Determining The Value of an Apartment Building
Commercial real estate agents are good at determining the value of an apartment building, simply because they have been doing professionally using the correct tools. It’s not like residential real estate where comps have a large influence on prices. With Apartment buildings being investment properties that produce cash flow, they have to be valuated as such. You buy investment properties because you place a certain value on the cash flow they produce or for the cash flow that will be produced.
Commercial real estate agents have the proper tools at their fingertips for getting information they need to do a proper valuation. They also have the experience to dissect that information, knowing which is accurate and which is Not! But how do you determine the value of an apartment building you are buying or selling ? Some of the most common methods for Valuating a multifamily property is as follows, using the CAP Rate , GRM and Cost Per Unit method.
In my opinion determining the CAP rate is a more accurate method of establishing value since it takes into account the NOI or net operating expenses and more accurately reflects the true value of an apartment building. You calculate NOI by taking the total annual rents minus all of the costs of running the building, including property taxes. Don’t include mortgage payments.
Let’s say your building brings in $ 100,000 in rents a year.
Rents : $ 100,000, minus vacancy factor of 5% = 5,000
utilities / repairs (usually around 35% ) $35,000,
From this you then get the NOI. This is the amount of net operating income the building generates. To calculate the Capitalization Rate, you will need the sale or purchase price of the property and the NOI, which you just calculated. In general, CAP rates in LA range from 3 % to 5 % . CAP rates vary from neighborhood to neighborhood. So you will need to check.
Let’s take our $60,000 Net Operating Income and divide it by the Cap rate to determine the value of the building.
If your selling your apartment building and don’t know the CAP Rate then you will need a list of comparable buildings in the area that sold. Ultimately you will find out that often of the information that you see out there, for example commercial realtors set up sheets, is not actually accurate and this could easily throw off your numbers when calculating the true value of your apartment building.
Commercial real estate agents know this and dig much deeper to find accurate information to help determine the value of investment properties.
Doing an accurate Rent Survey of the immediate area and estimating the Operating expenses (35%) and vacancy rates (5%) will help you determine accurate CAP Rates.
I will use the CAP Rate average in a particular neighborhood, with buildings of similar unit size and characteristic to obtain an average CAP Rate for that area. I can then use that average CAP rate in my calculations.
Keep in mind we are always comparing similar buildings, example Class A, B or C and the location and year type of multifamily building.
Gross Rent Multiplier (GRM)
Another valuation method, Gross Rent multiplier or GRM, is useful to get a rough estimate of a building’s value. Gross Rent is the gross rents collected on a monthly basis and added up to total gross yearly rents.
With a 10 Unit building that’s making $100,000 in rents yearly, we can use the GRM to calculate value. $100,000 multiplied by GRM = Value of the multifamily rental property.
Currently the GRM for Studio City is around 17. Multiply that by the yearly rents and you have an approximate value.
Be cautious as the GRM is different and particular to each individual neighborhood. In general, the more desirable an area, the higher the GRM. So a building in the Beverly Hills might go for 21 GRM and in other less desirable areas can be much lower. Great locations have a high GRM and seem to be more stable. Low GRM areas are associate with a higher risk investment. Keep in mind we are always comparing similar buildings, example Class A, B or C and the location and year type of multifamily building.
Cost Per Unit
So we went over CAP rate and GRM. So for cost per unit in a multi-family property let’s say it’s 10 units and the purchase price is a million dollars all we’re going to do is take a million dollars divided by the number of units. That’s 100K per unit. Obviously buildings are not the same, you might be considering buying a 10 unit or a 7 unit.
And all these may have different unit mixes so bedroom counts two bedrooms, one bedrooms and so forth. So how do we evaluate these properties side by side when they’re not the same size, they’re not in the same geographic location, and they’re not collecting the same amount of rent.
Same goes for capital improvements if we’re comparing properties. So to start with you will need to take the size of the rent-able square feet. Keep in mind we are always comparing similar buildings, example Class A, B or C and the location and construction year of a multifamily building. Similar location as well. Simple formula is to divide the number of units to the selling price and you have your cost per unit.
Cost Per Square Foot
very similar to cost per unit. In this case we divide the selling price by the rent able square footage.
What I Do To Analyze and Price Your Building
Location, number of units, condition of the building, year it was built and how much gross rent the building generates are all very important factors in determining the value of a Multifamily building. However many other factors are relevant to the value of the property. I will usually start by doing a quick visit to the property and do a walk around to visually see what’s going on with the building. Once I have a good idea about the condition of the property, I then focus on the following:
Initial research on Zoning and possible changes that have taken place since your original purchase of the building. If zoning changes have taken place and are a beneficial selling point and will allow for development , then it would be a good idea to mention it to potential buyers. Example , Transit Oriented Communities, enhancement to ADU regulations and much more beyond the scope of this article. Zimas is a good place to start.
Other important factors are the type of rent control in place, Soft Story Retrofit requirements if any, outstanding building and safety violations, LAHD violations and Title check. After I determine the price of an apartment building I put all the analysis information in our marketing package for buyers and investors. The marketing package is very valuable tool for investors.
Take a look at a sample marketing package I use.
Please feel free to contact me direct at 310-584-7721 to discuss your situation. I’ve been in the business for 25 years and I sure I will have some great advice options available to you.