Underwriting Value - Market Rent or Contract Rent
Washington, DC · Member since 2016 · 22 posts · 5 votes
Hey BP,
Just had a thought as I was reading through several appraisals that I found online.
When underwriting a property I've been taught by @Michael Blank to apply rules of thumb for expenses to the T12 income and to then apply the market cap rate to find a reasonable price to pay.
While looking through these different appraisals I have found online, the appraiser uses the market rent (not the T12 rent) and typical expenses/vacancy to come up with a NOI.
NOI/Cap rate = value...So if an NOI for a specific property is achieved by higher than normal rents, I thought the property's valuation would be rewarded and be higher. And not be discounted by applying norms of that market. Should I be underwriting potential acquisitions with typical rents and not with the T12 income? Can someone provide some clarity?
Thanks BP!
Thanks @Greg Dickerson. Here's a follow up for you. When I underwrite it based on the T-12 and those rents are higher than most of the comparable rents, then the true market value from the appraiser will be lower. For example, if the NOI in a 7 cap area is 200,000 its value that I derive from my underwriting would be 2.86 mil but compared to a 7 cap area where the appraiser drops the rents and now the NOI is around 175,000 then the value would be 2.5 mil. Where would you start the conversation with that broker.. the 2.86 or 2.5? My concern is that I don't want to overpay unless I have to be competitive of course.
You need to formulate your offer based on your underwriting and return requirements. It doesn’t matter what the broker or an appraiser says it all up to you. That being said make sure you are confident you will be able to keep your rents above market moving forward.
@Kyle Majors MAI appraisers use market rents because actual rents could by unusually high or low depending on a lot of factors. They are using averages just lie they do for replacement cost and comps.
Banks underwrite using actual income and expenses on stabilized assets and will not base the DSCR on proforma unless you are working on a distressed asset or new build.
When you underwrite the deal you should use actual T-12 so you know what the property is doing as it sits and how you can increase the value. You can also run your projections based on your business plan to determine the potential of the property.
Thanks @Greg Dickerson. Here's a follow up for you. When I underwrite it based on the T-12 and those rents are higher than most of the comparable rents, then the true market value from the appraiser will be lower. For example, if the NOI in a 7 cap area is 200,000 its value that I derive from my underwriting would be 2.86 mil but compared to a 7 cap area where the appraiser drops the rents and now the NOI is around 175,000 then the value would be 2.5 mil. Where would you start the conversation with that broker.. the 2.86 or 2.5? My concern is that I don't want to overpay unless I have to be competitive of course.
Thanks @Greg Dickerson. Here's a follow up for you. When I underwrite it based on the T-12 and those rents are higher than most of the comparable rents, then the true market value from the appraiser will be lower. For example, if the NOI in a 7 cap area is 200,000 its value that I derive from my underwriting would be 2.86 mil but compared to a 7 cap area where the appraiser drops the rents and now the NOI is around 175,000 then the value would be 2.5 mil. Where would you start the conversation with that broker.. the 2.86 or 2.5? My concern is that I don't want to overpay unless I have to be competitive of course.
You need to formulate your offer based on your underwriting and return requirements. It doesn’t matter what the broker or an appraiser says it all up to you. That being said make sure you are confident you will be able to keep your rents above market moving forward.
@Kyle Majors, the lenders I've worked with use T3 for income, not T12. I believe this is standard for agency loan underwriting also. The reason is that T3 income provides insight into what is happening with the property most recently. I've seen dramatic changes in income over a T12 period that will skew your NOI (either conservative or high risk), especially with vacancy.
As @Greg Dickerson says, your offer should be based on your underwriting. Use numbers you feel confident with. If you don't have confidence, do more research but don't rely on rules of thumb.
Thanks @Greg Dickerson. Here's a follow up for you. When I underwrite it based on the T-12 and those rents are higher than most of the comparable rents, then the true market value from the appraiser will be lower. For example, if the NOI in a 7 cap area is 200,000 its value that I derive from my underwriting would be 2.86 mil but compared to a 7 cap area where the appraiser drops the rents and now the NOI is around 175,000 then the value would be 2.5 mil. Where would you start the conversation with that broker.. the 2.86 or 2.5? My concern is that I don't want to overpay unless I have to be competitive of course.
Who cares about someone else's opinion? You have to go with your underwritten #s. That being said, you will realize that most gurus/coaches (at least the ones who are not doing active deals) provide amateur-hour advice when it comes to the actual negotiations around valuation.
Many times, the whisper price is just that - a whisper. The actual price can be significantly lower or higher than what the broker is guiding towards. This is where knowing the comps, the state of the market and the interest that the property is generating can really help.
We have been awarded deals where our price was significantly below the whisper price. In those cases, we either had some form of an edge - pre-existing relationship with the broker/seller, track record which provided surety of closing and/or more aggressive non-monetary terms (less days to close).