If you’ve been around the proverbial BiggerPockets block a time or two, you’re aware of the fact that commercial multi-family properties are valued differently than single-family homes.
Whereas a single-family home is valued based on the comparable properties (a.k.a “comps”) around it, commercial multi-family properties are valued based on the income that they produce.
This is done by applying a capitalization rate (a.k.a “cap rate”) to the Net Operating Income to determine its value.
Say you find a property.
According to the seller’s pro forma, it nets $50,000/yr. You then do a bit of research and find that it is located within a market where the cap rate is 8%. Since you know the market cap rate and you know the NOI, you can derive the property value based on the current market.
Cap Rate = NOI / Market Value
0.08 = $50,000 / Market Value
Market Value = $625,000
So let’s assume that you put in an offer for the property at $600,000 and it is accepted. Congratulations! You just got yourself a steal!
Until, of course, you realize that your NOI was off.
In fact, the NOI is actually only $45,000. But that’s not too bad, right? Just a $5,000 difference.
Well, lets run that math again.
Cap Rate = NOI / Market Value
0.08 = $45,000 / Market Value
Market Value = $562,500
Institute of Real Estate Management (IREM)
I’m not a seasoned multi-family investor like many of the people on BiggerPockets.
So when I decided to make the leap into commercial property, I couldn’t exactly refer to my own Excel spreadsheets and experience in order to know how much everything cost.
What are typical vacancies for a multi in my city?
How much are other owners spending for repairs every year?
What does electricity typically cost for common areas?
I had no idea.
Commercial real estate is a completely different game from single-family homes. Therefore, I wanted to make sure that I had all of my ducks in a row before I put an offer on anything.
I learned about The Institute of Real Estate Management in Steve Berges’ book The Complete Guide to Buying and Selling Apartment Buildings. This was a huge find and really helped me get a grasp on determining NOI.
The IREM Income/Expense Analysis program has been around for 59 years now. It started out as a brief survey of 200 apartment complexes and has evolved into a massive undertaking of approximately 10,000 properties throughout the United States.
After this data is acquired, 1,000 pages of analysis are published in 5 different volumes.
Although these reports start at a not-so-cheap $145, I couldn’t be more happy that I bought it.
IREM Income/Expense Report
As we saw in the above example, even a small error in the calculation of NOI can drastically change the value based on cap rates.
So how awesome would it be if you could see a list of real world values for apartment complexes in your city?
The income/expense items in the report are listed based off of the HUD Chart of Accounts in order to ensure consistency. Values are shown in the following three ways.
- Percentage of Gross Possible Income (%GPI)
- Dollars per Square Foot ($/SQFT)
- Dollars per Unit ($/Unit)
Here is a sampling of some of the line items listed on the report.
- Management Fee
How Do I Use the Data?
Is this property a good deal? Where can we improve the value? Can we raise rents? Can we decrease expenses? Most importantly, will the local market support these changes?
Answers to many of these questions can be found within the income/expense analysis report. It’s kind of like having a mentor who lets you peak inside his books from time to time.
What is the current value? If we were to raise rents to market and lower expenses, what could our future value be?
Armed with this data, you’ll have more confidence in your numbers when you present to investors, brokers, partners, or lenders.
3. Yearly Review
Are we managing effectively? Are we charging enough for rent? Are we seeing more vacancy or less vacancy than other apartments?
This resource, since it is published every year, is a great way to stay on top of your business. The income/expense analysis report can be used as a yearly “gut-check” in order to make sure that your investment is at the very least consistent with others in your neighborhood.
For those seasoned multi-investors out there, what other ways do you think this information can be used? Are there any other resources out there which provide similar information?
Please feel free to leave a message in the comments. Cheers!