Trying to understand MFH value, can you help me?

Question

Hi, as I'm starting to look at MFH I'm trying to understand how to properly value a property.  I know about the 'cap rate' calculation but when I talk to my agent, he's giving me different numbers for value.  He has experience with many SFH and has been a realtor for 20 some years so I feel like perhaps I'm missing something.  In addition, when I presented my numbers to him he said that others had already submitted higher bids.  If it had been a difference of 10k, I would just figure that was realtor hopefulness vs cold hard numbers but we had a much larger difference.

I have reviewed the numbers I'm putting into my calc with several local investors and they all agree that the numbers are close to reality (though I am a bit more conservative than others when it comes to saving for repairs/capex)

Property stats:

• 6 plex, 4 1 beds, 2 efficiencies.  
• The property is in OK condition. It could use new electrical (~$20k), a patch to the parking lot (~$4k), new bathrooms ($12k), updated kitchens ($5k) (Total: $33k)
• Listed at: $150k ($25k/door)
• Estimated NOI: $11,466  (based on "max" rents that I could get after repairs listed above)
• Local cap rates: 7-9%, this is probably a 9% property (according to my banker who also owns MFHs)

Cap rate calc:

• $11,466/9% = $127,400.  However, since that is after repairs and since I wanted some equity I thought I'd offer $85k.

According to the realtor:

He looked at some databases that he has access to and estimated the value of the property at $200k - $225k after repairs and getting the units rented up.

So, I have an experienced realtor and an experienced banker telling me 2 different things.  The people who are bidding are offering much higher than what I am offering.  Obviously you can make money on this property but my hope was that I would also get some equity after fix up.  Am I missing something or am I bidding against people who have different goals?  Maybe they aren't going to fix it?  Maybe they'll make no money for a few years and use the income to fix it up?

Thank you for any help you can give as I start the MFH journey.

David Dachtera · Answer

@Eric Y.,

By "MFH", do you mean multi-family residential? If so, that's 2 to 4 units.

For financing, such properties are subject to the "comparable sales" rules, just like SFR.

For valuation as an investment, however, you need to look at income vs. expenses (NOI) and evaluate it as you would any income property. Calculate the Cap(italization) Rate (annualized NOI divided by the purchase price) and compare that to similar properties in that area.

If the seller's asking price does not align with the purchase price calculated by inverting the Cap Rate formula, then you'll need to negotiate. Area rents (total for the building, annualized) x average Cap Rate should give you the MAO (maximum allowable offer) as a starting point for negotiations. The rest is up to you and the seller.

Valuation of 5+ units is based entirely on income vs. expenses, no comparables other than Cap Rates.

Jason Hirko · Answer

@Eric Y. There's several things to keep in mind here, but first and foremost, what it's worth and what a seller will take for it might not be the same. Similarly, different investors have different goals. In markets that I invest in, a 6% cap rate would be decent for a large apartment, but I might buy something that had a 3% cap rate because of the value adds I can do to it to make it a 10% cap. Other more passive investors might look at the 3 cap and think it is a bad deal, and it is for them, just like I wouldn't buy the 6 cap that they think is pretty reasonable.

Then once you take into account leverage and how you capitalize one of these, and the possible ways you can make a deal pencil out are almost infinite.

In your situation, if you are offering $85k and the seller sticks to $150k, I think it is time to move on and not waste anymore of your time trying to force a deal. Maybe he'll get $150k or maybe he won't, but at the end of the day, even if you're right and it's only worth $85k, he still may not sell for that.

Eric Y. · Answer

Thanks for the answers guys:

@Jason Hirko: Agreed that the owner and I may never agree.  It was more a question of why the widely disparate valuations.

@Kevin Vandenboss: The current income is basically $660/mo as they only have 2 apartments rented.  (Widow has been letting it go downhill).    This type of property is relatively rare in the area in that current owners are sitting on theirs so there aren't many on the market.  The seller has refused owner financing though they are in a position to do so.  I don't know whether the other offers are written, just going by what my agent is telling me (he is the listing agent as well).  I think the COCR, DSCR and 50% rule would end up at an OK point but I was worried about resale.  That is, when I get done with it in 5-10 years and want to sell it, the next investor will be using similar cap-rate based numbers for their offers.

@David Dachtera:   Thank you for the confirmation on valuing of 5+ units on NOI/cap rates alone.  That is what I thought but I see others trying to buy the place even though it may not work out for them.   I do think they're in the low 100s so maybe they have  lower estimates for repairs or don't care about things like the fuse boxes in the basement.  Maybe they don't worry as much about resale.

I appreciate your time and any other time you can give too.

Kevin Vandenboss · Answer

I would say $200k - $225k is extremely optimistic for a 6 unit in that condition.

You are right in that the other buyers may not be planning to fix it up yet, but I have a hard time believing they would be offering a price based on future potential.

What income is it generating currently? If it requires you to put in the money and effort to fix it up and raise rents then you shouldn't be paying the seller for what it can do after the improvements you make. You're right that you should be getting the equity in the repairs. Somebody else shouldn't get the equity that you create.

With all of that said there could be some variables in play here.

Is this type of property hard to come by in your market?

Is the seller offering seller financing terms?

Are these other bidders actually making written offers?

One thing I have witnessed several times is a buyer quickly offering full price to tie up the property then, within the inspection period, requiring that the seller either make all of the repairs at no cost to the buyer, or discount it based on the repairs the buyer says it needs. The seller then has to choose whether to take the hit to close the deal or let the buyer back out and start all over. If the seller has already started moving forward with their after sale plans they're more likely to just do the sale. It's a sneaky and unethical tactic, but it happens all the time.

Unless this type of deal is extremely hard to find in your market, I would recommend sticking to what you're comfortable offering. I would also look at some other factors besides cap rate.

Cash on cash return on the cash you're putting into the deal

The 50% rule

The DSCR

If you want to reach out to me directly I would be happy to look at the deal in more detail with you.

Eric Y. · Answer

*bump* just once since I posted so late last night.

Any advice?  Do you need more info?

Trying to understand MFH value, can you help me?

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