March 21, 2020
The Multifamily Firm offers its clients a periodic opinion and assessment of multifamily property value service so that owners can monitor their asset valuation similar to an annual statement in a brokerage account or a mutual fund. In order to better explain this, we’ve addressed the specific points of determining the value of a multifamily property, the steps taken to calculate it, and how to keep a pulse on your property’s value. We are answering the concept of how to properly establish and monitor my multifamily property value continuously.
How do you calculate the value of a multifamily property?
There are two primary ways to establish the value of a multifamily property and they can be used interchangeably or as a validation process:
- Income Approach using Capitalization Rate (Yield or Cap Rate) – This is the ratio of Net Operating Income (NOI) to the denominator that best represents the purpose of the calculation. (price if the property is being sold or cost if the property is being acquired) (Net Operating Income divided by Price (or cost) = Capitalization Rate (expressed in % terms) or by using the reverse calculation and using an input variable for Cap Rate. (Net Operating Income divided by Cap Rate (input variable)= Property Value)
- Price Per Unit / Price Per Square Foot, Etc – The total multifamily property asset value divided by the total amount of units in a property, living square foot etc. Primarily used to validate the Income Approach or used as a quick guide or measure when comparing similar properties.
What are the most important factors to consider when calculating the value of a multifamily property?
The process begins via collaboration with a multifamily property owner, and the collection of certain financial information on the subject property to determine a current operational cashflow. This typically involves current operational activity, although we collect information on capital expenditures those items tend to be treated differently than ongoing expense items. The result of that effort is to determine gross income, expenses, and current Net Operating Income.
Note: This does not include depreciation or debt service expense etc., it’s exclusively operational cost at this stage of value analysis.
Once we’ve established a current Net Operating Income, we look at the physical condition of the property as well as the quality of the income, tenant leases, overall submarket, neighborhood etc. While operational net income is the key driver to valuation, we also examine value add dynamics particularly when a property has been under-managed or not operating at full potential. In those circumstances we calibrate our analysis to include the additional cost and corresponding revenue enhancements that are “very likely” in high growth regions or submarkets.
When demand of Multifamily exceeds supply, investors are more likely to pay up for future potential income when submarkets conditions are favorable. This also plays a big part in valuation.
Additionally, cost of capital, interest rates and overall economic conditions come into play at a macro level while the market and investors will drive cap rates based on all these factors combined as outlined above.
What is the cap rate of a multifamily property?
The cap rate is the yield earned (expressed as a %) or Net operating income divided by overall cost or value of the property.
This can be a static value or can also fluctuate as a metric that can be driven by the market. In that case, the Cap rate desired by the market will determine the value of a property. When investors seek higher cap rates values will trend downward and if investors will accept lower cap rates values will rise.