Determining Purchase Price

[Brian Plajer]

Hello,

I'm looking at an apartment building that recently hit the market. The calculated purchase price based on actual numbers is significantly less than the calculated purchase price based on the proforma (best case scenario)  which requires capex improvements to increase the rents over a few years. Looking at similar properties, recently sold,  the Proforma price seems to be more in line with what it will sell for. My question is: aren't you giving up all the value/growth  by paying a  price based on the proforma which may or may not come to fruition? Seems like the purchase price should be somewhere between the actual and the proforma, acknowledging that improvements MIGHT increase the value to some unknown degree but certainly not a guarantee. I appreciate all of your expertise, suggestions and comments.

[Arn Cenedella]

@Brian Plajer

Welcome to the competitive world of multifamily. 😀

Prior to about 3 months ago, most MF properties sold OVER pricing guidance provided by broker.

Today, many sell BELOW pricing guidance.

Offer what makes sense to you and then sit back and see what happens.

[Nathan Grabau]

The market has changed a lot, in Colorado it was about 9-10 weeks ago that it almost flipped overnight from a very strong sellers market to a more neutral market. In the strong sellers market properties were selling for more than they were worth in their current condition, we are now seeing more realistic prices here. My personal view is I should not have to pay a current owner of a property for work that they have not done and that I will have to do. There are sellers that are realizing the market is changing with is creating more opportunity. 

With high appreciation in the short run off the table, and interest rates now higher, I would not be willing to pay based off of proforma and would want to buy deals based off of current numbers. That being said, if your time horizon and debt structure is long enough, you could still overpay today and be fine in the long term. I do think there are better opportunities with more realistic sellers you will be able to find. Sellers who are trying to sell at pro forma might also just need to rack up some days on market to realize the market has changed. 

[Chris Seveney]

Quote from @Brian Plajer:

Hello,

I'm looking at an apartment building that recently hit the market. The calculated purchase price based on actual numbers is significantly less than the calculated purchase price based on the proforma (best case scenario)  which requires capex improvements to increase the rents over a few years. Looking at similar properties, recently sold,  the Proforma price seems to be more in line with what it will sell for. My question is: aren't you giving up all the value/growth  by paying a  price based on the proforma which may or may not come to fruition? Seems like the purchase price should be somewhere between the actual and the proforma, acknowledging that improvements MIGHT increase the value to some unknown degree but certainly not a guarantee. I appreciate all of your expertise, suggestions and comments.

 There have been a lot of assets sold that the numbers make zero sense. Wait 3-5 years from now and see what happens to some of them.  To put it another way, what price do you pay for a car in an accident? The price its worth or the price it is worth all fixed up (and you have to fix it up)? 

[Taylor L.]

So, basically, the property is worth $X right now based on its current incomes and condition. 

It could be worth $Y down the road if you spend $Z to fix it up and raise the income. The seller is trying to get $Y for it right now. 

What is it worth right now to a disciplined investor? $X!!!

It's been an interesting phenomenon that seems to have increased in the last few years. Don't fall for it! It's not worth $Y until it is actually worth $Y. Stay disciplined.

[Todd Olson]

You are preaching to the choir. Too many sellers still think it’s April. Rates shot up. Proformas should not be be looked at the same. I agree that you should offer what makes sense and show the seller your proforma with current rates and cash flow. Chances are the seller is an investor like you and me and will have a more level head at this point in the market. Keep us posted and good luck. 

[Evan Polaski]

As others noted, but I will expand slightly, you pay what gets the deal done.  There is a lot of preaching on these forums about "only pay based on what's in-place", which I take a lot of issue with.  First, if that is the stance you take (doesn't sound like it is, necessarily), you will never get a deal, since others will pay for the "opportunity".  Second, even if you are paying based on in-place, it doesn't mean what is there will always be there.  The financial crisis is a great example of strong performing apartments in "GM towns".  For decades they remained full.  But then the plant shuts down and the demand disappeared.  Clearly, this is a risk of investing in markets with a single major employer, but the point being market's shift.  I write this from post from downtown San Fran, where rents continue to fall on downtown apartment complexes.

Third, even if you are paying for possible opportunities, it all comes down to return expectations. You may be want deals that kick off 10% annualized returns, but someone else is happy for 6%. If you are consistently chasing the same deals, you will always miss out on deals, and either need to look at other investment options (i.e. not real estate) or change what you can accept.

The point being, even with the market "softening" as rates have gone up, there is still a lot of demand for multifamily.  In some instances, possibly more, as people continue to be spooked of recessions and long term impacts on the stock market.  Good properties are still trading at very high prices, and even if they are trading below whisper pricing or list pricing, it is still a higher price than the same property likely would have traded for 2 yrs ago.

[Brian Plajer]

@Evan Polaski thanks for expanding. Everything you said makes sense. I think the purchase price falls somewhere between the current worth and adding additional for the opportunity. The tough part is, as you mentioned, is markets are changing and just because someone else is in a position to overpay doesn't mean it's a smart move. I'm going to grab my crystal ball!

[Evan Polaski]

@Brian Plajer, and there in lies the notion of setting your desired return threshold, and sticking to it based on what you are comfortable. I personally try not to set my mentality of someone else is "overpaying".  It is more than I would be comfortable paying, based on my view of returns and risk, but to them they may be able to mitigate risk in a way I can't (i.e. flippers who have their own salaried framers, electricians, etc) or have a lower return threshold that I can accept.  

I mention this because I have seen a lot of posts on these forums, where people want to get started, but also are only willing to accept a unicorn property.