BiggerPockets

I've been involved in the SFH game for a while and have had some success with it. But lately, I've had a strong desire to jump into investing in multifamily units. I'm currently reading the book Multi Family Millions and gaining a stronger grasp on how things work.

The biggest thing I learned since getting involved with real estate is that hesitating to take action is the worst thing you can do. After I close my most recent wholesaling deal today, I want to really go in with this. I've even been in contact with a guy who works for a hard money lending company that specializes in commercial properties so finding financing won't be as big of an issue. The main thing now is finding a deal.

So a few days ago, I ran across a craigslist ad for a 100 unit apartment in Atlanta. The owner is out of state in CA and wants to get rid of the property. The asking price is $1.7 million, occupancy is currently 71%, and the cap rate is 10%. The surrounding area is something I wanted to pay attention to. Wal-Mart plans to open a new store nearby. And the North American Porsche headquarters are moving their facilities from Sandy Springs to this area. Both of these things will bring new jobs to the area and possibly more tenants looking for a place to live.

Is there anything else I need to look for to determine if I should make a move on this? Obviously, there are things like repair issues that would be looked at during the due diligence period. But is there enough here to even make this worth looking at? And if so, what's the next step?

Touching on this topic of a MFR that has less than 100% occupancy:

If one is trying to value a commercial / MFR property and there is a fraction of full-occupancy (71% in this example)... how does one go about valuing a purchase price? I know that the overall NOI has most to do with it, but let's say there was 0% occupancy (such as a small retail commercial building with no current tenant ... - would one then value the property simply based on its "replacement costs" + "land" ?

In this case with a MFR with 71% occupancy, what would be the way to come up with a value - (all else being equal?)

Hi Clay,

When looking at purchasing properties like you are describing you go by what you think the "highest and best use" is.

When I worked for developers we looked at a property for not what it was in it's current state but what we wanted to use it for. Then you build a pro-forma of soft and hard costs and your targeted return and work you way backwards. You build in contingency money for worst case examples and then arrive at your price for the property going in.

The small retail building you would need to look at ( age of the building, who would go in there for the highest rent and it is mom and pop or corporate, is the building best demolished and build new, is the land better used assembled with adjacent properties, etc.)

As you can see it's not just a simple formula but a careful and detailed analysis goes into looking at every property individually.

Same thing with a apartment building. Is the current use the best use?? Can a higher density be built on the land for apartments?? Are apartments oversaturated but the land is valuable and the best use is retail or medical office for the land etc.?? Is the building good but unit mix and amenities need changing etc.??

Chris, you mentioned a cap rate, but that can be manipulated by sellers by hiding expenses or using pro forma income. To best analyze the deal, you need the current gross income, the unit mix, and the current vacancy (which you already have).

Clay, Joel provided answers to your question on evaluating deals that are not fully occupied. In the example, of course a building with 0% occupancy still has value, but how exactly do you come about finding it? Assuming the building is already using its highest and best use, the only way to do it is work somewhat backwards and using a pro forma for income. Lets say each door gets $100 (for simplicity sake) and you have 10 doors, but the building is empty. I would use $1000 as the pro forma gross income, then take out 50% for expenses and arrive at a pro forma NOI of $500. Then lets say the gong cap rate for that area was 10% and I was comfortable with that return. Thus, the value of the property would be $60,000 ($500 NOI x 12 months divided by 10% cap = $60k). So based on the building pro forma, it is worth $60k. But as an investor, I need to go through all the work to fill the build,IMF and stabilize it, so I want to be paid for that. In order to get paid for it, I must pay less than $60k. That is where the backwards math comes in. I can't tell you exactly how to calculate what discount you should seek as every investor is different and every investment is different. In the 50% rule, it is common to have 10% of that going towards vacancy. So, in our new example, lets say the building was 50% occupied. Since my 50% expenses includes 10% for vacancy already, I need another 40% to stabilize. Thus, I want to be paid for that 40% of tenant placement work so I would offer approx. 20% minimum to 40% maximum off of the value of $60k. Lest say I wanted 30% discount for the 40% placement, then my max offer would be $42k ($60k X .7)

Thanks, indeed, for the replies - (*this forum is sure a great medium...*)
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To recap and further clarify on the issue of trying to value a property that has a multitude of deficiencies (high current vacancy, repairs, etc.):

Let's assume that the subject property is, indeed, a multi-family apartment complex. And all else being equal, it is the "highest+best use" for the structure/property going into the future.

If we are performing due-diligence and trying to account for bringing the property "up-to-par," how would you approach items/issues that might be further down the road. For example, upon reviewing the property and adjusting for Will's example of the need to place 40% with new tenants, we find out that there will need to be new water heaters replaced in three years. Perhaps there also needs to be a new roof, but not for six or seven years down the road. The seller might tell you that every roof needs to be replaced "down the road" as do water heaters and given this, he doesn't see the need to offer a "discount" for future repairs/capex.

So, other than discounting the typical needs of stabilizing a property from the beginning and unless something significant (like a roof, etc.) needs to be repaired/replaced pretty much at the time of ownership change, how far into the future is necessary to calculate on a pro-forma and to evidence a seller about its significance?

Originally posted by Will Barnard:
... You also should realize that your 50% rule would allow and cover 15 years worth of reserves to cover said expense, but in the 5 year example, very little time.

This is very interesting and the type of info I was looking for. I've seen many different approaches to valuation in terms of time - (some look at an office building in terms of the next five years of cash-flow, or maybe 10 years, for example, etc. etc...)

So you're saying that for residential investments, investors like to envision the immediate 15-years of expenses/capex on average - as a basis?

Agreed, Will. Well noted.

-Clayton