 NOI would be worth $2 million to him (100,000/.05). So in summary, a lower buyer target cap rate is always better for the seller - it will generate a higher purchase price. Hope that helps understand it a bit better.

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    Joel: well, that's what the seller says at least, but atm I'm just looking through the theory to get a better insight in how the numbers works and what u should think about. So you say/mean that u will evaluate a property by the tenants living in it and the property itself ?

    Here's some info translated in poor english:

    *******************************************************************************
    Rental property with four residential buildings and a row of garages.Located near the lake and has partial sea views from the area.Very popular accommodation!

    Type: Residential
    Local, area: Bengtsfors Norebyn
    Price: 4 300 000 SEK.
    Area: 664 m²

    Layout: Rental Property with four residential buildings and a row of garages.Located near the lake and has partial sea views from the area. Very popular accommodation, Total 9st apartments, relatively newly built (1992). Cold Rents,( they pay for the electricy, water, heating and so on ) good economy and low risk of the owner.Owned today by the company and can be sold as a company or through normal real estate sale. 4 residential buildings with a total of 9 apartments, 5 apartments with 3-room and kitchen and 4 apartments with 2-room and kitchen. Garage long, carport for every apartment. Cold Rents gives good economy. Parking: Garage of length.

    Building 1 ( I guess building 2,3,4 is the same and they were all built equal time )
    Year built: 1992
    Foundation: Crawlspace
    Frame: Wood
    Floors: Wood
    Exterior: Wood
    Roofing: Concrete tiles
    Window type: 3-glass
    Ventilation: Mechanical supply and extract with heat recovery
    Water / Waste: Private water, deep drilled well., Onsite wastewater treatment, 3-chamber
    Heating: Exhaust air heat pump and fireplace in each apartment

    Communications: Good bus connections.
    Environment / Nature: Lakeside!.

    Size
    Total: 664 m²
    Housing: 9
    Living area: 664 m²
    Site area: 10,972 m²

    Economy
    Price: 4 300 000 SEK.
    Rental income: 434 000 SEK / year
    Assessed value: 1,813,000 SEK
    Operating cost: 75 000 / y

    This is everything that is posted, I guess u ahve 2 contact them for more info.


    **********************************************************************************

    Dan: Yes, I get what u mean to 100% but according to Ken, to get the value of a property, u take the NOI divided by the cap rate ( he describes the cap rate as: "If you have a property with an anual 100.000 NOI, in a market where the capitalization rate is 6%, then the value of that property would be 1.66 million dollars, that is: NOI ( 100.000 dollars ) divided by the cap rate ( 6 % ) = asset value ( 1.66 million dollars )" and taht is what he would pay for the property, yes ?

    so I mean, this "cap rate" he's talking about, could not be his "personally though", I mean, he also says that u can check the cap rate in that market area from a local banker, and ur not asking him/her for him/hers PERSONALLY cap rate, becouse the banker gonna give u the MARKETS cap rate, so is it the same thing we are talking about or is it 2 different things ?

    I'm from sweden and can read/write to 90% english, but sometimes I have a hard time understanding the words translated to swedish when they got many/more comparements ( means more than one thing translated ).

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    *Edit*

    Assessed value: 1,813,000, of which SEK 207 000 kr land
    Value year: 1992
    Tax Rate: 35.5
    ****

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    1 more edit: This whole thread is focused on how to calculate a price for a wholesale ( buying a property for a price, calculated with the active rental income? )

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  • William Donaldson
    Clemson, SC · Member since 2012 · 82 posts · 19 votes
    12y

    Ken Mcelroy is implementing basic algebra to the capitalization rate formula. The formula & the subsequent rearrangement:

    Capitalization Rate = Net Operating Income/Asset Cost

    *Now multiply both sides by Asset Cost to remove Asset Cost from right side and place it on the left side results in:

    (Capitalization Rate)(Asset Cost) = Net Operating Income

    *Now divide both sides by the Capitalization Rate to get:

    Asset Cost = Net Operating Income/Capitalization Rate

    I know most people on the forum understand this, but it may help beginners unfamiliar with the formula.

    The problem with the property you've posted:

    As Joel Owens notes, the operating costs of 75,000 (17% of gross income) are completely unrealistic. The 50% rule is usually pretty close, but can vary due to the property's age & condition, the amount of work you do yourself (PM, repairs, etc.), and many other factors. For example, it's usually safe to estimate a 5-10% vacancy rate (thus a 5-10% reduction in GI - gross income), 10-20% reduction in GI for maintenance and capital expenditures (major expenses that do not occur every year such as replacing a roof), 10% reduction in GI for property management (if in use), and taxes/insurance/etc. gets us up to the ~50% reduction in GI. The 50% rule helps investors quickly analyze a potential investment due the rule usually being close to the actual numbers.

    The analysis is also off because using the given 6% capitalization rate and 359,000 NOI, an investor will not arrive at a 5,983,333 price. The total cost to the investor will include closing costs and potential repairs right after closing.

    Also, the Cap rate required by investors will be different in relation to the characteristics, risk and other factors presented by the property. There is not a single cap rate in a local real estate market.

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  • Rikard Lorén
    OP
    Göteborg, Sweden · Member since 2013 · 60 posts · 2 votes
    12y

    Okey William, thanks for clearing the stuff out, So the cap rate is personally and not set by the market ?

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  • Chris Winterhalter
    Investor · Chicago, IL · Member since 2009 · 566 posts · 274 votes
    12y

    @Rikard Lorén

    I was in Stockholm in August of this year and was blown away how awesome that city is! I used to think I was redeveloping historic buildings when they were 100 years old...but you have buildings that make our oldest buildings look like new construction. Truly a beautiful city. And I commend you for becoming active in the BP community.

    Okay on to the cap rate....it can be a bit confusing in the beginning. For one it's used to value properties in a specific marketplace but isn't standard by any means. Capitalization rate valuation is really based on the market and risk. A new build Manhattan A++ institutionally owned 1,000 unit apartment building that trades at a 4% cap rate is much lower risk than a 10 unit property in a C- neighborhood in a tertiary market. The 10 unit property is a higher risk and the market rewards the higher risk with a higher rate of return. The market will only pay so much for a riskier investment and that is based off of a certain return.

    With that being said, as real estate investors we are always looking for a deal. So we might target properties that have cap rates of 10% or higher based on our investment philosophy. Because the real estate market has much more disparity than the stock market we are able to create value in certain ways. So we might be able to purchase a property that produces a 10% cap rate but is actually valued by the area, property type etc at an 8% cap. You have to be very careful that you are properly evaluating the deal. It takes a sophisticated investor to actually create real value from just the purchase. There are many known and unknown costs in acquisition that make it difficult to create value just from the acquisition. Generally value is created through turning around a distressed asset through proper management, renovation, value plays etc etc. That's not to say you can't create value over the long term with buying stable real estate at market value but only commenting to the fact of creating equity quickly.

    I hope this helps and wasn't too confusing...

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