How to value a multi-unit property in detail

Question

Exactly how do I get the figures to calculate NOI, cashflow etc. I understand the formulas but where do I get the variables? How can I find out exactly what the rents are for each unit and what the expenses are? Also, once I get my hands on the information how could I determine if it is valid or not (if the seller is inflating the rents or not being honest about the expenses etc.)?

I'm just starting out and I've contacted a few realtors so that I can look at a few properties. I want to get comfortable with analyzing and valuing properties before I move on to the next step of my investing plan.

Frank Gallinelli · Answer

Just a quick side note about cap rates in general and in regard to multi-family properties in particular. First, the market cap rate that you want to apply to your projected NOI is a function of both the property type and the particular market in which the property is located.  Don't expect to use same to rate for retail properties as you would for residential.  Good ol' apples and oranges.  Also, the rate that prevails for a particular type of property in one market may be very different from the rate in another market. Don't expect to use the same rate in East Tumbleweed that you would use in midtown Manhattan.
	
	The size of the property can be an issue with multifamily.  In general, cap rate analysis is appropriate for a property with more than four residential units, but I believe you will find that many appraisers put less emphasis on income capitalization with smaller buildings. They may be more likely to estimate value by comparable sales or even gross rent multiplier.
	
	Finally, while income capitalization is usually an essential part of your how-much-to-pay decision process, it should not be the only part. I would always recommend a complete cash flow analysis and pro forma projection into the future.  No matter what the appraisal may say, your real objective is to achieve a positive cash flow and an acceptable overall rate of return for the entire holding period, so your price and terms should be structured to achieve those goals.

Jake Kellerhals · Answer

In my experience they are going to inflate the rents (sometimes) and deflate the expenses. You can usually get a copy of the lease during your due diligence period (once you have an accepted contract, but can still back out). If you get a real lease, 95% of the time that's going to be an accurate number.

For expenses, ask for their tax returns on that property. They are obviously going to INFLATE expenses for the IRS so they can deduct as much as possible.

But in the end, it's impossible to expect to get a 100% accurate picture of the property until you own it. Expenses vary from year to year, a unit that has been occupied by the same person for 10 years might suddenly be vacant for 6 months.... you won't ever be 100% certain. The biggest variable of all is your management! Will you be a better manager of the property and lower expenses while increasing revenue? Will you perform at the same level? Or worse?

Vince Greenland · Answer

a few things that I do that have not been mentioned, unfortunately from lessons learned.

I now always get an estoppel certificate signed by both the current landlord and tenant. I include the following:

• rent
• security deposit
• who owns fridge/stove, etc
• also get phone number and other relative info on tenants

in addition, I also now verify with the utility the average monthly bills. I had one deal that I got lazy because the selling agent also managed the property. they were a reputable company and I "trusted" that they would have an accurate description of the utility cost. wrong!

don't trust anyone. just my two cents

Andrew Machado · Answer

@Ned Carey Thanks for the insight and elaborating further on my question. Really puts things into perspective.

@Ben Leybovich Ever so modest... I'll look further into CFFU and leave a review on Amazon once I've finished reading it.

Ben Leybovich · Answer

WOW - take it easy on the "inspirational man" stuff Andrew.  I appreciate your kindness, but I got a rep to protect around here - can't afford Brandon Turner, Josh Dorkin, and the rest of the BP Nation confusing me for a nice guy :)

Although, I have to say that being put in the same sentence as Frank makes me feel pretty good - thank you.  Frank likely has forgotten more than I care to ever know :)

Please let me know how you feel about the eBook Andrew.

And, naturally, I am always available to answer questions here :)

Ben Leybovich · Answer

@Leonid Sapronov - thanks for mentioning :)  Did you enjoy your copy?

@Andrew Machado The due-diligence process is possibly the most important part of real estate investing.  Listening to what you are being told is important but knowing how to verify is much more so.

Andrew Machado · Answer

Two gentleman that I look up to both comment on my first post. Thanks BP!

@Frank Gallinelli Thanks for the detailed info. I must admit your post brings a lot of questions to mind, more than may be necessary on this forum. Would you recommend any of your books or perhaps your program? I'm extremely interested seeing as how you're not only a veteran in the one subject I am most passionate in, but also a professor at the University I've been looking to attain my MBA.Thanks for the post Frank.

@Ben Leybovich I'm purchasing your book now. Your timing was perfect on this one. I listened to your podcast just the other day and found that our investing goals align well. Would you happen to have any other recommendations? You're an inspirational man Ben, thanks for the post.

Ned Carey · Answer

Yes and no. The process for a larger multi-family is pre-screen the property based on the info provided. Then you put the property under contract.

Contracts for commercial properties generally have a Due Diligence period. This is basically contingency for you to verify the sellers numbers to your satisfaction or a "Free Look."

Often a letter of intent is used to negotiate back and forth until buyer and seller come to terms then an attorney draws up the contract.

The lease Jake is referring to is the lease or leases with the tenants. You need copies of them to verify the rents and terms that the tenants are currently getting.

PS How to evaluate a multi family in detail is not a forum reply or even a book, it is a lifelong study. However Frank's book and Ben's book are both probably great starts.

Andrew Machado · Answer

Thanks @Usha  Angou any assistance helps.

Usha Angou · Answer

Do all what you can with the figures they give and find out the one main thing, what sort of Cash flow you are getting.The most important parameters are Cash flow scenario & Occupancy rate. I always do a conservative NOI calculation ... you can say thumb rule - gross rental income - gross expenses (Taxes, repairs, HOA fees,staff, emergency maintenance etc etc.)  50-60% write it off as expenses of all sorts. The remaining is NOI. See if   NOI/Capital (Value of the Property) is >10%. This is what is called Caprate.

Anything less it is not worth to look at such property. Hope this helps.

How to value a multi-unit property in detail

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