A common misconception is that multifamily (MF) apartments are valued the same way that single family homes (SFH) are. However,
1. SFH values are determined by market value
2. MF apartment values are determined by market value and income
This means, we can control the value of MF properties much greater than with SFH. For more details, read on!
SFH values are determined by the market, or “comparable sales” aka “comps” in the area. These comps will have similar square footage, number of bedrooms and bathrooms, vintage and in close proximity to the property. If those homes recently sold for a certain price, the home will be appraised at a value that is similar to its comps.
When it comes to MF apartments, there can be a couple things that can be used to determine the value of a property. Two are Gross Rent Multiplier and Cap Rates.
Gross Rent Multiplier (GRM)
An estimated property value can be calculated simply by multiplying the rent received per year by the average GRM in the area. For example, in Phoenix, according to Kidder Matthews, in 2021, the average GRM is 15 to 16. Let's say we want to use the GRM to calculate the value of a 50-unit property which gets monthly rents of $1,000 per door.
On Initial Purchase
Average Annual Rent Per Door: $1,000 x 12 = $12,000
Average Price Per Door = Average Annual Rent x GRM = $12,000 x 15 = $180,000
Estimated Property Value = $180,000 x 50 units = $9,000,000
Now let’s say the syndicator raised the rents by 10% over 2 years and the GRM remained the same
Average Annual Rent Per Door: $1,100 x 12 = $13,200
Average Price Per Door = Average Annual Rent x GRM = $13,200 x 15 = $198,000
Estimated Property Value = $198,000 x 50 units = $9,900,000
So let’s take this in. By increasing rents just $100 per door, the operator can increase the property value by nearly a million dollars! The addition of in-unit washers and dryers increase rents by $75 a door. Imagine the potential in increasing property value if you renovate the units as well! This is the power of multifamily – you can force the appreciation of your property.
Cap Rate
Short for Capitalization Rate, Cap Rate is a formula that values the property based on the profitability of the building or the “Net Operating Income” (NOI). To get this number, we use the total revenue minus the costs to operate and maintain the property. We also factor in estimates for vacancies. The one thing that isn’t include in the operating expenses is the mortgage payment.
Before I get into the formula, remember that the average cap rate in the area is just one measurement and you should really consider many other factors. It’s common for a group of apartments in the area to have poor management, or it’s possible that the snapshot data for the NOI in the area is outdated. Now on to the formula:
To get a property’s cap rate
For example, if a 50-unit property was bringing in $600,000 of annual rent
To get the NOI, we subtract all the operating expenses. Let’s say we ended up with $450,000 of profit
Then the Cap rate would be $450,000 / $600,000 = .05 = 5%
To get the value of a property, we need to flip the math. If you know the cap rate in your area, and know the approximate NOI, you can determine the value of a property that way. According to Kidder Matthews, in Phoenix, the cap rate was around 5% in 2021.
For example, if the NOI for a property is $450,000, and the cap rate is 5%, simply divide: NOI / Cap rate = $450,000 / .05 = $9,000,000
Let say that due to raising rents and making operating improvements, the syndicator was able to get the NOI to $495,000 a year
To get the new value of the property based on cap rates, you could get $495,000 / .05 = $9,900,000
This is another example of being able to increase rents and improve operations to increase the NOI, resulting in increasing the value by almost $1M! When I put together the business plan for a multifamily property, I take a lot into consideration to increase our NOI, ultimately giving us a great future valuation of our property.