The Challenge to Multifamily Evaluations

[Ashley Wilson]

Over the past year plus, multifamily has endured some difficult blows. Most would agree the top three are interest rates, taxes and insurance. Breaking these three down on the direct impact they have had on multifamily pricing: rising interest rates impact your cost of capital, and taxes and insurance impact your net operating income (NOI) which has a multiple effect on evaluations when using the NOI approach for assessing value.

Value, while a simple definition, is a complex concept. There are three ways in which multifamily is evaluated. The most recognizable is the comparable sales approach which uses comp properties to assess value. This is how most tax authorities determine value. The second approach is the replacement value. This is the cost of rebuilding the same product. Insurance companies use this method when determining their policy pricing. The last approach is the NOI approach which is the most common way investors buy multifamily. This method evaluates the business through taking the income minus the expenses and then dividing the NOI by the trading cap rate.

Comparing the three evaluation methods to the three challenges facing multifamily yields different changes to value. Specifically, for most properties the value on both the comparable sales approach and the replacement value has risen, but on the NOI approach it has fallen. This creates a stalemate as buyers are forced to make a decision on whether or not they want to change their approach on how they evaluate multifamily.

So far, it looks like the industry has responded by holding steadfast on their commitment to the NOI approach. But will this last? Or, will a new way emerge? Interested to hear your thoughts on evaluation methods and the future of multifamily transactions in this current environment.