Looking for people's experience with appraisers on small multi family properties (2-4 units). Will they tend to use the sales comparison approach or the income approach for valuation on residential multis? The reason I ask is I'm trying to determine if you can drive up the value of 2-4 unit multis simply by raising the rent vs making capital improvements.
I am am currently training to be an appraiser, so I'll answer this the best I can.
Most clients (more often than not banks) will require the appraiser to do the assignment on the Fannie Mae 1025 form (https://www.fanniemae.com/content/guide_form/1025.pdf).
The form requires the appraiser to input comparable sales and also active rent comps. If you "jack" the rent up (even if you find a tenant willing to pay it), typically the appraiser will not give credit for additional value above and beyond what market rents would determine.
The appraiser might also deem the cost approach applicable, usually if the building is 5 years old or less.
The appraiser will reconcile all applicable approaches to value used: sales comparison, income and/or cost in order to determine a final valuation of the property. This process of reconciliation can be weighted anyway the appraiser subjectively determines is most accurate. 50/50 20/30/50 80/20 whatever...
Hope this helps.
@David Whartnaby I really appreciate your excellent answer!
Let me expand my question with an example: say I acquired (with cash) a 4 plex that had rents way below market for the area. I raise rents on all tenants to current market levels (not above market). I don't make any capital improvements to the property. If in about 3-4 months I go to refinance to pull my cash out, will the appraiser be able to justify a higher valuation based solely on the market rent increase? Thanks!
@Ryan Swan You might get lucky and find an appraiser that will do that but my experience is that they look much more at comps on the smaller properties. So if there are sales of comparable 4 plexes they will probably base the value more on that.
Also, they are usually very conservative on refi appraisals and if the value they come up with is a lot higher than they see I paid they will usually call me and ask what kind of improvements I made to the property.
If you sell it on the other hand and get a contract at a much higher price due to the higher rents they probably will appraise it much higher to get to the contract price.
Makes no sense to me personally, value should be value regardless of why they are appraising it. I'm just telling you what my experience has been.
@Jeff Kehl Thanks for chiming in with some more great info. I had a sinking feeling that the consensus is it's hard to get higher refi appraisals based solely on rent increases without capital improvements.
Since it's considered residential I'm guessing it'll be based on comps. Commercial property is based on cap rates and NOI. To be commercial you need 5 or more units
@Caleb Heimsoth yeah, that's what I figured. I just wasn't sure if they'd give any value weight to the income portion, since it's still a residential income property.
@Ryan Swan under those circumstances, no, the valuation would probably not change much. The original appraisal should take into account that in a quick period of time you could raise the rents to market. Therefore, the appraiser would take this into account on the form.
Things get stickier if a tenant is locked into a below market rent for a significant amount of time. In that case, how much should the property be discounted from an appraiser's point of view? This doesn't appear to be your case though.
Appraisers use a gross rent multiplier to determine the income approach in small multifamily properties. They do this and not CAP rates because they don't have access to all of the necessary expenses to calculate an accurate NOI. Is the landlord paying electric? Heat? Snow removal? Etc... oftentimes they end up comparing apples to oranges without all of the necessary expenses.
So, can use raise the rent and increase value? It is might be possible, but it is unlikely. Much of it depends upon the fact that you hypothetically bought the property for cash. Did you base YOUR analysis and negotiate the deal based upon comparable sales or the income that the property was previously generating? I think that really is the key to the equation.
Howdy @Ryan Swan
The only time I have seen the income approach for 2 - 4 units is when there are no comps in the area. Not sure about your idea of a Cash-out Refinance after only 3 - 4 months will work. The lender will want 6 - 12 months seasoning prior to a "Cash-out Refi ". They also usually want a minimum of 6 months between appraisals.
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