Other than using our site and getting a quick, accurate, valuation we figured it would be nice to break down some of the factors that come into play when valuing an apartment building. We use all these factors when considering a valuation for a multifamily property in our algorithm on the site. These factors are not in any particular order!
Condition of the building - This is going to be a case by case situation. Depending on the current ownership/management people's ideas of "good" and "poor" condition can range ALOT! There can be very minor things that may need to be fixed while also some major problems that may need immediate attention. The major problems (foundation, new roof needed asap, all new plumbing, electrical) are the ones that are going to have a big influence on the value of your building. These major fixes can add up to 100's of thousands of dollars. It's not always easy to identify these problems and how serious of a situation it may be, so leave it up to the inspectors to really see what is going on. However, just know that the price may need to be adjusted once a professional actually gets a chance to see what's going on. Most people have the new buyer pay for an inspector to come out during due diligence and inspect the property. If you would like to figure out these problems before and avoid any hiccups during the escrow process aka the buyer asking for a price credit or possibly walking away from the deal after finding these issues out you can pay for an inspector to come out before you take the property to the market and factor in any fixes into the listing price. You are likely to have a more successful transaction if you are upfront about what the actual condition of the building is. The majority of sellers try to avoid this (even if they know there is a problem) and have the buyer bring an inspector during the due diligence period. Most of the time this results in the buyer coming back to the seller and saying "There are some major problems that need to be fixed. In order for me to continue escrow, I will need a price reduction to X amount." Keep in mind, this process can happen multiple times with multiple different buyers resulting in months of wasted time for everyone! If you want to sell your building, spend the $500-$1,000 dollars for an inspector to come out beforehand so you can show the potential buyers what is going on even before entering into escrow! This way there won't be any shock during the due diligence process resulting in an unsuccessful escrow! Trust us!
Location of the building - What kind of area is the subject property located in? Is it located in a very nice prestigious neighborhood such as Beverly Hills? Or is it located in an "up and coming" neighborhood that isn't the nicest right now but in a few years might change drastically. Silverlake, Echo Park, and Highland Park are good examples of how neighborhoods can change quite drastically over the course of a few years. Or is it in a "low income" neighborhood that hasn't seen much change in a long time and main remain that way. This comes into play when you are considering the appreciation of the real estate value. Although in Los Angeles it is probably safe to say that everything is going to appreciate over time it's mainly just a question of how much!
Non-Rent Control (NRC) vs Rent Control (RC) building - For more details on this topic, you can visit our "Why is Rent Control vs. Non-Rent Control Such a Big Deal?" blog. To make it quick, some areas put regulations on certain buildings as to whether how much the rent can be raised. For the most part, Rent Controlled buildings can be raised 3% each year if the tenant decides to stay (You can raise it to market rent if the tenant leaves and you start a new lease). Non-rent control buildings can be raised to "market rent" at the end of the tenant's lease even if they decide to stay. Typically a lease term is one year and an owner can let the tenant know that if they would like to stay the rent is now 10% higher then their current rent because now that is "market rent" in the particular area. Some areas don't have these regulations while others do. The areas that do usually operate under the guidelines that a building built before 1978 falls under Rent Control and a building built after 1978 is considered Non-Rent Control. As you can imagine, this is a pretty big deal. There has been a lot of commotion over these guidelines which is another story. Whether your building is Rent Controlled or Non-Rent Controlled will definitely be a factor in determining the value of your building!
Income of the building - This is a very important category in determining the value of your building. What is the return that the new owner will make on your building when they purchase it and what is the potential return (upside) they can achieve with the subject property? People typically buy apartment buildings as investments meaning they want the best return possible! Here are the two metrics that go with the income your building generates.
Gross Rent Multiplier (GRM) = the purchase price divided by the gross yearly income. For example, $1,500,000 purchase price divided by $100,000 yearly gross income = 15 GRM. The lower the GRM the better for the buyer. You will see GRM's at the time of sale from 9 (rougher neighborhoods) all the way up to 20+ (Santa Monica, Beverly Hills)
Capitalization Rate (CAP Rate) = Net Operating Income divided by the purchase price. To get the Net Operating Income, (Gross yearly income - expenses = Net Operating Income) So using the example above, we had a gross income of $100,000. Typically expenses are around 35% leaving our Net Operating Income at $65,000 ($100,000 - $35,000). $65,000 divided by $1,500,000 = 4.3% CAP Rate. You will see CAP Rates range from 1% (ex. Santa Monica, Beverly Hills) all the way up to 6.5% (rougher neighborhoods)
So the example property would have a 15 GRM and a 4.3% CAP. Not the worst but not the best depending on where this property is located!
Price per square foot & price per unit - These are also important metrics that need to be looked at in apartment sales but these are simply calculated using the purchase price and nothing else. For example, a 5 unit 5,000 square foot building sells for $1,000,000 dollars putting the price per square foot at $200 ($1,000,000 divided by 5,000) and the price per unit at $200,000 (1,000,000 divided by 5)
Future potential of the building - Now as you've seen in the example above, some buildings may not be very attractive on paper based on their condition and their return on investment from Day 1. However, it's possible the building has been mismanaged or the full potential of the building hasn't been achieved yet. For example, it could be a Non-Rent Controlled building that hasn't had the rents raised in years! That would mean the income it generates today is very poor but could potentially double or triple in a month or two if the new owner raises rents! Or it is a rent-controlled building that is having a few low paying tenants leave in the near future meaning the rents can be brought up to market! Or more commonly it is a Rent Controlled building and the new owner goes in and talks to the tenants about relocating in exchange for $cash$. Some tenants may want to leave and some won't. They get to make the decision on that but if some tenants do leave then the owner can raise the rents to market rent ultimately improving the CAP rate and GRM of the building! Every situation is going to be different but the point is the future potential of the building should play into the value of an apartment building. How much that future potential plays into the value is usually going to be related to how easily that future value can be achieved. A Rent Controlled buildings future potential won't be taken into consideration too much as the tenants may never leave and the future potential may never be achieved! A non-rent controlled buildings future potential is much easier to achieve thus making it more valuable from day 1.