How do you assess value of a rental property based on cash flow?

Question

I'm wondering how the sale price of a property is affected by the rental history cash flow.

If my property generates $50k / year, how much value does that add to the list price of the property?

Happy to fill in any required detail helpful for making a better assessment.

Spencer Gray · Answer

@Jackson Sandland

Commercial properties most commonly trade by a ratio of the market cap rate and property NOI, although sometimes they can be priced by the unit or other similar metric that are usually marginally close in proximity to each other. The cap rate is market specific and is usually determined by recent sales, but not necessarily. Talking to local lenders, brokers and investors should help you find a good range of cap rates for your target asset criteria and market.

NOI (total operating income - total operating expenses) / Cap Rate (Current Market Value) = price

For Example a 200 unit Class B+ Asset in an A location in Indianapolis at a 5% Market Cap Rate$1,000,000 NOI / 5% Cap Rate = $20,000,000 or $100,000/ unit

Properties don't trade off of straight cash flow because free cash flow is "below the line" and after debt service, capital expenses, and reserves all which may change with ownership. For example, just because Joe Schmo apartment owner financed a property with a 15% interest hard money loan and has little or negative cash flow, doesn't mean the property is worthless and may have a healthy NOI. When you buy the asset and finance it with a 6% interest rate the cash flow will increase significantly. Same goes with if the owner had done extensive capital repairs that wiped out most of their cashflow, the property would still trade off of it's NOI (although the broker may try and sell you on "pro forma NOI based on the renovations).

Hope this helps!

Spencer Gray · Answer

@Jackson Sandland sorry I didn't see your recent post. I would think about your exit plan with a property like that. How many buyers/investors have a 13 bedroom single family home in their criteria? If it's in a vacation destination maybe a large AirBnB? If you have a very clear vision for the asset, more power to you, but if it was me I would stay away and stick to my target acquisition criteria.

Since it is a single family home and comps may be hard to find, you could use an average $/sqaure foot in the area for 5+ bedrooms?

Mike D'Arrigo · Answer

@Jackson Sandland I'm assuming that it's commercial, it's going to be valued on the basis of gross rent multiplier and cap rate.

Justin Kane · Answer

if its under 4 units.. it doesnt.. you have to sell based on local comps

Caleb Heimsoth · Answer

@Jackson Sandland. NOI divided by cap rate.  Google can fill in the gaps

Chase Louderback · Answer

@Jackson Sandland

If there is a market already there for similar properties then I would look at what the successful ones are doing and create a similar model.

Also,  you should try to pull comps from ones that are operating the way you believe you will be able to operate your property and see what they sold for.  That can give you an idea of what you will likely get for yours and a better idea of what your cash flow situation may be like.

This may be something you would want to check with your city/county on with regards to the number of people you are looking to house and if that will be allowed with the current zoning or ordinances.  Just to check all your bases before you commit.

Josue Vargas · Answer

Wait... a 13BR SFR generating 50K a year in rent?  What are you waiting for?

I hear you saying lack of space for companies to get their employees on-site... Companies often prefer hotels or apartment complexes offering short term stay with a lot of amenities... not a house of 13 BR sharing bathrooms and kitchen...  I travel a lot, I have never stay in a house with even 2 bedroom sharing the common areas with another employee.

Good luck.

Jackson Sandland · Answer

It was used as a long term rental property in the past that was deemed commercial.

There is incredible high demand because of the lack of affordable housing. For example, beautifully renovated properties - decked out to the 9's - may rent for 40k / week. So, most people are catering to that market, and renovating their properties. This means renting a room to work for the summer is almost impossible.

This property is not in that type of shape, but it is fine for housing employees and people there to work for the season.

In the long run - it could be completely renovated and re-purposed into a legacy property or a mega cash flow property.

For the time being it fills a need in the market and doesn't need extensive renovation to be attractive.

Thanks for the ideas Spencer. Not able to "@" for some reason.

Jaron Walling · Answer

That sounds like a beautiful mansion or massive money pit to me. Can you expand on the "been used commercially in the past"? I will assume there's demand for the property.

Jackson Sandland · Answer

This is a very unique property. It's located in a residential neighborhood but has been used commercially in the past.

It's a single family house with 13BR. Due to a lack of available housing in the market it is attractive to companies looking to house their employees.

So, it sounds like if it's marketed to someone looking to rent - the cap rate will effect the sale price.

It could become a beautiful single family legacy home that has strong income potential as well due to the local rental market. It's in a vacation destination.

You could definitely house hack this property. You could live in it, and never run into tenants. It never ends :)

How do you assess value of a rental property based on cash flow?

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