Cap rates for MF in small cities in Georgia

[Leon Lee]

Hi, All

I am practicing analyzing MF deals in small cities in Georgia, such as Columbus, Macon, Griffin, etc.. These properties are mostly in B and C neighborhoods. What are reasonable cap rates I should plug in for a fast estimation on their values using Michael Blank's 10-min method? I am using 8% and found that estimated values for many on-market deals are only about 70% of what is being asked. Basically, I am using 10% of the current potential income as the vacancy rate and 55% of the rest as repairs and maintenance, i.e., NOI = current_potential_income * 90% * (100%-55%). Does this fast estimation have any value in serving as the first pass for analyzing small MF deals ( < 20 units)?
Thank you in advance!

[Account Closed]

Hey Leon,
That's great that you are practicing. I hope for your sake, the practice eventually translates into a deal.

For your smaller deals (less than 30 units) using a 10% vacancy/collection loss factor and a 55% expense ratio is a pretty good place to start the analysis (might be a little conservative from a V&C standpoint). Your 8.0% cap rate is also in-line with B-C product of this size in second- & third-tier markets (7-9% OAR is a good range for B/C product in tertiary markets). That said, and depending on location/property, you can probably lower your cap rate closer to 7-7.5% and still be within the range of reason.

You also have to consider that you are looking at asking prices, not sale prices. There is a growing disconnect out there between buyer and seller expectations. I think this mostly falls on the shoulders of unrealistic seller expectations.

Yes, we are at the top of the cycle. Yes, we are turning into a nation of renters pushing user demand for multifamily product to historic highs. And yes, there is growing demand from investors. But these are macro-economic trends primarily attributed to the Millennial and Baby Boomer demographics who typically are not leasing at this type of property. As such, the noted trends do not necessarily trickle down to class B/C properties in tertiary markets. Only buyers can bring sellers back in-line.

The properties you are likely seeing in these markets usually do not have separately metered utilities. They also tend to have elevated levels of deferred maintenance. These characteristics push expense ratios closer to 60-65% (maybe even 70% - be careful!). Additionally, as alluded to above, this class of property typically does not have the best clientele and comes with tenant issues that are not easily (or cheaply) solved.

In summary, stick to your guns and be careful with smaller, class B/C properties in tertiary markets. Your "quick" test underwriting isn't too far off the mark. Whatever you do, don't compromise your requirements just to get a deal done. Stay with it - it is worth it when you land a good deal. Best of success!