How to find the ARV of a multi-family

Question

Hi all

I was wondering how to find the ARV of a multifamily that needs repositioning!

I want to make offers between 50% - 70% of ARV but I have no idea what the ARV will be. I understand cap rates, GRM and all that stuff but I have the feeling you just cant rely on that information. NOI provided by the seller is probably very unreliably as mom and pop investors hardly keep track of their operating expenses.

So my question is how do you find out what the after repaired value of an apartment building is since you cant really rely on NOI and Cap rates???

J Scott · Answer

It's not that you can't rely on NOI and cap rates to determine value...the issue is that you can't rely on the seller to provide you with the data you need to determine an accurate NOI.
          
          During due diligence, it's YOUR responsibility to ensure that you have all the information you need to determine an accurate NOI.  
          
          For example, for income, current rental income from the property isn't necessarily reflective of market rates, especially if the property needs repositioning and improved management.  So, research the market and determine on your own what net income will be once the property is rehabbed.
          
          Also, make sure you visit every single unit and get your hands on every single lease so that you're confident of the property condition, the concessions made to current tenants, etc.  Never accept a "representative sample" or take the word of the seller.
          
          For expenses, don't rely on what the seller tells you.  Ask for tax returns (which, if anything, will overstate expenses giving you ammunition to negotiate), ask vendors for historic records, ask to see actual utility bills, etc.
          
          If you do proper due diligence, you should be able to accurately determine NOI for once the property has been improved.  If you can then get accurate cap rate information (this may be even harder than determining NOI), you should be able to get a good ballpark of the after-improved value.
          
Btw, a lot of people will try to take the easy way out and just look at the per-unti cost of "comparable sales" in the area.  There are a couple problems with this (in my opinion):

- Unlike single family homes, no two commercial properties are alike once you consider management, condition, expenses, etc.  So, getting "comparable" numbers is very difficult.

- There are a LOT of idiot apartment buyers out there, so just because some guy down the street paid $25K per unit doesn't mean he knew what he was doing or that $25K per unit was a reasonable deal.

I prefer to stick with income analysis of apartment buildings, not comparables...

Steve Sparks · Answer

This is my game of choice. I echo what others are telling you. Every building is different and offering 50 to 60 cent of what you perceive the ARV to be is EXTREMELY dangerous. What I can tell you is I am buying them here at 10 to 30 cents depending on too many factors to name. There are enough of these out there that I can miss my estimates by 100% and still be extremely profitable. But I surely would never consider throwing out offers without knowing the building extremely well. The great part of this strategy is that cash flow can be created and sold.. but it is a high stakes game if you don't have the facts. You will never have ALL the facts as apartment buildings are full of surprises, but you have to make sure you have enough.

Champak Shah · Answer

I think you are making BIG Mistake -- 
I hope you have LOTS of cash  available --
Jason is very right -- 
However, I will not pay 60% --based on what value ? You need to student the market and find real Motivated Sellers -- tired of land lording or needs lot of work and have less than 30% occupancy --then check the Building construction and deferred maintenance --get good estimates for rehab -  offer lowest possible price --I have seen at $5000 per unit -- no matter Stabilized value can be $30,000 per unit --You need to know market demands in thh area --vacancy rates and also check availabilty of Condominiums and town houses in the area.  If you can  find Town Homes type built apartments --do rehab and convert to Fee Simple Town Homes or Condominiums --then make lots of money.

As far as checking thh tax returns --you need to compare some from existing --operating apartment complexes -- operated and managed by large corporations --to find expenses --then take out extra over heads and expenses and figure out how you can save expenses -- and net profit ( NOI ) - before taxes. Also you need to find some serious buyers --or interestesd parties and talk to them to see what they will buy ---

Then do three and five year projetcions on Income  and Expenses and NOI -- you will need that for a loan also--think about two or three Exit strategies and determine profit potential for each exit and how long you have to hold.

You can also talk to some commercial brokers and ask for names of Appraisors who specialize in apartments. If you buy him lunch --he may share with you good info and may be one or two actual appraisals --so you get the idea. Do not go for Repalcement value. Commercial property always go for NOI and cap rate.  Good Luck.

Curtis Gabhart · Answer

Sounds like you may be wasting your time and a lot of other peoples.

1) If you can't figure out the ARV a few posts on this board isn't going to help. It actually may be dangerous because you may think you know how to buy and operate apartments.
2) In hundreds of transactions I really can't think of 1 where there was an absolute as is value and then a 50% discount applied. People make there money because they buy buildings that they are able to add value to because they are an expert in that niche and knows what other buyers over look.

Who in there right mind gives away a property at 50 cents on the dollar when the market will give them 100? Even if you have 10 million in the bank cash the likely hood is small you are going to be successful using the machine gun offer approach.

As a matter of fact by the time you do realize how to underwrite apartment buildings your credibility will have been lost. You'll be the boy who cried wolf.

In summary you need to be an expert in the market niche you are buying so you can spot deals at 50-60% ltv because if it is obvious a building is 50-60% the property will be bid up to 90-100%.

J Scott · Answer

Musa -

A lot of people who do this type of apartment building flipping call is a "value play," and personally I think there is huge opportunity to make BIG money with these types of investments over the next few years.

It's going to take a good amount of cash to get into this game (commercial lending is tight, especially for poorly managed properties), but if you have the cash to invest, a smart investor will be able to make millions quickly in the upcoming commercial market.

I've written a bit about this strategy on my blog, including this:

[REMOVED]

Once the banks start moving the apartment assets on their books (REOs), this is where I will be focusing my strategy as well.

All that said, your formula for estimating the after-repositioned value of the asset is sound, but as Will pointed out, there are a LOT of factors that come into play.

For example, what type of management will you put into place?  On-site?  Off-site?  Full-time?  Part-time?

How many units you plan to buy will play a huge factor in how well you can scale things like management, marketing, rehab cost, etc.  So that plays a factors as well.

Your 50% of income for operating expenses may be correct, or it may be way off, depending on the specifics of your plan.

Just some things to think about...

Bill Gulley · Answer

Not at all Curtis, and I was being sarcastic.

I have seen multis purchased by people who had other units in different areas, like surrounding towns, even the other side of town where they thought they had a deal, thought they could go in using the same management techinques and improve the value. They fell flat on their face, why? Because multifamily markets can change for various influences within a small area or neighborhood.

Assessing the value from an income approach is the most weighted approach, that's a given, but the cost and market are not thrown out the window! Some economic areas can be narrowly defined within any city.

An experienced appraiser/investor will look to trends in the subject area, transportation lines, types of employment in that area, employment security, proximity to parks, hopsitals, shopping centers and schools. You can have identical apartment buildings three miles away, in similar condition and one may have a much better cash flow.

There is no substitute for knowing the market.

If rehab costs are going to be 25% of the cost, what does that tell you? It should be saying that the current rents and NOI are nothing to use for the assessment of ARV, that comps in the after repair condition in that area should be used and take the actual figures and throw them out the window!

M A. · Answer

I use that formula to estimate the fully stabilized value (remanaged and rehabbed) in under a minute

I'm making offers on properties 50 to 60 cents on the dollar ( 60% x fully stabilized value)

My strategy is all about making massive offers. When I get a reply from someone interested in my low ball offer I go into due diligence mode and research how utilities are being paid, necessary improvements etc etc)

If someone has a better idea to quickly grasp the potential of a multifamily please inform me :D

Musa

Mario J Perez · Answer

Here is something I saw here on BP to determine CAP rate and thus value. The â€œnormalâ€ CAP rate formula is NOI/Purchase Price. But this formula does not take into account financing terms which will affect the rate of return. This formula (aka Band of Equity Investment method) tells us the max price we can pay and realize the rate of return we are looking for. The advantage being that it takes into consideration financing terms. Here it is:

Mortgage: Loan to Value of Mortgage x Mortgage Constant = ______

Property: Down Payment on Property (%) x Desired Rate of Return = ______

Mortgage: 80% (.80) x 7.99% (.0799) = 0.06 + Equity 20% (.20) x 11% (.11) = 0.02

0.06 + 0.02 = 0.08 CAP Rate

Curtis Gabhart · Answer

btw I was not trying to be critical or overly harsh like it sounded just trying to make a point that there may be more effective methods of accomplishing your goals.

Bill Gulley · Answer

Hi, you have been given very good advice here! If your net worth is in 8 or 9 figures, then the quickest way is to just say. I'll take that one and that one and that one. That's the quick and dirty way. If your net worth is not as mentioned, what's the hurry? If you don't put a sharp pencil to your deal, you're going to be hurting. If all you are wanting is attention of the seller and a low ball offer, why not offer the asking price paid by the future value of  discounted zero coupon bonds, say at 25 or 30 cents on the dollar?   (LOL) Bill

How to find the ARV of a multi-family

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