On income producing properties, such as 6 unit buildings and larger, investors and real estate professionals measure value differently than the way single family homes and condominiums are valuated.
When agents and appraisers value homes, they look at what similar properties are actually selling at. We also note the
The sun coming up behind the Chugach Range over Cook Inlet
amount of “active” competition of similar property are on the market. The assumption is if homes in close proximity to yours and with similar “specs” as the subject home sold at a certain price, its logical that your house will get a similar price.
Income properties are valuated based upon their ability to produce income after all expenses are paid. The condition of the property is taken into account, of course. If the property isn’t properly maintained, the rents will decrease and become more management intensive as tenants come and go more often.
There are a number of ways investors might value a building such as “Cash on Cash” which is the return on the investors actual invested cash and other “quick and dirty” methods. However, by far the most common method of valuing a building is a factor known as a “cap rate.”
The process is started bylocating the properties income from all sources (rents and laundry), and then accurately show all the property expenses. Expenses are items such as property taxes, insurance, gas or other heating, electric, water & sewer, refuse and lawn and/or snow removal. Of course, overstating the rent or understating the expenses will give you inaccurate results. A buyer, a seller, an appraiser and the lender will all scrutinize the expenses to make sure they are accurate.
In addition, to properly analyze the property, it is important to assign a value for vacancy, even if a property happens to be fully rented at the present time. Most cities keep track of the actual local vacancy rate so you don’t have to guess at it. Don’t forget set-asides, or property reserves! Your building is going to need paint in 7 – 10 years and the roof will need work in 15 or so years depending on your weather, etc. Another item of expense that can be overlooked is property management. On larger buildings lenders won’t let you manage your own building, especially if you haven’t had experience at it. Management fees run between 5% and 8% depending on the scope of work and the condition of the property.
Once you get to the bottom line of income minus all real expenses, you assign a capitalization (or cap) rate. A cap rate is a multiplier to get to building value. In our market, a very nice well maintained property in a good neighborhood might have a cap rate of 7.5 or 8. If the building is run down or you need a security team in Kevlar to collect the rent, you could see cap rates of 12 – 13. The lower the cap rate, the higher the value.
Sadly, in our market rents have remained flat or only increased nominally, while expenses have steadily increased. For instance, the municipality’s assessed value is often higher than the actual appraisal value, meaning taxes are high. Property insurance isn’t necessarily a given commodity but varies on the building and how often the buyers have had a insurance claim.
