Determining The Value of an Apartment Building
Determining the value of an apartment building takes some skill and experience. It’s not like residential real estate where comps have a large influence on prices. Apartment buildings are investment properties that produce cash flow. 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.
But how do you determine the value of an apartment building you are buying or selling ? The 2 most common methods used are CAP Rate and GRM.
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,
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 3.5% to 7 % . 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 dont 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.
Gross rent multiple (GRM)
Another valuation method, Gross Rent multiplier or GRM, is useful to get a rough estimate of a building’s value.
With a 10 Unit building that’s making $100,000 in rents yearly, we can use the GRM to calculate value. $100,000 X GRM = Value.
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 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 21GRM. A run-down building in Compton might go for 7 GRM.
range for a building. But it leaves out something very important: costs! To get a more accurate sense for the value of a building, we should look to the CAP rate method, which takes costs into account.