So, How Much Is That Investment Property Worth Today?
Recently, I have had opportunities to speak with several owners of investment properties in the Tampa Bay area. All of these investor-owners purchased their duplexes, triplexes and apartment buildings during 2004 and 2005, and now they want to sell them in 2007 and hoped to double or triple their money.
I guess they don't believe what the newspaper is printing, or think the news does not apply to them.
My unpleasant assignment has been to snap them back into reality -- a thankless task, I assure you.
The mistake that these owners of income-producing properties have all made is one common to amateur real estate investors. They approached ownership of an income producing building as if it was a single-family home. They made improvements -- tile floors in all the apartments, granite counter tops in kitchens and baths, lavish kitchen appliances and so forth. One fellow even built a wet bar into one of the units. Another added jetted bathtubs.
These kinds of improvements are great if you're selling a single-family home where the new buyer will ultimately live in the property and will appreciate all those nice things you did to upgrade the home. The buyer will generally pay you more money for a house with all those wonderful luxuries.
A professional investor, however, probably won't give you one red cent more for a building with all that new stuff in it. In fact, he'll wonder why in the world you spent all that money unless the upgrades actually resulted in higher rents and increased annual profit on the building.
If you are selling an income producing property you need to keep in mind that you are not selling a building at all. You are really selling a future income stream to an investor. As such, the only thing the investor wants to know is how much return he will receive from buying your building. Real estate investors are primarily concerned with the calculations which prove a property's value in relation to its cash flow, and they will purchase property only if it is self-supporting and delivers an acceptable return on investment (ROI).
The Mistake
Most investors and many real estate agents treat investment-grade property as if it was ordinary residential property. In determining value for resale, they do a Comparative Market Analysis (CMA) and attempt to compare the subject property to the known selling price of similar properties. Sometimes they even go so far as to make a value determination based on the selling price per square foot of similar properties.
That's a mistake. No two properties are exactly alike, and they probably do not have equal income streams and net profits. And since the value determination is based on pure arithmetic, you can not make any adjustments to rental dollars delivered annually. In other words, you can't adjust one income stream from building "A" to somehow match the income stream from building "B" because dollars are always dollars and there is nothing to adjust.
Determining Value
The value of income producing property -- especially commercial property of 5 rental units or more -- must be determined using two mathematical formulas called "The Stack" and "IRV".
What's disappointing is that all real estate agents in Florida learned these two methods when they earned their real estate license. They just don't use the technique much, and if you don't use it you lose it. So, they fall back on doing CMA's and trying to adjust values by comparing one property to another, and that just doesn't work for reasons mentioned above.
The stack is very simple. You calculate the Potential Gross Income of your building annually by adding up all the rent as if you had 100% occupancy all year. You then deduct about 7% of that figure for vacancy and collection losses, then add in any additional income earned by the building (for a laundry, parking fees, cola machines or whatever). This gives you the building's Effective Gross Income.
From the Effective Gross Income you must deduct the operating expenses of the building. Operating expenses include mowing the grass, general repairs, and those darn property taxes among other things. Once you have made these deductions, you have the Net Operating Income (NOI) of the building.
NOI is the figure professional investors really want to look at and analyze. Your calculations must be accurate and not fudged. Fudging NOI figures may lead you to a lawsuit. Frankly, some of these serious investor-type people take a real dim view of fudging NOI figures.
The next thing professional investors do is calculate the value of your building by taking the NOI and dividing it by a Capitalization Rate, or Cap Rate. The cap rate varies from investor to investor. Essentially, the cap rate is how much profit, expressed as a percentage, that an investor wants to make on his money. Some people want cap rates of 10%, some people want 20%, others will settle for a lot less.
Today, I'm hearing that investors will generally consider buying a building if the cap rate is more than they can make by investing in bank certificates of deposit. So, that would mean investors are looking for caps of about 6% to 8%, and 7% seems to be a popular number.
So, to determine the value of the building you apply the second math formula -- the IRV formula. In this formula "I" stands for the Net Operating Income. "R" stands for the Capitalization Rate. "V" stands for the value of the property. You simply divide the NOI by the cap rate and you get the value of the building. Essentially, this formula tells an investor how much he can pay for your building based on its NOI and the cap rate he wants to earn on his money.
So, if you own an income producing building and you want to sell it for a bundle, you need to get your NOI as high as possible before putting it on the market. This generally means that you need to pump-up the rent and cut down on the expenses -- and stop doing remodeling that does not increase the rent flow but does increase the overhead against the building.
You can almost always tell when a landlord is thinking about selling his investment property. About a year to eighteen months ahead of selling, he starts pumping up the rents until his tenants are crying the blues and close to leaving. That's when he's got the rents right for re-sale. He then calculates the NOI and determines the asking price by dividing the NOI by an acceptable cap rate. The rest is just a matter of finding a ready, willing and able buyer.
If you own multi-unit investment property and are thinking about selling it, I urge you to consider the approaches described in this little story. It may not result in giving you the selling price you hoped for, but it will give you a realistic figure with which to go to the market. Without a realistic figure, your property will sit unsold for months on end because your income-stream will not entice any investors to make an offer.
For more information about the real estate market in Tampa Bay, visit my website at http://www.thestpeterealestatesite.com/.
I guess they don't believe what the newspaper is printing, or think the news does not apply to them.
My unpleasant assignment has been to snap them back into reality -- a thankless task, I assure you.
The mistake that these owners of income-producing properties have all made is one common to amateur real estate investors. They approached ownership of an income producing building as if it was a single-family home. They made improvements -- tile floors in all the apartments, granite counter tops in kitchens and baths, lavish kitchen appliances and so forth. One fellow even built a wet bar into one of the units. Another added jetted bathtubs.
These kinds of improvements are great if you're selling a single-family home where the new buyer will ultimately live in the property and will appreciate all those nice things you did to upgrade the home. The buyer will generally pay you more money for a house with all those wonderful luxuries.
A professional investor, however, probably won't give you one red cent more for a building with all that new stuff in it. In fact, he'll wonder why in the world you spent all that money unless the upgrades actually resulted in higher rents and increased annual profit on the building.
If you are selling an income producing property you need to keep in mind that you are not selling a building at all. You are really selling a future income stream to an investor. As such, the only thing the investor wants to know is how much return he will receive from buying your building. Real estate investors are primarily concerned with the calculations which prove a property's value in relation to its cash flow, and they will purchase property only if it is self-supporting and delivers an acceptable return on investment (ROI).
The Mistake
Most investors and many real estate agents treat investment-grade property as if it was ordinary residential property. In determining value for resale, they do a Comparative Market Analysis (CMA) and attempt to compare the subject property to the known selling price of similar properties. Sometimes they even go so far as to make a value determination based on the selling price per square foot of similar properties.
That's a mistake. No two properties are exactly alike, and they probably do not have equal income streams and net profits. And since the value determination is based on pure arithmetic, you can not make any adjustments to rental dollars delivered annually. In other words, you can't adjust one income stream from building "A" to somehow match the income stream from building "B" because dollars are always dollars and there is nothing to adjust.
Determining Value
The value of income producing property -- especially commercial property of 5 rental units or more -- must be determined using two mathematical formulas called "The Stack" and "IRV".
What's disappointing is that all real estate agents in Florida learned these two methods when they earned their real estate license. They just don't use the technique much, and if you don't use it you lose it. So, they fall back on doing CMA's and trying to adjust values by comparing one property to another, and that just doesn't work for reasons mentioned above.
The stack is very simple. You calculate the Potential Gross Income of your building annually by adding up all the rent as if you had 100% occupancy all year. You then deduct about 7% of that figure for vacancy and collection losses, then add in any additional income earned by the building (for a laundry, parking fees, cola machines or whatever). This gives you the building's Effective Gross Income.
From the Effective Gross Income you must deduct the operating expenses of the building. Operating expenses include mowing the grass, general repairs, and those darn property taxes among other things. Once you have made these deductions, you have the Net Operating Income (NOI) of the building.
NOI is the figure professional investors really want to look at and analyze. Your calculations must be accurate and not fudged. Fudging NOI figures may lead you to a lawsuit. Frankly, some of these serious investor-type people take a real dim view of fudging NOI figures.
The next thing professional investors do is calculate the value of your building by taking the NOI and dividing it by a Capitalization Rate, or Cap Rate. The cap rate varies from investor to investor. Essentially, the cap rate is how much profit, expressed as a percentage, that an investor wants to make on his money. Some people want cap rates of 10%, some people want 20%, others will settle for a lot less.
Today, I'm hearing that investors will generally consider buying a building if the cap rate is more than they can make by investing in bank certificates of deposit. So, that would mean investors are looking for caps of about 6% to 8%, and 7% seems to be a popular number.
So, to determine the value of the building you apply the second math formula -- the IRV formula. In this formula "I" stands for the Net Operating Income. "R" stands for the Capitalization Rate. "V" stands for the value of the property. You simply divide the NOI by the cap rate and you get the value of the building. Essentially, this formula tells an investor how much he can pay for your building based on its NOI and the cap rate he wants to earn on his money.
So, if you own an income producing building and you want to sell it for a bundle, you need to get your NOI as high as possible before putting it on the market. This generally means that you need to pump-up the rent and cut down on the expenses -- and stop doing remodeling that does not increase the rent flow but does increase the overhead against the building.
You can almost always tell when a landlord is thinking about selling his investment property. About a year to eighteen months ahead of selling, he starts pumping up the rents until his tenants are crying the blues and close to leaving. That's when he's got the rents right for re-sale. He then calculates the NOI and determines the asking price by dividing the NOI by an acceptable cap rate. The rest is just a matter of finding a ready, willing and able buyer.
If you own multi-unit investment property and are thinking about selling it, I urge you to consider the approaches described in this little story. It may not result in giving you the selling price you hoped for, but it will give you a realistic figure with which to go to the market. Without a realistic figure, your property will sit unsold for months on end because your income-stream will not entice any investors to make an offer.
For more information about the real estate market in Tampa Bay, visit my website at http://www.thestpeterealestatesite.com/.
-30-
posted by Terry Ward at 11:57 AM
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