Related:<\/strong> Multifamily Myths: 5 Reasons People Think Multifamily Investing Is Easy (& Lucrative!) <\/a><\/em><\/p>\n Therein lies the trap in placing a value to multifamily properties or any other income-producing real estate. You are buying the income stream, and that income stream has value. But how much value? And how much is the income stream? No, I mean really\u2026\u00a0how much is the income stream<\/em>? You may think you know, but you might not know. There unknown unknowns.<\/p>\n Consider these five key takeaways:<\/p>\n The truth: Income is difficult to quantify.<\/strong><\/em><\/p>\n What are the rents? How much below the quoted rate are they really charging (this is called \u201closs to lease\u201d)? How much are they losing to physical vacancy now, and how much is expected in the future? If you decide to raise the rents, what will your<\/em> vacancy rate be? Are there concession losses (ever seen those \u201cfirst month free\u201d banners)? What about units that aren\u2019t rented because they are given to employees, used as a leasing office or model unit, or as storage? Those are called non-revenue units.<\/p>\n And let\u2019s not forget that tenants have their own problems, and sometimes they skip out and leave you holding the bag for hundreds or even thousands of dollars in unpaid rent (it happens often enough to have its own name \u2014 Credit Losses). These are known unknowns. But you have to figure it out, and whatever you do, don\u2019t be wrong. Self defense: estimate conservatively.<\/p>\n The Truth: It\u2019s called NET Operating Income, remember?<\/strong><\/em><\/p>\n NOI consists of two components: 1) gross income and 2) expenses. Subtract number two from number one, and you get NOI. But what about number 2? Expenses consist of many individual components, and some of them are easily forgotten. Make a list of expenses that you use consistently on every property that you analyze to make sure that you never forget to include an expense. A consistent approach to underwriting income and expenses will help keep you out of trouble.<\/p>\n The Truth: Your expenses will be different than the seller\u2019s.<\/strong><\/em><\/p>\n Whenever someone tells you to just take the seller\u2019s trailing 12 month net income and divide that by the cap rate to get your value, ignore them. When you buy the property, it\u2019s very likely that the tax assessor will re-assess the real estate and the taxes will go up. You have to account for that in your expenses. Next year\u2019s utility bills will likely be higher than last year\u2019s. (Has your rate ever gone down at home? I didn\u2019t think so.)<\/p>\n The seller might be self-managing (which is usually a clear sign of trouble), but you being the professional that you are will hire an experienced management company, and it\u2019ll cost you. Subtract that expense. The seller\u2019s sister might be the on-site manager and work for minimum wage because she couldn\u2019t get a job anywhere else, but you\u2019ll have to pay an experienced manager, and that\u2019ll cost you more. You get the idea; the list goes on and on.<\/p>\n The Truth: Cap rate is determined by the market.<\/strong><\/em><\/p>\n OK, you finally got the income figured out. To complete the simple equation that I introduced you to in the intro of this article, you need to divide the income by the cap rate. But what\u2019s the cap rate? If you tell me that you want a 10% cap rate, you\u2019re missing the point. Cap rate isn\u2019t about you. It\u2019s about the market.<\/p>\n Don\u2019t believe me? Wait until you\u2019re a seller\u2026 I\u2019ll bet you won\u2019t tell me that you want to sell<\/em> at a 10% cap rate! The cap rate is what other similar properties are trading for. You need solid comps and opinions from brokers and appraisers in that market who can tell you what they are seeing in the market in terms of cap rate.<\/p>\n5 Reasons Investors Think Multifamily is Easy to Value<\/h2>\n
Myth #1: Income is easily quantifiable.<\/h3>\n
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<\/a><\/p>\nMyth #2: Calculating NOI is foolproof.<\/h3>\n
Myth #3: To gauge your expenses, simply look at the seller’s.<\/h3>\n
Myth #4: I can determine my ideal cap rate.<\/h3>\n
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