Whether you’re buying your first multifamily investment property or ready to sell what you currently have in your portfolio, it’s imperative that you know how much that property is valued. Even if it seems to be the perfect investment on paper, if you pay too much or the buyers pay too little, your return on investment greatly diminishes.
The property valuation process is pretty simple and the formula doesn’t require key performance indicators that you need to dive deep to find. The most basic formula is income capitalization using two particular numbers: the net operating income (NOI) and capitalization (cap) rate.
Net Operating Income
Residential property valuation is based on comparable pricing of similar properties in the general vicinity, while commercial and multifamily properties are valued based on their projected NOI — calculated by subtracting operating expenses from gross income.
Add up all sources of income from your commercial property; the majority of this revenue will come from rent. Lease or application fees, pet rent, and laundry machine income all fall under the umbrella of gross income. Operating expenses are the costs required to run your multifamily apartment on a day-to-day basis and typically remain fixed. These are line items like property taxes, utilities, or maintenance costs.
To calculate cap rate: “Multifamily cap rate is simple to measure. You’ll first need to determine the net operating income (NOI) of a multifamily property by subtracting all operating expenses from the overall gross income of the building. Once you determine a property’s NOI, you’re ready to calculate cap rate by taking NOI and dividing it by the multifamily investment’s purchasing price or current market value.”
The Pros and Cons of This Approach
Income capitalization is the property valuation method that property appraisers and real estate investors use, and the cap rate is directly correlated with the risk of investing in that property. While this is a quick and easy way to find the valuation of a commercial multifamily property, the numbers to plug into the formula are easy to find. On the other hand, there’s a lot of estimating to be done to get your final numbers.
More downsides to using this approach:
- It isn’t easy to calculate a definite value net operating income even if the property is leased to a tenant. You can’t accurately predict your rental income if your tenant doesn’t diligently pay on time. Expect lapses in your cash flow that will affect your NOI.
- Second, maintenance costs are unpredictable. You cannot properly consider events such as earthquakes, fires, and floods that can increase it.
- Capitalization rates are only estimated values. These are based on market-average numbers and don’t take into account the variables of the subject property. These particular variables can affect property value.
- Property-specific factors also significantly affect property valuation. For example, if a building immediately needs repairs, it costs less than other buildings similar to the subject property. Different lot sizes also affect property valuation.
Talk to the Professionals
It takes a team of multifamily professionals to truly understand (and successfully calculate) the income capitalization approach. LEX Group, Inc. is a St. Louis-based commercial real estate investment firm specializing in buying, renovating, maintaining, and selling greatly improved multifamily properties. We seek multifamily properties for our investment portfolio, specifically affordable, mid-density, and high-density developments, as well as government-subsidized projects working with local, state, and federal financing.
We purchase properties and improve them! We operate our communities ourselves and occasionally sell them to interested parties who share our commitment to maintaining them at the highest level possible. Our objective is to invest, transform in impactful ways, and create long-lasting communities that are truly unique. Please reach out to us if you are a prospective resident interested in leasing an apartment in one of our communities or a multifamily owner or investor in the market to buy or sell an asset.