Figuring out Providence ARV.

[An Duong]

Looking to buy a 6 plus unit in Providence but I am having trouble finding comps to assess ARV there doesn't seem to too many sold multifamilies (at least not on MLS) and the ones that are there seem to be all over the place in price. Any suggestions? Much appreciate any incite. Thanks!

[Anthony Thompson]

@An Duong yes, it's pretty difficult to find good comps for 5+ unit properties. Because the financing is different for buildings with more than 4 units, as you may already know, you can't really use a per-unit price on a 4-unit and extrapolate to a 5 or 6 unit :(

Instead of looking for comparable sales, you usually end up having to apply a market cap rate to the net income (NOI) of the property, which appraisers call the "income approach".

As for what's a "market cap rate", well that's about as much art vs. science as (in some way) choosing good sales comps are.

For a B area of Providence I think you'd be safe using a 5% or 5.5% cap rate, but if it was an A area like the East Side you might want to go with 4% or 4.5%.

You should also ask around as I certainly haven't done any market survey of cap rates. I don't see a lot of deals that probably do close, simply because the cap rate is too low (i.e., price is too high) so I knock it out pretty early on and it might not even cross my radar.

An active agent or broker in the area who's working with clients probably has a better exposure to a lot of deals closing, and thus a lot of cap rates, than an individual investor like me who pre-screens a lot of deals and only does transactions for her/himself.

As far as "applying a cap rate", you may already know this but in case someone else reading this in the future doesn't, what I mean is taking the net income (NOI) of the property and dividing it by a (somewhat-arbitarily-chosen, I admit) market cap rate to result in an estimated value. It's a way of saying "people in the market are willing to get 4% return on net income in an A area in this market, so if I know the net income of the 6 unit subject property, I can derive what someone would be willing to pay i.e. what it might be worth".

Incidentally, when people talk about the "income approach" as one of the three appraisal methods (the others being sales comparables and replacement cost), it's usually introduced for exactly this scenario - that there are usually plenty of comps for 1-4 families and buyers are more likely to look at recent sales of similar properties to determine what they'll be willing to pay, but once you start looking at 5+ units there are both far fewer comps and the buyers are investors who really are looking at cash flow more than similar property sales.

Anyway, I hope this helps. Personally I like to try to do both (comps and value from income/cap rate), even if one does better than the other, to see how they compare. Even if I don't find a lot of comps, if the #s from comps come in even in the same ballpark as the value derived from a market cap rate then I feel pretty good about the general ballpark of its value.

(Note that a "market" cap rate might not be what you are willing or want to pay, it's just saying what people "in the market" generally have been paying. You might want a higher cap rate, which means you'll end up getting priced out of most deals because others are willing to pay more for a smaller return than you are. In which case, welcome to the club! Personally, for me real estate involves risk and aggravation and is illiquid, so there's only so far down I'm willing to go on cap rates. But it does mean passing on a lot of deals, which can be hard when other people are talking about XYZ deals they've done recently. It's lonely being a contrarian, lol.)