How much is it worth….?

Question

12 unit apartment complex that will gross $9,000 month in rent, after expenses nets about $7,000 per month. Fully renovated, Low property tax area, low insurance area. No mortgage on it. High rental demand due to little availability in area and high demand for cheap housing. What do you guys think it’s worth on resale - selling price?

Thanks

Victor Saumarez · Answer

Expenses are usually about 50% of gross rental so you’d be netting closer to $4,500 a month. A very crude rule of thumb is to aim for $1,000 a month rent for every $100k invested. That nets down to a healthy +5% cap rate. So you’d be looking to pay about $1m. You could use the current industry standard gross rent multiplier. You simply multiply the number by the gross rent to arrive at a value. The NAR affordability index looks at fundamental value by comparing income to price. Locations that feature low on the index will give you an idea of whether homes are over-valued, or not on a fundamental level. You could experiment with the Gordon growth model of discounted cash flows to arrive at a fair value. Substitute stock price for RE price, and dividends for annual rents for five years. Might be interesting to see what the result is. The best method is really working backwards from the required rate of return. Start with a return % you want based on what you can get from other assets that carry similar risks.

Ari Stern · Answer

With an NOI of $75,600, utilizing a 75% LTV, and using an interest rate of 8%, and assuming a 30-year AM - the way to get to a 1.25x DSCR is by using an 8.25% cap rate, which will give you a value of $916,364.

Keep in mind, that only works with a 30-year AM mortgage. If the lender is only willing to give a 25-year AM, that will drop the DSCR to 1.19x. In that scenario, to maintain the 1.25x DSCR, you will need to bump up your cap rate to 8.65%, giving a value of $873,988.

Hope that helps.

Matt D. · Answer

Thanks Ari.  I’m looking at the property as what price do I need to market it at to have investors seriously interested, and be able to conclude a deal that is fair and favorable for both parties. So an investor based market valuation. Based on your metrics, I am assuming about a $900,000 selling price, which coincides (ironically) to 1% or monthly gross rent. Cash flow of $75,000, divided by 1.25 DSCR = $60,000.  When looking at mortgage calculator on 8% loan, that yields around a $900k value (assuming 25% or so down payment).  Is my math or valuation semi-accurate ?

Thanks

Matt

Ari Stern · Answer

The first question you need to ask yourself is, are you looking to price the property like other unrealistic sellers out there, still living 9 months ago in a 3.5% interest rate world? Or are you looking at the property like an investor, and pricing the property in a way that makes sense.

Lenders tend to use industry standards for expenses when underwriting deals. Just back of the napkin, since the property was just renovated, for this example I would allocate a 30% expense ratio (although it can easily be much higher, especially since it's a relatively small property).

EGI - $108,000

Expenses - $32,400 (30%)

NOI - $75,600

At this point, it depends on two things. What’s the cap rate is in the area? And based on today’s interest rate, assuming a 70-75% LTV, does it DSCR at a 1.25x?

Crunch those numbers, and you’ll find a value that makes sense.

All the best.

Matt D. · Answer

Mason,

I would say the area is “steady”, and always has been.  It’s kind of geographically protected by local industry and doesn’t feel the brunt of economic impacts as you would in a large metro areas, it’s always been that way around the area. So the rents will never go down much if any, but they won’t go up exponentially either, just slowly increase over the years basically. It’s a rural type area, but it’s the city center location that brings all the rural population to this zone, if that makes sense…. Example, in 2008, the market was little affected.Thanks

Matt

Mason Hickman · Answer

@Matt D.

Cap rate will vary widely based on market. Is this an A market with rapidly increasing population and jobs or in a tertiary market with declining population and no job growth?

Taylor L. · Answer

First thought is no way is that place actually netting $7k out of $9k gross while being properly maintained. The price has to factor in its condition, which is probably not fantastic.

How much is it worth….?

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