How to establish ARV on multifamilies

Question

How do you establish ARV on multifamily properties? What systems are being used? What formulas? A cheat sheet of steps or a system with ABCs would be great. I've got a 6 unit in my sights and need a little guidance on how to get to the ARV.

Roy N. · Answer

@KJ Smith

Multifamily (i.e. commercial) properties are valued, like a business, based upon the cash flow they produce.

In the case of your six unit, to realize the maximum sales price possible, you will need to renovate, fill and demonstrate "stabilized" operation the building (usually for 2-years).    You most certainly can sell the building before it is stabilized, but buyers will discount the validity of the buildings performance.

So, to figure out the {potential} value of the building you need to:

1) Determine your revenue:

• determine what is the market rent for each unit type in the building and calculate your scheduled rent;
• determine the market vacancy for the area (for each unit type) and calculate your anticipated physical vacancy;
• Subtract the second from the first above and you have your {projected} effective gross revenue;

2) Determine your total operating expenses:

These include: property tax, insurance, yard maintenance / snow removal, electricity (house metre), oil/gas (if common heat); water/sewer, garbage collection; janitorial service; maintenance (10% of effective gross revenue); Property Management (7-10% of effective gross revenue); advertising, accounting & administration, etc.

3) Calculate your Net Operating Income (NOI): Effective Gross Revenue - Total Operating Expenses

4) Now you need to determine/learn the price being paid for similar (i.e. same class of building) cash flows in the local area.   This ratio: (Net Operating Income / Price) is the often misunderstood and misused CAPitalization Rate (CAP rate) you see bandied about BP.   Unless you are well experienced in the local market, the easiest way to find the prevailing market CAP rate would be to contact a {local} commercial broker.

Once you know the market CAP rate, you can transpose the above equation:

Price = Net Operating Income / CAP rate.

Which will give you an idea of the price at which you could expect to sell your property.  Naturally, the validity of the end result is only as reliable as the data inputs used to determine your revenue and operating expenses and relies on the assumption that the market CAP rate was determined using the same methodology and inputs.

Jeff B. · Answer

Cap Rates do not equal Cap Rates.  By that I mean, just because the property next door has CR=7.5% doesn't imply that yours  will or should be the same.

A back of the napkin equation for ARV would be

• the sum of all monthly rents
• times 12 months; this get's you to the GSI(Gross Scheduled Income)
• times a GRM(gross rent multiplier) and reasonable number is 10

and the ARV is ~= FMV just calculated.

Roy N. · Answer

CAP rates are only valid locally and all they do is tell you what someone was willing to pay for a specific amount of cash flow.  It is true that CAP tells you nothing about the quality of the cashflows.    As much as I am not a proponent of folks (mis)using CAP rates, they do serve well for the purpose of positioning a property for sale.  If the property next door to yours, and the one on the other side, and the six other comparable assets which sold in the neighbour during the past 12 -18 months averaged out to a market CAP of 7.5, then you know where your property will need to be priced (within 1 -2 standard deviations depending on where in the spectrum you determine the property fits) when it goes to market.

CAP rate are only really meaningful when  you are trying to set a sale price in a given market - we don't even look at them when we are purchasing.

If you read my post above, you will see I suggested finding our the market cap rate to garner an idea of where the stabilized property should be priced when it sells.

BTW:  GRM is another single-point-in-time ratio that, on its own, should carry no more water than a CAP rate in your analysis.

KJ Smith · Answer

Good point on the assumed Cape Rate J.

Can you give me an example of your calculations using actual numbers? Say a 6 unit that "will have, once we aquire and address the issues" rents of 600 per unit. That's 43,200 GSI, correct? Okay... take me home from there. Also, what factors affect the GRM? Class of building? I would definitely say this is a C class building.

John Cohen · Answer

@KJ Smith I would have to agree with @Roy N. wouldn't say it better myself.

Jeff B. · Answer

Last point first; Class {A,B,C} are generalities comparing your unit to the community average rent for the same bed/bath configuration.  You cite $600/m per unit so if it's a class-c, then the average would be anything above your $600 - - that ought to be your first concern IMO.

You got the GSI, but to calc either cash/cash or caprate, we need the NOI.  Making an assumption that the expenses are 30% of the GSI (this is different than what most refer to here as the 50% rule), the NOI would be $30240.

cash/cash is NOI / Down Payment

caprate  is NOI / Purchase Price

GRM is the GSI / Purchase Price

Ethan Vegas · Answer

Well saidn @Roy N., ditto 100%

KJ Smith · Answer

@Roy N,

Good Man. Thanks for your generosity. I'm on it.

Roy N. · Answer

As I said above ... find a commercial real estate broker who operates in the area.

KJ Smith · Answer

@Roy N,

Thanks Roy. Excellent advice. How do I find or determine the Cap Rate for a particular geographical area?

How to establish ARV on multifamilies

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