Underwriting Value - Market Rent or Contract Rent

[Kyle Majors]

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!

[Greg Dickerson]

Originally posted by @Kyle Majors:

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.