Need help with property value

[Jeremy Hartwig]

I'm looking to purchase an 8 unit property.  The owner is asking 600k but I'm not sure his valuation is accurate. The property consists of two 3 unit and one 2 unit buildings.  All units are 2 bed 1 bath, single story with off street parking.  He is currently getting $550/month for each unit.  I believe that when determining value in commercial real estate part is based on current rent.  If I'm wrong I'm sure someone will correct me.  If someone can explain or point me in a direction that could help with that that would be great!

[Kevin Sobilo]

@Jeremy Hartwig yes for 5+ unit properties (considered commercial), the "income approach" is primarily used to determine an appraisal value. That not only considers the rental income, but all the expenses as well.

However, when determining a sale price, that may not tell the whole story!

What if rents can be increased 50% without doing any rehab work? A fair sales price might fall somewhere between the value calculated based on current rents and the value calculated using future rents.

[Evan Polaski]

@Jeremy Hartwig, I know this is a slightly glib answer, but property is worth what a willing buyer and willing seller can agree on.

You can use cap rates, but admittedly those can be useless too, for similar reasons that Kevin outlined.  At the end of the day, you need to underwrite this property based on the cashflow it is currently creating and possible "stabilized cashflow", then back into your purchase price based on the returns you want to hit.

I.e. if you are wanting to make 20% CoC returns day one (your expectations are pretty unrealistic), but it may only be worth $250,000. If someone from California is happy making 5% CoC returns, then they may be willing to pay $600k.

And your returns need to be based on risks and opportunity.  I.e. if this property were located in Oakbrook/Centerville versus Miami Chapel/West Dayton, you will have a dramatic shift in price and operational ease.

I would talk to brokers in the area.  At the end of the day, YOU need to know the market to determine if it is worth buying at all, and at what price.  

[Scott Albritton]

Assuming $4,400 in monthly rental income = $53,800 for the year. At $600k, you'd be at a 8.36% CAP RATE this wouldn't be taking into account any other income from the property..

What are typical CAP RATES for the area? General rule of thumb, higher the CAP RATE, higher the risk. Not always, but very common.

[Tom S.]

@Jeremy Hartwig  You can always pay for an appraisal to be sure.  Yes, it may go by the income approach but depending on your area, the comp approach may also be factored in.  I have a 5 unit in VT and the appraisal weighed the comp approach slightly more than the income approach, because the area was pretty rural.

[Alfath Ahmed]

Quote from @Jeremy Hartwig:

I'm looking to purchase an 8 unit property.  The owner is asking 600k but I'm not sure his valuation is accurate. The property consists of two 3 unit and one 2 unit buildings.  All units are 2 bed 1 bath, single story with off street parking.  He is currently getting $550/month for each unit.  I believe that when determining value in commercial real estate part is based on current rent.  If I'm wrong I'm sure someone will correct me.  If someone can explain or point me in a direction that could help with that that would be great!

 It really depends on the location of the property. Most dayton sellers are starting to think that dayton is columbus when it is not. I would do a cap rate evaluation and try to achieve close to a 8-cap after all expenses. 

Look at the per sqft cost. Run comps on duplex, 3-unit, 4-units, etc. This will give you a really good understanding of what you are paying.

Lastly, look at the capEx on the property. What needs to be taken care of immediately vs later. 

[Austin McClain]

The location is a huge part of the deal. Make sure it's in a spot you believe will appreciate in 5+ years for the exit 

[Jimmy Lieu]

Quote from @Jeremy Hartwig:

I'm looking to purchase an 8 unit property.  The owner is asking 600k but I'm not sure his valuation is accurate. The property consists of two 3 unit and one 2 unit buildings.  All units are 2 bed 1 bath, single story with off street parking.  He is currently getting $550/month for each unit.  I believe that when determining value in commercial real estate part is based on current rent.  If I'm wrong I'm sure someone will correct me.  If someone can explain or point me in a direction that could help with that that would be great!

Hi Jeremy! With annual gross rents at $52.8k, that's a solid income stream but you'll need to factor in expenses like taxes, maintenance, vacancies, etc. to get the NOI. If we assume expenses are around 35-40% of the gross rents, NOI could be around the $30k-$35k range. That would put the property value at around $300k-$500k ballpark. But of course, the actual value will depend on a lot of variables - local market conditions, planned renovations, etc. The best down to nail down the value is to review the financials, look at comps, and get an appraisal. And don't forget to also factor in your investment goals, cashflow needs, and exit strategy. Happy to connect and answer any questions you may have.

[Gino Barbaro]

@Jeremy Hartwig

You are missing a lot of important data, such as median income of the area, rent comps in the area, what current values are.

You are buying on actuals, but in many markets that have low supply and have a lot of demand, it makes it difficult buy based on actuals. It comes down to what your pro forma is, and what lenders are willing to lend on the property.

75k per unit for 550 in rents in Dayton is probably over valued, especially if there is deferred maintenance. Now if rents can go to 1,100, different story.

Value is based on Net Operating Income, and lending is based on Debt Service Coverage Ratio.

Gino

[Trevor Finn]

Hey @Jeremy Hartwig, 

You’re spot on! In commercial real estate, the property value is often based on the income approach, meaning it’s largely determined by the Net Operating Income (NOI) and the market’s cap rate. Here’s a quick way to evaluate:

1. Calculate NOI: Subtract expenses from gross rent (e.g., $550 x 8 units x 12 months).
2. Determine Cap Rate: Research similar multi-family properties in your area to find the typical cap rate.
3. Estimate Value: Divide NOI by the cap rate. This should give a fair market value based on income.

This approach gives you leverage to negotiate if the seller’s price seems off. Let me know if you want more details on any step!
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Here's my breakdown for an 8-unit property listed at $600k, but based on your analysis, it doesn't seem to cash flow positively. With current rents at $550/unit, the property yields a low 4.84% cap rate. Your estimated first-year NOI is $29,040, but after loan payments, you're left with a negative cash flow of -$9,126 and a DSCR of 0.761, indicating the income doesn't cover debt service. Cash-on-cash return is also negative at -5.63%. These figures suggest the property may be overpriced based on current rents, so negotiating a lower price and increasing rents could improve the deal.

[Alicia W.]

Quote from @Scott Albritton:

Assuming $4,400 in monthly rental income = $53,800 for the year. At $600k, you'd be at a 8.36% CAP RATE this wouldn't be taking into account any other income from the property..

What are typical CAP RATES for the area? General rule of thumb, higher the CAP RATE, higher the risk. Not always, but very common.

$550  / mth * 8 unit = $4,400 * 12 mths = $ 52,800 GRI  ****not $53,800****
The formula for CAP = NOI/Price
NOI = [GRI - V&C loss + OI] - EXP  *****You did not subtract for expenses to arrive at NOI nor include a vacancy and collection factor****
Assuming expenses are 50% and 100% occupancy (which 100% occ is not realistic all the time). Also, zero leverage (ie: no loan)
$ 52,800 * .50 = $ 26,400 = NOI
CAP = $ 26,400 / $600,000 purchase price
CAP = 4.4%  (NOT a good return considering you can yield higher returns elsewhere in less risky investments)

[Joshua Christensen]

Everyone has shared some valuable insights, so I won't rehash that.

I'm curious though if you want to make payments monthly to build your nest?  How long can you do that to achieve your results?

With a current $550 per month rate, that's only $4400 monthly revenue at 100% occupancy.  I didn't see where you factored in a $3000 mortgage payment (principal & interest only) in today's higher rate environment.  There's nothing left to cover expenses so you better have deep pockets to cover maintenance, admin, turns, etc.

If you think you can quickly improve rents to a point that covers your expenses and pads your pocket a bit, then maybe, IF it hits your return threshold.

If you're buying cash, then the mortgage is not a factor.  If you're financing with 25% down, you may need to search the pits of your investor soul to determine if this is solid.  Consider all your risk (much is listd in other posts).  

[Sarah Brown]

Commercial value is frequently (but not always) calculated by income.  BP has calculators to help you determine cap rates and values.  I definitely recommend using them.  When mathing this out on the spreadsheet I made, that seems fairly in line with the data that is given.  However, there is data not given that needs to be taken into consideration.  For example, has all maintenance been upkept? How old is the property?  Will or does it need any capital improvements such as a roof?  Are all tenants in good standing on the rent.  Do they keep their units up? 

[Bonnie Griffin Kaake]

@Jeremy Hartwig  As part of your due diligence, you may want to consider doing a no-cost estimate/pre-analysis of the potential tax benefits available. Sometimes it can make or break a deal. Expediting the depreciation with a cost segregation study can add a healthy amount of cash flow in the first year to 5 years when you need it most.