10 unit Multi-Family value

14 Replies

Hi!  I have only posted here a couple of times, mostly because I like to find the answers on my own.  I am having trouble with MF value.  I have read many, many forum posts, blog posts, and heard it talked about again and again on the podcast, but I am thick-headed in some things and this seems to be one of them.  I am currently looking at an MF that is being sold by an investor who is retiring.  He's been in the game for 40 years and wants out.  I see this as an opportunity to be able to come at a guy with numbers and walk away with a deal that will cashflow decently while at the same time giving this guy the ability to retire from a solid investing career.  Here's my issue: it only cashflows at 35% equity or more.  I am new to the game, but I see that as a problem.

I will post this deal later for analysis, but right now, I am trying to figure out value for the property. I understand the NOI/CAP rate, but I cannot for the life of me figure out why that would be important. I also do not understand NOI. Sometimes it includes all expenses, sometimes it seems to be income-mortgage, sometimes it seems to cherry pick. And here I was thinking that MF values were easier to determine. So, back to my question: how should I come up with a number to show this retiring investor?

I could determine based on CAP rate, but it seems like the thing should at least break even at 0% and be pretty cash rich at 20% down. Is that pie-in-the-sky dreaming by me? Or is that what everyone else is seeing? Shouldn't value be more determined on where the property breaks even? I know I am bucking the system (I tend to do that a lot), but it doesn't make sense to me, and I am beginning to get frustrated. So, I thought I would turn for help. I would really like to buy this at a price that cashflows for my partner and I (OK, I admit it - it's my dad), but I really don't want to put more than the normal 20% down.

Any and all advice is welcome!  Thank you BP community!

Hey @Trevis Kelley  - without more info, it sounds like the place is over priced.  If you need to put down 35% to break even then it better be in downtown Manhattan or San Fran!

NOI is the key thing you need to be able to determine. It is not income - mortgage. NOI is income less vacancy, taxes, insurance, expenses and CapEx. I would never take an owner/agent's word on what NOI is or should be. You want to be able to estimate this very well based on your own knowledge/research of the area.

Once you've got an NOI, then you can look at going CAP rates for the area. A normal range would be somewhere between 8 and 12%. Anything above or below that for a stable property would be getting towards very premium areas or not so good areas.

If you come up with an NOI of 60,000 and the going CAP rate for the area is 10% then a fair price would be about $600K.

You can then go 1 step further and figure out the DSCR (debt service coverage ratio) which should be 1.2 or better.

I highly recommend reading Commercial Mortgages 101 by Reinhard which covers this valuation in great detail as well as getting into the lending side of things.

Bottom line - a true, reasonable NOI is key and you should be able to come up with that number on your own based on current/projected rents and projected expenses, not current owner's stated expenses.

@Trevis Kelley  

You probably won't have access to reliable cap rate comps for this size building so forget the direct cap approach. Better to go with a GRM (comparable sales divided by gross rents) and use that number to multiply against your gross rents. That is your market value. Make any adjustments from that for any differences between the comparables.

NOI uses "operating" expenses and would generally NOT include any capEx unless necessary to collecting rents in that year.

@Trevis Kelley  

Net Operating Income (NOI) is pretty straight forward. Take your gross revenue and from it subtract all your operating expenses (business licence, property tax, insurance, maintenance, utilities, administration, property management, etc). What remains is your NOI.

Gross Revenue is your scheduled rent (what the building would bring in if every unit were full all the time) minus your vacancy allowance/bad debts (typically 8.33 - 10%, but should be adjusted based on the area where the building exists).  Some folks include alternative revenue streams such as parking, laundry, storage, etc.; while technically correct, I never count laundry or parking revenue when evaluating a property.

NOI does not include debt service (your mortgage). [Some folks include the interest from the debt as an operating expense ... you are getting into debatable accounting practices at that point. It is simpler, and more truthful, to analyse a property without including interest as an operating expense.

Your cash-flow-before-taxes (CBFT) is your NOI minus debt service.

CAP rate is simply a ratio (NOI / acquisition cost) which allows you to compare the cost of one cash flow (that is really what you are buying) against other cash-flows in the same area. Though CAP rates appear to be simple, it is one of the most abused terms in real estate and can easily be misleading and meaningless. To be able to compare multiple properties (cash-flows) using CAP, the CAP on each property must be calculated using he same methodology to be meaningful.

On a building like this you might be better off to compare it to its peers using the Gross Rent Multiplier (GRM) which is the ratio of the price of the property (cash-flow) to the annual gross revenue.

CAP rates that I have seen based on 5-20 unit MF listings in my area have been between 7-8%. Now, this is based on listings (and my own calculations/assumptions), and I am aware that those do not necessarily represent the actual purchase CAP rates. However, I do have to start somewhere with this.

I am mainly just trying to get confirmation that I know enough to be able to say to the owner that I need to get the property at X price for it to fit into my standards, or I need certain concessions to make the deal work better (like seller financing or carry-back of about 15% or so for down payment so I don't have to share cashflow with my dad). It sounds like NOI should be more than just the mortgage, although there is still some disagreement about what all should be included in the expenses side of things.

@Michael Seeker    Thank you for your response.  I am in the process of finding the comps in Trulia so that I can show those to the owner as well.  I am not finding a lot of 10 unit places in my area, but 12 units seem to be popular.  I will do my best to calculate both ways and see if the numbers are at least similar.  Maybe then I can show the owner that he's overpriced both ways, but of course, he probably already knows this.

That leads me to another question.  Why would a retiring investor be trying to sell a property to other investors at such a high price?  Is he hoping that some sucker will come along, or is he trying to find a smart young investor that he can work with?  I guess I will be finding out the more I work with him.  I will have to just go there, offer what makes sense, and then let the cards fall as they may.  Once I get the values worked up, I will probably be posting this under the analysis section to see if what I am looking at makes sense.

Originally posted by @Trevis Kelley :

It sounds like NOI should be more than just the mortgage, although there is still some disagreement about what all should be included in the expenses side of things.

NOI does not include any debt service payments. It is calculated assuming the property is owned free and clear.

@Roy N.  

Thank you for the info. I know that CAP rates are almost impossible to come by. It seems like everyone has their own opinion on what NOI is, and it seems to be a nebulous term without much real meaning. I may have to just do GRM on this, and see what I come up with from there. I'll let the accountants handle the fun tax reporting stuff (of course, I will be consulting them the whole way through this process as well as tax lawyers). All I care about is getting a property that cashflows, and solving any issues that the owner may have so that he feels comfortable moving forward. That way, we can both win and I can finally get into the real estate game. That may not have anything to do with the properties' "value". I will try that approach first, as it is likely the the retiring investor is motivated to see this property gone and be able to do whatever in his retirement.

All in all, valuation seems to be more complex than is probably needed, and solving the owners problems while getting what I need out of the deal seems to be simpler to me.  Just the way I am wired.  I am a problem solver.

@Michael Seeker    Yeah, I worded that wrong.  I was pretty confident that's what it was, but I saw a couple of forum posts talking about it being income minus mortgage (or I dreamed them up), and I got confused.  After your initial explanation, I was confident that's what it meant.  I was trying to say that what I read about it being mortgage only was wrong, and that I needed to go back to it being income - expenses (no debt service).  Thanks for the heads up, though!

(what sometimes adds to the confusion, is whether or not capex is included above or below the line in your expense.  This will effect your cap rate.  Cap is important in evaluating whether or not this is a good deal in this market.

If you are concerned about cash on cash return, then you need to look at net cashflow before taxes, which will include both debt service and capex. Don't make the mistake many brokers make and divide this by your down. Your cfbt should be divided by your all in expenses to close the deal, in order to get your COC.

With all that said, find out what the seller really needs.  If all he is looking for is to kick back and relax with profit from the sale, convince him that a low down owner finance deal is the best way to go. Either that or master lease to reduce your capital injection.

If you were the seller wouldn't you start with the highest price you could name with a straight face? I would too. Sounds like this isn't your seller's first rodeo so he's probably doing the same, who knows there's one born every minute and he might be able to unload his deal on one. I tend to ignore the asking price until I determine what a property is worth to me as an acquisition.

The question for the thread is; what's this deal worth to you? Most professional investors buy apartments for the stream of economic benefits they estimate the property will produce. Different investors will give varying weights to the different benefits; I happen to favor cash flow but others may lean towards appreciation and still others may look to the tax benefits. I've known some who bought hoping the thing would just break even until the mortgage was paid off when they'd have both a ton of equity and nice cash flow.

Once you know which of the benefits would be most attractive to you then you can estimate what those should be going forward and develop a price you're willing to pay for them. Likely your price will be lower than the seller's ask but it may not be that far from what he'd actually settle for. You never know until you put an offer on the table and begin to negotiate.

One thing to consider is that if the seller is really retiring, a stream of payments may work better for him than a lump sum at the close of the transaction. There are definite tax benefits for a retiring seller structuring the deal this way. You may have to give some amount in a lump up front to sweeten the deal but it's worth exploring.

Good hunting-

@Giovanni Isaksen  

 This is close to what I was thinking.  It's hard to imagine him saying that price with a straight face, but this guy's been playing poker longer than I've been alive, so he's got a little bit on me (a lot, actually).

I don't know about the rest of the board, but if I'm going to put effort into doing the due diligence and putting together the deal, I want to see some cashflow.  I saw equity vanish basically overnight on properties, so I want some money in my pocket.  I am attracted to the idea of cashflow because I can multiply it over time to something I would be quite comfortable with and then put minimal effort in.  Flips and wholesaling can make a good chunk of change for the moment, but to make more, you have to do more work.  I am not opposed to work, but I like the idea of my work paying dividends over the long term.

Now, that being said, I might accept minimal to no cashflow now for good cashflow later.  What I mean is, if I got no cashflow for 5 years because I'm paying off a seller-financed down payment, then I would probably do that deal because in 5 years, I should have cashflow.  30 years is too long for me, but some may take that as well.  Of course, I am just starting in this business, and things may change based on what I encounter.

I believe you are probably right about this guy needing cashflow more than a chunk of money upfront, and the price may reflect what he expects to get per month based on a loan for that upfront.  I certainly hope so, because that may make it easier to figure a deal that works for both of us.

@Trevis Kelley   I'm with you 100% on cash flow. I'm also having to look far and wide to find deals that will actually cash flow fully reserved right now. For me as a value investor the key requirement is to have a margin of safety and one of the main ways to have a margin of safety with income properties is to have good positive cash flow.

Some people have hard boundaries around cash flow, like a deal must cash on cash 10 or 12% but in a 2.2% 10yr Treasury world to get that kind of spread requires battling in war zones or taking on serious risk of some kind. Being a slum lord isn't my gig and so I'm willing to accept a lower cash flow (say 6-7%) if it's actual cash flow after reserving for capex and other emergencies.

Accepting low cash flow now while you'd be paying off a seller second makes sense by the numbers but in my crocodile brain I'd feel better with a bit of a cushion. That said, a number of my associates have done quite well buying apartments in '06 and '07 that they wrote checks on every month through '08, '09, '10 and '11. They're smiling now but there was a lot of gray hair between now and then.

Good hunting-

@Trevis Kelley  

I am also looking at getting into small multi family investments vs the single family house game that I have been in so far.  I had 3 duplexes I wanted to buy and everything looked good in terms of Loan to Value....but I had to accept the fact that those units were too nice for the area and the market rents would not support the purchase price sufficiently.  I could get a bank to lend the money, but I could make more money buying other properties, so why mess with this one.  Maybe this place has an appraised value that is higher than the building is worth by revenue calculations.  Anyway, a couple questions for you.

1)  In your concessions part...you mention possibly the seller taking a 15% owner carry and that keeping you from having to share cash flow with your dad.  Is your dad wanting to be a fractional investor...ie chip in 15% of the funds in return for 15% of net revenues or will he just lend you the money at near market rates?  If he will loan you the money, would you rather your dad make some money off this deal or the seller?

2)  Regarding the final question around why someone would want top dollar or even more for a property.  First, for the rational reasons, he is probably in a fairly low debt service situation with good cash flow, so what is his motivation for giving it away.  He may be thinking things are good, but for the right price, I will let it go and be done with it.  Depending on his needs, a somewhat steady cash flow can be worth quite a bit more than a big wad of cash in the bank...or depending on his investing appetite, even worse in the stock market.  Even if he decides to get out of the game, he probably has run the numbers and figured out with a property management company running things for me, I still get X.  Maybe he just values the recurring cash flow too highly and thus not rationally for any time value of money calculations with market rates to work out.  Now, for the irrational side, maybe he is crazy or just thinking if my neighbor recently sold that for X, mine has to be worth X plus.  Or maybe he is just emotionally tied to the building he has had for so long.  Maybe he is just someone who can't properly value real estate or even worse listen to someone that can.  At the end of the day, it comes down to how motivated he is to sell.  Sure he want's to retire.  But why should he have to give it away to do so?  As long as he is willing to sit on it, I would expect him to sit around and wait for someone with no sense and way too much cash to come along and buy those.  If he decides he wants to retire more urgently in a few years, he will ratchet down the price until they sell.

@Chris Simmons  

My dad would want 50% of cashflow.  He considers cashflow weird and it would have to be based on his very low estimate of cashflow.  I come out just a little ahead initially this way, but over the long term, I lose a lot.  Plus, I would prefer to do the deal on my own.

I spoke to the owner on the phone, and even though he is 75 years old, he still seems quite rational.  No one is asking him to give his property away, but he has to know his pricing is high.  You don't do the real estate business for 40 years and acquire several properties (I have found 30 or so under one company and I know he has at least one other company) without knowing how to price them.  So, the only thing I can figure is that he has done it intentionally.  He expressed to me several times over the phone that he is trying to get out of the real estate business and a carry-back on his part would only keep him tied to the business.  I think that he is worried that I won't be able to make the payments to him.  I just did another quick search of his properties under that one company and there are now only 10 left.  I saw a property he owned for sale about 6 months ago, but it didn't fit well for me (which is how I found the 30 originally).  This tells me that he is liquidating, but it doesn't tell me exactly what he is looking for.  That is what I am going to try to find out tomorrow.  If he seems unwilling to budge, then I will move on.

I have yet to find other properties that will make me more money in my area.  They seem to be hard to find and some of the deals that others talk about don't seem to be available in my area.  I will continue to search, but this deal could actually make money if the rents are as low as I suspect they are (but won't know until I see the place).

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