{"id":41720,"date":"2013-04-16T08:00:00","date_gmt":"2013-04-16T14:00:00","guid":{"rendered":"https:\/\/www.biggerpockets.com\/renewsblog\/?p=41720"},"modified":"2024-06-06T00:15:53","modified_gmt":"2024-06-06T06:15:53","slug":"2013-04-16-forced-appreciation-expandability-single-multi-family","status":"publish","type":"post","link":"https:\/\/www.biggerpockets.com\/blog\/2013-04-16-forced-appreciation-expandability-single-multi-family","title":{"rendered":"Why Forced Appreciation Makes Multi Family Investing Better, Hands Down."},"content":{"rendered":"

In an earlier article entitled Which Is Better \u2013 Single or Multi-Unit Real Estate?<\/a> I explored some of the advantages and disadvantages of utilizing single family residences verses multi-unit properties as the basis for building a cash flow investment portfolio. \u00a0I am going to now build onto this conversation by exploring the subject of Forced Appreciation<\/i> as it relates to both the single-family (SFR) and Multi-unit investment spaces.<\/p>\n

Expandability Defined<\/h2>\n

In order to discuss forced appreciation, we must first address something I call Expandability.<\/i>\u00a0 Expandability is defined in the following way:<\/p>\n

Expandability – any tool, technique, term, or approach implementation of which allows an investor to either improve upon the investment returns on a given investment or portfolio of investments, or to facilitate a transaction which would otherwise not be possible.\u00a0 <\/i><\/p>\n

Expandability items cover a gamut ranging from the setting of the closing date, which as we all know can have a dramatic impact on a transaction, to financing clauses, rehab items, and everything in-between.<\/p>\n

Expandability represents a great advantage of the real estate investment vehicle.\u00a0 For instance, when buying shares of stock, we essentially are making a \u201cguess\u201d as to whether those shares will go up or down in price.\u00a0 If we guess correctly, then we make money.\u00a0 However, fundamentally there is nothing that we can personally do to force the price-action one way or the other.\u00a0 The same is true of pork bellies, precious metals, bonds, art, and most other things that we can invest in \u2013 there are no expandability options available to us in these asset classes.<\/p>\n

As we all know, however, this is not at all how things work in the real estate market.\u00a0 Through strategic management we can exploit elements of expandability and in doing so we can significantly impact the intrinsic value of the asset we are holding.\u00a0 While expandability can exist in both the single and multi-unit spaces, the inner workings of what is involved are quite different, and this is the subject for today\u2019s article.\u00a0 Let\u2019s start out by understanding the value-setting mechanism in both markets.<\/p>\n

Setting of Value in the Single Family World<\/h2>\n

If you were to ask your appraiser friend how he determines value in a single family dwelling, he would tell you something like this:<\/p>\n

I use the Comparative Market Analysis (CMA) \u2013 a process of compare and contrasting sold properties of similar quality and in the same geographic vicinity that sold within a few months prior, and by making adjustments for amenities and square footage I arrive at an approximation of value for the subject\u2026or something like that.<\/p>\n

Setting of Value in Multi-Family World<\/h2>\n

If, however, you ask the same appraiser friend how he determines value of an apartment building, this is what you would hear:<\/p>\n

The main reason people buy apartment buildings is because these buildings represent an income-stream.\u00a0 As such, the valuation of an apartment building is a function of the income, more specifically the Net Operating Income (NOI).\u00a0 When I appraise an apartment building the question I am asking and answering is: What would a reasonably aggressive investor pay for the income stream represented by this building in this location in today\u2019s economic landscape?<\/p>\n

So, if I know that investors in a particular market typically look to achieve a 10% return, then a building with an NOI of $50,000\/year should be attractive to them at a $500,000 purchase price.\u00a0 Having verified the income and expense structures of the subject, and having made adjustments for age, amenities, unit make-up, etc. $500,000 becomes my approximation of value, more or less.<\/p>\n

What Does This Mean?<\/h2>\n

As is evident from the above definitions, the only way to achieve a value spread in the single family world is by buying low, which can be accomplished by either buying a distressed property or buying from a distressed seller.\u00a0 However, regardless of the reason for the discounted price, buying low is the only way to create a spread in this market since the top-line value of any asset in excellent condition is set by the marketplace based on the comparable sales, and it is impossible to supersede that in a substantive way.\u00a0 You may very well have done the most incredible remodel and have the best house on the block, but if the comps have established that a house like the one you\u2019ve got, in this location, and with these amenities is worth no more than X, then you won\u2019t be able to beat the market by much!<\/p>\n

What I described above is the essence of the Fix and Flip strategy whereby \u201cIF\u201d we\u2019ve purchased the property at a low enough price and \u201cIF\u201d the value created by the remodel exceeds the cost of said remodel, and a whole lot of other \u201cIfs\u201d, then we can achieve forced appreciation and the property is said to have expandability. (Read So – You Think You What t Flip<\/a> <\/i>for more on the subject)<\/p>\n

An interesting distinction here is that in this scenario we are not improving the underlying intrinsic value of the real estate, as much as we are recapturing the value which had been discounted by the market due to distress of the property or the seller.<\/p>\n

Forced Appreciation element of Expandability in Multi-unit market.<\/h2>\n

Similar rational can apply to the multi-unit space in that we certainly can negotiate a discounted price based on either the property or the seller distress.\u00a0 We can then perform the necessary repairs and recapture lost value.\u00a0 But, in this space opportunities exist to go beyond simply recapturing of discounted value and to actually force the intrinsic value of an asset to expand, and here is why:<\/p>\n

This is because unlike the single-family market which establishes value<\/i> based on comparable sales (I underscore value<\/i>), on the income-producing side the market establishes the desired rate of return <\/i>based on returns that investors are able to achieve \u2013 this is the essence of CAP Rate.\u00a0 In turn, the application of the CAP Rate to the income of the specific building is what establishes the value of the building.\u00a0 Forcing of appreciation in this space, therefore, is a function of expansion of the income, which represents an interesting distinction and creates an opportunity.<\/p>\n

The Opportunity<\/h2>\n

While in order to create spreads in a single family we must purchase at a deep discount, we do not necessarily have to do the same in the multi-unit market.\u00a0 We can pay a price which is fair based on current financials of the building, and then we can improve the financials and back into an increased valuation, presuming that the rental market will support the higher rents of course.\u00a0 And naturally, we can do both \u2013 we can negotiate a lower price than the current intrinsic value, and then improve the intrinsic value thus benefitting on both sides of the value equation.<\/p>\n

Successful investing is conditioned upon many elements, one of which is our capacity to outmaneuver the competition.\u00a0 So, do you think that there may be an advantage in being able to pay a price that the seller can deem fair?\u00a0 Is there an advantage in not having to \u201csteel\u201d each and every time?\u00a0\u00a0 Do you think that recognizing and capitalizing on opportunities which go beyond the purchase price opens additional doors of possibility for us?<\/p>\n

I think so.\u00a0 While I am no different from anyone else in trying to achieve the most advantageous purchase price that I can, I realize that the purchase price is only one of many negotiable terms and techniques under the umbrella of expandability which can have a dramatic impact on the validity of an investment.\u00a0 This view of things often enables me to do deals that many other investors look past simply because they can\u2019t \u201csteel\u201d them.\u00a0 This suits me just fine.\u00a0 As a matter of general philosophy, I believe that the more fertile ground will be found where the stampede has not been!<\/p>\n

While most investors focus on searching for deep discounts, I search for items of expandability.<\/i><\/b><\/p>\n

Photo: Fin Fahey<\/a><\/span><\/p>\n","protected":false},"excerpt":{"rendered":"

In an earlier article entitled Which Is Better \u2013 Single or Multi-Unit Real Estate? I explored some of the advantages and disadvantages of utilizing single family residences verses multi-unit properties […]<\/p>\n","protected":false},"author":810,"featured_media":169998,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[5529],"tags":[],"class_list":["post-41720","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate-marketing"],"acf":[],"comment_count":0,"_links":{"self":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/41720","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/users\/810"}],"replies":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/comments?post=41720"}],"version-history":[{"count":0,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/posts\/41720\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media\/169998"}],"wp:attachment":[{"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/media?parent=41720"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/categories?post=41720"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.biggerpockets.com\/blog\/wp-json\/wp\/v2\/tags?post=41720"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}