Investor · Hercules, CA · Member since 2015 · 208 posts · 47 votes
I'm starting to look into performing a 1031 exchange into an apartment complex and am looking for more information on value adds and how a lender obtains their valuation based on the CAP rate. See example below.
- 30 unit complex
- 80% occupancy
- 6% CAP rate based on current income and expenses
- $700K purchase price
- Value add is performed via renovation and increasing rents
- CAP rate is now 8% based on value add
- My assumption is value is higher based on the new CAP ratea dn I want to refinance and pull cash out.
My questions are:
1. How will lender value property after value add?
2. Is there a CAP rate for each specific area? How is this obtained?
3. For lenders, is there seasoning required for new rents to be coming in to be counted in the new CAP rate?
4. Is there a typical seasoning period for refinancing an apartment complex after initial purchase?
I'm in the beginning stages of research on this topic. Thanks in advance for your replies!
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
10y
Cap rates are set by the market and do not change based on the change in income or expenses. If these change then the VALUE changes. Cap rate comps come from closed sales of similar properties in similar location at a similar time. A sale will be analyzed by an independent third party after interviewing the buyer and seller.
If the property you are buying is underperforming the value will be based on its potential NOI/current market cap rate LESS the costs to get it there. These will be actual costs and estimated costs of risk and lease up. $100,000 NOI/10% market cap rate = $1,000,000 value if fully performing. Subtract the lost rents and costs to get the property performing and include a risk factor. That will be the market value of the property as is.
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
10y
Cap rates are set by the market and do not change based on the change in income or expenses. If these change then the VALUE changes. Cap rate comps come from closed sales of similar properties in similar location at a similar time. A sale will be analyzed by an independent third party after interviewing the buyer and seller.
If the property you are buying is underperforming the value will be based on its potential NOI/current market cap rate LESS the costs to get it there. These will be actual costs and estimated costs of risk and lease up. $100,000 NOI/10% market cap rate = $1,000,000 value if fully performing. Subtract the lost rents and costs to get the property performing and include a risk factor. That will be the market value of the property as is.
Investor · Hercules, CA · Member since 2015 · 208 posts · 47 votes
10y
Thanks @Account Closed Super helpful!
A couple follow up questions:
1. When an appraiser comps cap rates, do they go out a mile radius and similar square footage like in residential appraisals? I would imagine that there could be a single apartment complex in an area with all SFH and few and far recent sales.
2. If the value is based on potential NOI, does that mean the appraiser will have to pull market rental comps as well?
3. How does an appraiser look at costs to rehab a property? Will a contractor bid have to be included?
This appraisal definitely sounds a lot more complex and rigorous than a typical residential appraisal.
1. When an appraiser comps cap rates, do they go out a mile radius and similar square footage like in residential appraisals? I would imagine that there could be a single apartment complex in an area with all SFH and few and far recent sales.
2. If the value is based on potential NOI, does that mean the appraiser will have to pull market rental comps as well?
3. How does an appraiser look at costs to rehab a property? Will a contractor bid have to be included?
This appraisal definitely sounds a lot more complex and rigorous than a typical residential appraisal.
1. Since real estate is all about location of course you want your comps as close as possible but the market for commercial is broader than residential comps. Class A office buildings would comp to the central business district but when there are few sales then you would look to Class A office buildings in other cities.
2. Remember I said potential NOI for a non performing property. If a property is encumbered say 95% with long term leases the appraiser will use current in place rents that could include market, above market and below. He is only looking at the financials for one year but if the building has 20 year leases that all are going to expire within a year or two he will mostly look at expected market rents for the new leases less the rent loss for a couple years of below market rents.
3. http://www.marshallswift.com/c-2-commercial-produc... An experienced appraiser will have all kinds of documentation from previous appraisals to help with costs. There are also publications such as Marshall and Swift that they will look to.
The best appraisal is direct sales comparison for any property. 100 unit apartment will sell for what similar 100 unit apartments have sold for adjusted for specific differences. Cap rates really only come into play when a NOI consists of rents that are either above or below market for a long term. Using them for small residential or any property that you can't get reliable analyzed sales comps is useless.