Valuing small multifamily 5-10 units

21 Replies

Hello, Looking into purchasing a 5-10 unit property north of Boston. I was always taught that the value of a commercial property is NOI/ cap rate= value of building I have done my research and determine my cap rates based on comparable sales. When I make an offer based on this math it is typically much lower than what the seller is looking for. Underwriters are unlikely to approve a loan that is say $150-200k more than this correct? Thanks, Tom

Hi @Thomas Hickey ,

You are correct on all fronts. Multi-family is very hot right now and virtually everything is over-priced.  That's why we target off-market, distressed properties/sellers.  People who need to sell, not just looking for an astronomical price.

Good luck!

@Thomas Hickey markets are very tight right now and folks are being ultra competitive. You have folks paying cash for properties and ok making 4 or 5% returns, which to me is crazy. I have noticed that there is a lot of competition in the sub $1.5M or small-ish multifamily (20 units or less) space. Folks are willing to pay way more than I ever would. Try to find those off market deals where you would be the only person in talks for the property. 

@Thomas Hickey , at a high level, you were taught correctly, and just because a seller is asking way more than the building is fundamentally worth, doesn't mean you should pay up. The challenge is because we're in a such a hot market around Boston, rookie and veteran investors a like, are over paying for properties. Sellers are essentially asking for all the upside you're going to create with whatever value-add strategy you put in place.

Whether or not an underwriter will approve a loan that is higher than the value the income approach finds depends on how much that underwriter factors in sales comps etc. However, you definitely don't want to be in a situation where you're trying to pay more than what it's underwritten for. 

My advice is stick to your guns & conservative underwriting and keep making offers. It's important to remember that the way to make money in this business is on the buy side. You never want to win a bad deal. 

This is a time to be careful and keep looking.  You will if you keep searching find the right deal.  Unlike some people I am willing to slightly overpay for something if it makes sense to me for other reasons, ie I like the area and see long term rent growth, there are obvious inefficiencies that I can resolve but to do so often means placing more money down.  I dont think you should chase something if the numbers dont work for your analysis then keep looking.

@Max Taylor

Thanks that was my next question, it seems as though to actually close underwriters would have to consider comps instead of just income? Which I thought they did not do in commercial?

If such a person overpays $200k aren't they going to have a very hard time meeting the balloon payment in 5-7 years?


Your formula is correct. If you have done your research correctly and have consulted with experienced brokers in the area about what Cap Rates have recent properties traded for, then your numbers should be fine.

As everyone has mentioned here, the problem is about other people's willingness to overpay in a hot market and get the property at a much lower cap rate.

Don't give in to that and keep playing the game under a conservative approach. 

One advice I would give you is to focus on building strong(er) relationships with brokers and property owners and do it from a genuine place. Try to add value in whatever way possible and with patience, you will reap the rewards in the form of potential deals coming your way without the need to overpay.

Happy Investing!

@Thomas Hickey   Agreed with the previous posts regarding the current market and your approach. 

Food for thought:

Investors are also thinking creatively beyond current cash flows willing to take on moderate near term cash flows with limited downside and significant potential upside.  These investments are predicated on the assumption that these sites may be prime candidates for redevelopment in future markets.  In this scenario, investors could also look to assemble adjacent properties during the hold period to further maximize the upside exit.

Originally posted by @Thomas Hickey :

Max Taylor

Thanks that was my next question, it seems as though to actually close underwriters would have to consider comps instead of just income? Which I thought they did not do in commercial?

If such a person overpays $200k aren't they going to have a very hard time meeting the balloon payment in 5-7 years?

Over 5 units, the income approach is used to value the property. But in my experience, most will also factor in sales comps; however, the degree to which they actually affect the value varies. If someone is over paying $200k, they're banking on appreciation which in my opinion is a dangerous game and those are going to be the first investors that get creamed in the next correction. 

Now having said all that, there's a possibility that on a certain property, someone paid more for it because they saw an opportunity to add significant value that others didn't, (adding units, drastically reducing expenses, etc.) 

@Thomas Hickey If I overpay by $200K today that's probably cash coming out of my pocket.  So when it's 5-7 years I've already "paid" so it doesn't really impact the subsequent loan balance.  That's assuming I'm just going get a new 5-7 year loan for the remaining balance.

And there's nothing wrong with your "math" and there's also no gaurentee that your cap-rate is correct.  I don't mean that in a negative way but if you haven't toured properties, know the relative condition, age, roof life, etc. then it's more of an educated guess.  

That's not to say that the current 5-10 unit properties that are on the market aren't over priced.  They might well be overpriced which is...well...why they are still on the market.  And very few sellers are going to list their commercial multifamily property for below what they think the value is. 

On a practical level there's also no gaurentee that they really *want* to sell.  Maybe a broker said: "I think I can get you $800K!"  The owner thinks: "Well, if that offer comes in, I'd take it."  So it gets put up, sits around, and then expires.  I've seen it happen where I invest (not Boston).  More properties are just expiring (going off market) than actually selling.

So I would look at your comps and ask this: "How many of them sold for over what I would have paid for it?"  What's that percentage.  If it's 10% and you would have happily done 90% of the deals that you've tracked for the past 6 months, you're on the right track.  If you think 90% of the deals out there had the buyer overpay, well, the cap-rate is probably different than what you think it is.

And (this is a non-data-driven hunch) I'd imagine that it's easy to overprice small commercial multifamily right now. SFRs have gone through a massive appreciation cycle as well. 1031ing is popular. If someone makes an offer on your SFR and you want to 1031 (and you want to get into multifamily) then these small-scale 5-10 apartment buildings are probably that sweet spot you're looking at. It's easier to go SFR/duplex -> 6 units than it is to to SFR/duplex -> 30 units. The 1031ers all have compressed timeframes and could be faced with: "suboptimal deal vs. tax consequences". And who wants to pay the gov't when they don't have to? But that's just a hunch, no idea if that's actually valid.


Using a cap rate is only 1 means of valuing a property, and a means that many lock into and can not move off of.  Many times it is the best way to value a property...however a completely vacant building has a zero cap rate...and that does not make it worthless.

Very often you will find smaller buildings, 5-10 units might be owned by a small mom and pop landlord who have been bad with raising the rent through the years, so you will often find under market rents.

Ive found a number of times these smaller units will trade based on a price per unit basis when measured against similar smaller buildings with similar type units.

@Andrew Johnson

Very good points, my cap rates that I price on have been very similar units often times on the same street that have sold recently.

@Russell Brazil
I also suspect many of these properties are being priced on a residential per unit basis. The ones that actually close seem to close on a number closer to the income based approach. It could be that this is a bad segment to pursue during this time of the cycle.

@Thomas Hickey If it's similar units on the same street, what happens if you rerun the pro-forma with the sold units rents? Does the NOI materially change? Does the "fair market" price change along with it. I think @Russell Brazil is right that you can definitely get some funky stuff going on with mom and pop properties.  The last deal I seriously considered was 50% vacant because only one of two buildings had been rehabbed.  It doesn't mean the second building has no value but in order for me to come up with what it's worth (to me) I have to come up with a post-rehab value, subtract rehab dollars, subtract lost rent during the renovation period, subtract opportunity cost for that portion of the building (and rehab dollars), and then scratch my head over what hassle and risk are worth to me.  The catch is that "opportunity cost" can be hazy, "hassle and risk" can be hazy, and "rehab dollars" are never exactly perfect in estimation.  Still, for that building, there wasn't a $200K discretion between my suggested price and what the seller wanted.  He wants 8%ish more than I want to spend so I'll see how things go and revisit.  Circling back to your situation...

What would be a little odd (to me) is that you could have two 5-unit buildings on the same block that are $150K-$200K apart in professed value.  I mean sellers might be ambitious but pricing it $200K over the last sold comp?  Any seller has to know they're above market, it likely won't appraise, and the buyer is going to have to come out-of-pocket $150K-$200K.  Even if you're pricing these at $1MM for a 5-plex that's huge hit for a buyer.  I think I'm going to pay $250K down and I'm now going to pay $400K to $450K?  Maybe I'm nuts but that's going to put more than a few buyers back on their heels and there's a solid possibility that the deal get killed post-appraisal where the buyer gets told they need to increase (nearly double) their downpayment.

@Thomas Hickey Interestingly, as you analyze more buildings in your MSA, you should start to see a common theme as far as the average cap rates are concerned in your market. 

Your scenario isn't dissimilar to other investors trying to acquire these buildings, and in some cases, the brokers would fantasize the OM and make the proforma figures look amazing. 

So, your offer is probably closer to the reality of operating the asset. So, keep putting your offers in! 💯

Hope this helps, Tom. Goodluck. Thanks! - Ola 

@Thomas Hickey

I’ll second what Ola mentioned about analyzing properties and a common trend appearing. I’m looking for small-multi family properties (2-20 units) in specific areas in Central Florida and almost everything I’ve looked at has been in a 4%-5% cap rate range, some even lower. Tight market indeed.

At the end we need to make offers that work for us while addressing the needs of the owner. Stay persistent and good luck with your offers.

@Thomas Hickey

Hi Thomas,

have you looked at what last six months sales activity to try to gauge what the market is selling at? Do you know the cap rate in your market.  With theses smaller properties, cap rates are not as relevant. What you need to focus on is if you can add value to the deal you are buying, i.e. lowering expenses or raising income.


@Thomas Hickey The infuriating key to using and understanding Cap Rates is locked up in a combination of these threads.  

First, as many have mentioned, they fluctuate.   (HINT: So does the Market!) 

Second, as @Ola Dantis has mentioned, you actually use Cap Rates the opposite of the way that most people want to use them. You don't just have NOI, and divide by a rate-- how are you going to know what rate to use? You use known market values and divide by known NOI to get the rates, then apply those rates to your proposed purchase (or rehab, or development.) Yes, lots of Brokers and Analysts know the 'going rate' off the top of their heads, but that's only because they're embedded in the processes of all four activities: leasing, buying, selling, and financing in those particular markets.

I'll also draw your attention back to the key that @Russell Brazil  mentioned with one quick edit: He said, however a completely vacant building has a zero cap rate...and that does not make it worthless.  This is very true, but easier to understand in the formula if one says 

...however a completely vacant building has a zero NOI...and that does not make it worthless. 

These are low, simple round numbers, just for show. Let's take a NOI of 10,000 and divide it by a cap rate of .1 ("a Ten-cap") ; we get a value of $100K.

Ok,  so if a 10 Cap reflects a reasonably stable market in Springfield, AnyState, USA, the property's worth 100K.   4 years later, Mom & Pop have the same tenants, haven't raised the rents, and the market goes out of control.  Now when we divide it by a Cap of .04, ("a 4-cap") we get $250K. Someone's going to be willing to pay $250K for this property and its $10K income (...or investment, or .."opportunity" as we all like to describe it, here.)  

Mom & Pop did nothing.  The Market did it all, and the market increased the "Value" of this property 150-fold.  But no one thinks about Cap Rates at this moment when they buy & sell...  a "son"  enters the picture and thinks "I'm going to get 300 for this place!" and puts it on the market at $300K.  When someone bites, they then reset the cap rates in that market to a 3.33 Cap (!)  

Bottom line: The NOI Describes the property's operating expedience; the CAP RATE Describes the market, and from that comes value. (Yes, there are tweaks for quality and obsolescence and deferred maintenance, and some for location, but generally location describes your market and its subsets... and yes, you need to understand a market's traditional Cap rate to know what's up and what's down... ) But for general purposes, I'll repeat it and suggest you file this somewhere in your matters: The NOI Describes the property; the Rate describes the market.  

In a super-heated market, if & when you're willing to consider paying the premium, you need to look carefully at that NOI, because small tweaks there, mean small adjustments to value in a stable market, whereas sometimes small tweaks to the Market (AKA the Going Cap Rate ) can make or break you. If you know you can double your NOI, then you're likely safe, but if you can only find upward rental increases of 10%, then look out.

When you buy the property under a 4 cap, and you you've improved operations significantly but you can't refinance in 2 years -- not because the economy's bad or because your tenants are losing their jobs, but just because the market then reflects a more-normal 8 cap and you lost 100K of value-- in market interest alone--  that's when lots of Owners go mad.  

Run the numbers in every scenario, improved, unimproved, refurbished, as-is, Low Income, Market rent, Section 8, run EVERYTHING. This is the moment in history when all the DD matters.  

Good luck.       

A lot of good advice already. The key question I would be asking is what can you do to increase NOI (value add, reduce expenses, etc) to hit your yield objective. If you hit your yield then the going in CAP rate doesn't matter as much.

@Steve McGovern

Thank you for the thorough response. Most of the properties I am coming across do not have upside potential of doubling my NOI and this gives me pause like you mention.

Here is a good question for everyone. At what unit count or dollar amount do you typically start to see sellers operating more by the numbers and less by per unit residential style valuation?

@Thomas Hickey in my opinion, answers will vary. Reason being, there are three traditional approaches to any appraisals.
In terms of Fannie and Freddie, and what constitutes that “secondary level of real estate“, that usually starts at five families. The initial residential style mortgages for example are on 1 to 4 family properties. A quick review of most standard mortgages will show that threshold as a subtitle to the document.

However, Let’s talk solely about a SFR for a moment. It’s in a moderate -to- low income area, but rents are proportionately higher than purchase values. The income shedding off this property is literally worth more than the property itself.

If & when income trumps a comp, I’m going to jump to income (as a seller, which is the point of view you asked your question from) immediately, and I’m RIGHT To do so, for the above-mentioned reasons.. On the other hand, as a buyer, I would die on the hill of the comp in this situation, and I would also be right to do so. Usually the lender — whether it is or is not willing to lend to the higher amount –is the one to break the impasse here.

I frequently see people recommending to look off market in hot market areas. I'd rather look in non-hot markets, where even on market deals are decent. Off market deals there can be even better. Or, look for a different type of investment.

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