What is an underperforming property worth?
I am looking at an 8 unit apartment. Four 1br, 1ba and Four 2br, 1ba. I just got financial information and since Jan 2016 the income is up and down several times. They lose tenants, then get some units filled, then they lose tenants, etc. Right now they have two vacants. Rents are in line with the area - maybe a bit higher than average. Property is in good physical condition but there have been some expensive repairs and all the utilities seem high to me. I suspect that the tenants are not screened and that the management company is spending too much on repairs. I will learn more during due diligence. The property is listed for $189,900. The max income from rents is $3900 at 100% occupancy. Assuming 55% of gross income is going out to expenses (owner pays all utilities), then this has a CAP rate of 11.1%. With two vacancies the income from rents is $2800 today.
Here is the question: What is it worth? Using the $2800 and the CAP of 11.1, I calculate a value of $136,000. Is this an appropriate place to start my offer. The current owner has proven on paper that he can not control costs and can not keep tenants, so why would I offer more than this?
Thanks for any comments and suggestions.
You can't base your purchase on 100% occupancy, because that's not reasonable. You must account for at least 10% vacancy, but seems like you could argue for more on this property. Base your initial offer on the current financials, keeping in mind that you will manage it better, screen better, and get expenses down and income up. So ultimately, you could pay somewhere between what it's worth based on current financials and what it will be worth on the new proforma from your better management. I wouldn't go up too much from current though, because you need to leave room for your upside.
You need to figure the NOI and the CAP rate for the area ( not the cap you came up with) then the math is like this: Purchase price = NOI / CAP
IF, the NOI is $2,800 X 12 = $33,600 and the market cap rate is 16% then the value is $210,000.
1. Where did you get the 11.1% cap rate?
2. How did you calculate a $136,000 value?
3. How did you calculate NOI ?
@Kevin Farrell At all utilities covered I guarantee it will be more than 55% expenses unless you are extremely handy/do-it-yourself type.
Can you separate some of those utilities to put them back on the tenant? If the building is in decent physical shape then why is there so much turnover? My guess would be that this is not a great location or tenant class that will provide the kind of return you want or are looking for.
Originally posted by @Chris Eaker:
You can't base your purchase on 100% occupancy, because that's not reasonable. You must account for at least 10% vacancy, but seems like you could argue for more on this property. Base your initial offer on the current financials, keeping in mind that you will manage it better, screen better, and get expenses down and income up. So ultimately, you could pay somewhere between what it's worth based on current financials and what it will be worth on the new proforma from your better management. I wouldn't go up too much from current though, because you need to leave room for your upside.
Chris - Agree with the 10% vacancy, just didn't include that much detail. Thanks.
Originally posted by @Patrick Liska:
You need to figure the NOI and the CAP rate for the area ( not the cap you came up with) then the math is like this: Purchase price = NOI / CAP
Patrick, this gets to the heart of my question. I don't know the CAP rate for the area. It is a D area. Census data shows incomes in the immediate area to be mostly $30K or less per year. I am assuming a CAP rate of 10 to 12.
Originally posted by @Account Closed:
IF, the NOI is $2,800 X 12 = $33,600 and the market cap rate is 16% then the value is $210,000.
1. Where did you get the 11.1% cap rate?
2. How did you calculate a $136,000 value?
3. How did you calculate NOI ?
Bob - I took the max rent income at 100% occupancy as $3900. NOI estimated like this assuming 55% for maint $3900 X 12 X.45 = 21,060. Then I took that NOI and divided by the listing price of $189,900 to get a fudged CAP rate of 11.1%.
With that CAP rate I used the actual stated current income produced by this property - $2800 to calculate present value. NOIcurrent = $2800 X 12 X .45 = 15,120. Valuecurrent = $15,120 / 11.1% = $136,216.
Originally posted by @Zach Quick:
@Kevin Farrell At all utilities covered I guarantee it will be more than 55% expenses unless you are extremely handy/do-it-yourself type.
Can you separate some of those utilities to put them back on the tenant? If the building is in decent physical shape then why is there so much turnover? My guess would be that this is not a great location or tenant class that will provide the kind of return you want or are looking for.
Hey Zach - you are very perceptive. Yes, in truth the costs are more than 55% of gross but there is room for improvement that current management is not addressing. In this area tenants expect to have utilities paid. That is the competition for renters in this area. With good screening good renters can be found - I know two properties that are in similar areas here that do it.
Yes, the location is a challenge.
Best way to find local CAP rate is to talk to commercial realtor and ask them what it is, or see what other properties have sold for recently, but you would need to know their NOI. you can't assume the percentage for maintenance ( not just maintenance, utilities, taxes, water, sewer, etc to determine your NOI ) you have the numbers, as inconsistent as they seem to be, some should remain constant, those that fluctuate try to use an average.
Patrick, thanks. I will ask the agent when I speak to her.