Whether you own a multi-family or are shopping around for one, it’s critical to understand how to value your property to ensure you’re either getting the best sale price or trying to find a deal on the market. The good thing is that it is very easy to calculate multi-family valuations if you’re willing to put in some time crunching the numbers to get you there. The good thing is that the formulas we’ll cover here can help you value everything from a triplex to a 50 unit commercial real estate building.
Why exactly is investing in multi-family properties a good idea? They come with significant advantages such as cash flow, tax advantages, and ability to create appreciation through managing your Net Operating Income, all of which can benefit your bottom line.
The first thing we need to get a handle on in our computations is to get a total sum of our operating expenses for managing and maintaining the property. These will include expenses such as trash, sewer, water, snow plowing, lawn mowing, pest control, etc.
The next item we need to get a hold of expenses that will improve or upkeep the building on a greater than one year time scale. Think of these expenses as larger than just minor maintenance tasks. They can be anything from water heater repair, driveway repair, roof replacement, A/C unit replacement, exterior painting, window replacement, etc.
Total Rental Income
Total rental incomes are usually a quick calculation on a property, however there can be some complicating factors that may go into the formula. Firstly, you’ll want to start with a full understanding of rental rolls for the property and any additional income sources that can generate rental incomes (storage and parking spaces, etc.). Once you get this number down, you should also consider things like vacancy rates into the equation. Thankfully, vacancy rates are usually available from industry reports on larger metropolitan localities and can be found with a Google Search or two.
Net Operating Income (NOI)
The Net Operating Income or NOI number is one of the critical components of finding out the current market value of a property. It is used mainly to help us understand all rental income minus then subtracting all of our expense factors. So the formula would work as below:
NOI = Total Income – Capital Expenses – Operating Expenses
One important note is that NOI does not include financing such as mortgage payments (principal or interest) as a part of either operating expenses or capital expenses. Keep in mind that when you’re computing these numbers they must be annualized numbers, so be sure to look back over a long history of building finances to get the best holistic understanding of your rental income and expenses.
When you’re purchasing a property it is best to ask for the sellers last 12 months of income and expense figures to approximate your NOI based on real data.
Cap Rates are the next formula that we need to understand. Many times cap rates are something that brokers will know about a specific market and location that you’re interested in investing in, however, there are means of computing cap rate if you know the list price of a property and the NOI on the property.
Through the formula below, we can get our cap rate:
Cap Rate = NOI/Price
The market cap rate in a specific location is a very useful piece of data here so that you can know whether the acquisition you’re considering is above or below the market average cap rate in that area. For instance, if our Cap Rate calculation on a property .10 but the average market cap rate is .07 in a given area, we know we’ve found a deal worth looking into in more detail. The good thing is that both NOI and Price are known variables for a property at the time of purchase as well, so there isn’t much guessing about these core metrics.
Current Market Value
Once we have all the components down mentioned above, we will be able to compute our market value of a property. This valuation approach is known as the “income approach” of appraisal and has a rather straight forward formula:
Current Market Value = Net Operating Income/Cap Rate
There are several things to understand about valuations, mainly understanding the trade-off between cap rate and value in a given market. When understanding the risk of an investment what we tend to find is that the more valuable a comparable property is it tends to have a lower cap rate. This is largely due to investors understanding of risk. With lower cap rates come higher valuations as investors are willing to pay more for a low-risk property. We must also keep in mind that even after the acquisition of a property the cap rate and NOI can fluctuate resulting in changes in the current market value. For instance, if market rents go up high relative to expenses, our NOI will increase and we’ll see our valuations increase.