How do you underwrite an apartment complex with a negative NOI?

[Chris Washington]

Need some help from the community. I'm meeting with a broker to walk an off-market apartment complex here in Cincinnati. The property is in a downward spiral, so I think this could be a fantastic deal with great value add/upside potential.

The problem: I just got financials today, and P&L from 2015 and YTD 2016 shows a negative NOI. Since rule #1 of multifamily investing is to buy on actuals, and NOI/CAP = value, how should I go about calculating the value of this property? The asking price is significantly overpriced (priced off stabilized/proforma numbers), so I want to be able to rationally/credibly defend my valuation and potential offer price. Any advice is greatly appreciated...thanks!

[Anthony Chara]

Hi Chris, there are 2 ways you can evaluate the property in its current condition. First off, since you have a negative NOI, I'm assuming the property has high vacancy. Only other explanation would be that they cannot charge enough rent in that area to offset the Operating Expenses. Either spells potential disaster.

Valuation #1 is just like a SFH. The appraiser would use the Comparison Approach. What did other properties in the area in similar condition sell for on a per unit basis.

Valuation #2 would be just like doing a Fix & Flip. Start with the ARV. Use proforma GPI (assuming all units are occupied and everyone is paying rent), then, subtract out the market vacancy and add in any Other Income the property would generate from things like laundry, storage, parking, pet fees, etc. This will give you your EGI or Effective Gross Income. From that, subtract out market rate for Operating Expenses (Taxes, Insurance, Management, Maintenance, Utilities and Repairs/Reserves). You should be able to find these amounts by talking to PM's in the area that manage similar properties. This will give you your proforma NOI. Using this proforma NOI you can now divide it by your Market Cap rate (NOI/CR = Value) to come up with your After Repair Value (ARV).

Once you have your ARV, now the fun begins. The questions you have to answer is, "Why is the property the way it is and what needs to be done to it to get it to produce income based on these market numbers"? Let's say it's under performing due to it needing extensive rehab. Great, figure out your rehab costs, add in holding costs while you're making the needed repairs (taxes, insurance and mortgage costs) during that same time frame and then subtract that from the ARV. You should also subtract out a 'fudge factor' to be conservative. Next, subtract out what you think is a fair profit for the money you're putting into this deal and the risk you're taking in order to turn it into a performing property and you now have the Maximum you should pay for the property 'as is'.

If you've never done a Fix & Flip or Fix & Hold, I would suggest you partner up with someone in your area that has a great reputation for doing them. Someone who's good can estimate rehab costs within a few percentage points of the final costs as I've outlined above.

Good luck to you Chris!