Valuation of multi-family

[Vlad Denisov]

If the value of a multi-family is based on NOI, and we know that rents in B - , C+ are gonna stay the same during recession, then why would the price of our property fall? What are the reasons behind it I don't see?

[Kyle Joseph]

@Vlad Denisov Assuming this multi-family is valued based on income (typically 5+ units), and not on sales comps (typically 1-4 units), then I think it's important to remember what a cap rate actually is  and how it effects the value of your proprety.  The cap rate is the initial unlevered yield that a buyer is willing to accept.  It's a reflection of the risk of the cash flows, the quality of the underlying real estate, etc.  Another way to think about a cap rate is to think about it as an inverse multiple.  For example, a 5% cap rate is a 20x multiple (1/5%).  In other words, the buyer is willing to pay 20x the income to buy that income stream.  That may true in Greater Boston where supply is limited, rental demand is high and the underlying value of the real estate is high due to its proximity to Boston and the scarcity of available land.  But in a Western Mass town someone may be only willing to pay a 8% cap (12.5x) because there's less rental demand, less chance of appreciation and no scarcity of land.  For reasons stated above, the price a buyer is willing to pay for a $1,000/mo income stream in Greater Boston is much different than a $1,000/mo income stream somewhere like Western MA.  This is all driven by risk which I'll mention below.

To address your question about what would change the value of the multi-family even if income doesn't change, I think most of it comes down to risk.  Let's just use an example and say interest rates increase, and now you can buy a 10-year US treasury bond and get a 4% yield.  A US treasury bond is essentially risk-free unless you think the US collapses and can't pay its debts (different conversation).  By comparison, real estate is a more risky asset class.    If you could buy a 4% 10 year treasury bond riskf-free, or buy a multi-family at a 5% cap, which would you do? Is that 1% delta worth the risk and potential reward of going from a US treasury bond to real estate?  At some point the market says it isn't and therefore the cap rate moves up.  In other words, people are willing to pay less for that same set of cash flows because they can buy less risky cash flows in the US Treasury bond for a similar price.

This is just one example, but the point was to illustrate that there' s a lot of factors how your multi-family will be valued.  As I said, I think most of it comes down to how the market views risk.