NOI & ARV Commercial Multifamily (Question)

9 Replies

Hey BP family,

I got a question I hope someone can answer. This all gears toward getting a predication on what my ARV will be on a commercial multifamily property. I'm running into a catch 22 where I can't determine my ARV because I don't know what my CAP rate will be and I can't assess my CAP rate because I don't know what my ARV will be.

What I've learned is ARV = NOI/CAP and CAP = NOI/VALUE

How do you get in the ballpark of what you're ARV or CAP rate will be after repair?

Everyone has similar issues. I'm going through it myself with with a multi-family property I'm seeking to buy in Houston. You can do one of 3 Options which range from FREE to costing of several hundred dollars:

1-Ask your realtor to do a comparison analysis in the immediate area up to 1-1.5 miles out of similar properties of what has sold in recent years. Or on what their MLS system may value the property as being. The system can give you estimated rent rates as well. This is usually a few clicks of a button, the local MLS system does all the work. If you have the realtor under contract there is no cost for this.

2-Go to Zillow and type in the addresses of similar properties nearby that may not be for sale.  Zillow gives you an estimate of market value and estimated rent the property might gain.  In addition you can look up nearby active rental listing to see what the rate is going for in that same area.   Also use other sites like Property Shark and RedFin for market value estimates.

3-Hire an independent appraiser to assess the value. He/she will pull comparables and give you both a current and After-Repair Value.  Note there is typically $500-$750+ cost or more depending on where you live for this service and you will likely need to pay for another appraisal by a separate company AGAIN if you use a lender for financing.

Either option gives you the Value and Rental Income which can be used to calculate an average CAP rate for the area after you renovate. You also get an average ARV value as well from the comparables.

Hope this helps!!



Originally posted by @Herndon Davis :

Everyone has similar issues. I'm going through it myself with with a multi-family property I'm seeking to buy in Houston. You can do one of 3 Options which range from FREE to costing of several hundred dollars:

1-Ask your realtor to do a comparison analysis in the immediate area up to 1-1.5 miles out of similar properties of what has sold in recent years. Or on what their MLS system may value the property as being. The system can give you estimated rent rates as well. This is usually a few clicks of a button, the local MLS system does all the work. If you have the realtor under contract there is no cost for this.

2-Go to Zillow and type in the addresses of similar properties nearby that may not be for sale.  Zillow gives you an estimate of market value and estimated rent the property might gain.  In addition you can look up nearby active rental listing to see what the rate is going for in that same area.   Also use other sites like Property Shark and RedFin for market value estimates.

3-Hire an independent appraiser to assess the value. He/she will pull comparables and give you both a current and After-Repair Value.  Note there is typically $500-$750+ cost or more depending on where you live for this service and you will likely need to pay for another appraisal by a separate company AGAIN if you use a lender for financing.

Either option gives you the Value and Rental Income which can be used to calculate an average CAP rate for the area after you renovate. You also get an average ARV value as well from the comparables.

Hope this helps!!


Very helpful! Thanks! 

@Mike Dusenka , you have to make an assumption about your exit cap rate. There is no other way of doing it. You are essentially trying to predict what rate of return investors would expect in the future and would be willing to pay for.

How to you make that assumption?

There are two usual techniques:

  1. Take current market cap rate (this has nothing to do with your property) and add .1% for each year of anticipated holding period. E.g. if current cap rate is 5.5% and you expect to exit in 5 years, your exit cap is 6%. If you want to be more conservative, use .2% for each year, so your 5.5% would go up to 6.5%.
  2. Use historical mean number for a given submarket. E.g. if the range was 5% to 10%, use 7.5% as your exit cap.

In both case, ask multifamily brokers for the current and historical cap rates. Do not waste your time with residential agents as they usually do not have a clue.

Originally posted by @Nick B. :

@Mike Dusenka, you have to make an assumption about your exit cap rate. There is no other way of doing it. You are essentially trying to predict what rate of return investors would expect in the future and would be willing to pay for.

How to you make that assumption?

There are two usual techniques:

  1. Take current market cap rate (this has nothing to do with your property) and add .1% for each year of anticipated holding period. E.g. if current cap rate is 5.5% and you expect to exit in 5 years, your exit cap is 6%. If you want to be more conservative, use .2% for each year, so your 5.5% would go up to 6.5%.
  2. Use historical mean number for a given submarket. E.g. if the range was 5% to 10%, use 7.5% as your exit cap.

In both case, ask multifamily brokers for the current and historical cap rates. Do not waste your time with residential agents as they usually do not have a clue.


Thanks for replying, and understood. 

I'm looking at a deal with a CAP rate of 3.8% and NOI of $35,705, and after renovations, rents will increase NOI to $57,248

If the CAP rate stayed at 3.8% hallelujah for a 70% cash-out refi ($1,054,568), but the marketing brochure says after renovations the CAP rate will be 8.61% and with a 70% cash-out refi that's ($664,901). 

I'm trying to buy cash with a partner at $800,000 + $100,000 Rehab. NOI improves from $35,705 to $57,248.

Now, I want to give my partner back their money on the refi + more. However, if the CAP rate becomes 8.61% the ARV would be $664,901 and a 70% cash-out refi would leave me with $465,430, and that's a no-deal.

So, something seems off or this property is not meant for what I'm trying to do.

@Mike Dusenka ,

There are 4 types of cap rates:

  • Current market cap rate - this is an average cap rate of what stabilized properties sold for in the last 6 months or so. What is it for your sub-market?
  • Current property cap rate - current NOI divided by asking price. That is your 3.8%. It may have nothing to do with the market cap rate if the property is a heavy value-add or it may be a market cap rate if the property is stable.
  • Exit market cap rate - this is what you think market cap rate would be in the future (today's + 1%, historical average, etc.)
  • Exit property cap rate - exit NOI divided by acquisition cost. That is what broker's marketing package refers to when they say "8.61%". You want your property exit cap rate to be higher than the marker exit (future) cap rate.

One side note. Do not rely on broker's material. Check all their numbers and come up with yours for each income and expense line item.

Originally posted by @Nick B. :

@Mike Dusenka,

There are 4 types of cap rates:

  • Current market cap rate - this is an average cap rate of what stabilized properties sold for in the last 6 months or so. What is it for your sub-market?
  • Current property cap rate - current NOI divided by asking price. That is your 3.8%. It may have nothing to do with the market cap rate if the property is a heavy value-add or it may be a market cap rate if the property is stable.
  • Exit market cap rate - this is what you think market cap rate would be in the future (today's + 1%, historical average, etc.)
  • Exit property cap rate - exit NOI divided by acquisition cost. That is what broker's marketing package refers to when they say "8.61%". You want your property exit cap rate to be higher than the marker exit (future) cap rate.

One side note. Do not rely on broker's material. Check all their numbers and come up with yours for each income and expense line item.

Very helpful! Appreciate it.

So, with the 8.61% (Exit CAP Rate) - would that be the CAP an appraiser would use to determine the ARV?

Thanks for all the help!

 

Originally posted by @Mike Dusenka :
Originally posted by @Nick B.:

@Mike Dusenka,

There are 4 types of cap rates:

  • Current market cap rate - this is an average cap rate of what stabilized properties sold for in the last 6 months or so. What is it for your sub-market?
  • Current property cap rate - current NOI divided by asking price. That is your 3.8%. It may have nothing to do with the market cap rate if the property is a heavy value-add or it may be a market cap rate if the property is stable.
  • Exit market cap rate - this is what you think market cap rate would be in the future (today's + 1%, historical average, etc.)
  • Exit property cap rate - exit NOI divided by acquisition cost. That is what broker's marketing package refers to when they say "8.61%". You want your property exit cap rate to be higher than the marker exit (future) cap rate.

One side note. Do not rely on broker's material. Check all their numbers and come up with yours for each income and expense line item.

Very helpful! Appreciate it.

So, with the 8.61% (Exit CAP Rate) - would that be the CAP an appraiser would use to determine the ARV?

Thanks for all the help!

No. 8.61% is for your reference only. Think of it as your "break even" point: "If my NOI reaches $XX and market cap rate increases to 8.61%, I can still sell the property for the same price I bought it for 5 years ago".

The appraiser will use market cap rate at the time of the appraisal. 

 

Originally posted by @Nick B. :
Originally posted by @Mike Dusenka:
Originally posted by @Nick B.:

@Mike Dusenka,

There are 4 types of cap rates:

  • Current market cap rate - this is an average cap rate of what stabilized properties sold for in the last 6 months or so. What is it for your sub-market?
  • Current property cap rate - current NOI divided by asking price. That is your 3.8%. It may have nothing to do with the market cap rate if the property is a heavy value-add or it may be a market cap rate if the property is stable.
  • Exit market cap rate - this is what you think market cap rate would be in the future (today's + 1%, historical average, etc.)
  • Exit property cap rate - exit NOI divided by acquisition cost. That is what broker's marketing package refers to when they say "8.61%". You want your property exit cap rate to be higher than the marker exit (future) cap rate.

One side note. Do not rely on broker's material. Check all their numbers and come up with yours for each income and expense line item.

Very helpful! Appreciate it.

So, with the 8.61% (Exit CAP Rate) - would that be the CAP an appraiser would use to determine the ARV?

Thanks for all the help!

No. 8.61% is for your reference only. Think of it as your "break even" point: "If my NOI reaches $XX and market cap rate increases to 8.61%, I can still sell the property for the same price I bought it for 5 years ago".

The appraiser will use market cap rate at the time of the appraisal. 

 

I appreciate your knowledge and willingness to share, immensely. Thank you.