Determining the value of an apartment complex
Buying an apartment complex takes a lot of work. You have a lot of things to cover in a short amount of time. Inspections, lease audits, mortgage options, taxes, insurance and a host of other things.
All of these things combined comes down to one thing. Determining the value of the apartment complex. Below I cover how the value is actually determined.
NOT LIKE A SINGLE FAMILY HOUSE
First, you have to understand that the price of an apartment complex is not the same as determining the price of a single family house.
The price of a single family house is determined by its comparable’s sold in the last 6-12 months within that neighborhood.
For example, a 3 bedroom 2 bathroom, 2,500 square foot house with a pool, will be compared to other homes with similar features.
It does not matter how much you upgrade the house with all the latest technology and features. The comps will still set the value for the house.
This is not the case for apartment complexes.
NET OPERATING INCOME
The price of an apartment complex is based off of its net operating income.
The net operating income is the income a property produces before income taxes and debt service. The formula is below.
NOI = GROSS INCOME – OPERATING EXPENSES
A rule of thumb is, the higher the net operating income (“NOI”), the higher the value.
INCREASING THE NOI
You can buy apartment complexes turnkey, or you can buy to add value. Adding value will increase the net operating income of the property.
So what are some ways to increase the NOI? Simply finding ways to decrease expenses and increase income.
You can decrease expenses by restructuring service contracts such as washer/dryer contracts or landscaping contracts.
Ways you can increase the income is by offering valet trash, installing cover parking or even installing storage units. These all increase the income of the property.
DETERMINING THE VALUE
So now that we have the basics down. How do you actually determine the value of an apartment complex?
Lets do some quick back of the napkin math to determine the value of one.
Lets say the gross income of a property is $100,000. And the operating expenses is $45,000. That leaves you with $55,000 of NOI.
To determine the value, you simply divide the NOI by the cap rate.
If the going cap rate is 5%, then the value of the property is $1,100,000.
If you were to go in, fix up the property and increase its income to $125,000, and kept the same expenses, the value would have increased to $1,600,000.
You have just created $500,000 of equity by increasing income by only $25,000.
A very important closing statement is that you never want to buy an apartment complex based on proformas.
Using proformas to value a property can be a very dangerous tactic.
You always want to purchase based on its actual income.
And by buying based on actual income. That will give you a definite number to determine the value of an apartment complex.