How to Calculate the Value of an Apartment Building
If you have invested or are considering investing in an apartment building, how can you understand the value of that property? There are a number of ways to calculate the value of an apartment building, from researching market comps to calculating the cap rate of a building.
In the end, finding the right purchase price depends on calculating value in a number of ways. Everyone has their own favorite metric be it equity multiple, IRR, or Return on Cost. It's always best to start with your own pro forma model. This model will capture key aspects of due diligence reminding you of maintenance costs, taxes, capital improvements, current rents, and potential rents.
While it is fun to do back-of-napkin calculations, success in this effort depends on being as thorough as possible. Here are a few methods to consider to help you calculate the value of an apartment building according to your goals for the property.
1. Consider Comparative Sales
For most real estate investors, comparative sales are an easy place to start. It's simple to take a look at similar buildings in your area and see what they've most recently sold for.
Comps are listed as a cost per square foot. While comps tell you that you paid the same as the next person, they do not speak to the income potential for the building.
Think of purchasing an apartment as akin to buying a small business. The sales price is inextricably linked to the income it produces.
So, start with comps to know that the place you are looking at is a relative value. But to get a true picture of value, you have to look further.
2. Calculate Net Operating Income (NOI)
NOI, or net operating income, represents a property's gross operating income, minus its operating expenses. This is the fundamental tool that any commercial real estate analyst uses to arrive at a general value for an apartment building. In fact, many sites like MLS and CoStar often list NOI for each property. Remember that NOI is a forward-looking number. When you calculate NOI, you're doing so for the upcoming 12 months.
How to Calculate NOI
NOI is calculated by first adding up a property's annual gross income. The majority of this is rent, although there can be other sources of income, such as:
Vending machines
Paid washer and dryer units
From that annual gross income, you subtract the property's projected annual expenses. This might include:
Property management fees
Property tax
Insurance costs
Maintenance costs
And any other cost you expect to have to pay for the building over the course of the upcoming year.
By subtracting all of those expenses from the gross annual income number, you arrive at your net operating income.
Again, it is vital to do your own calculations. Others may anticipate different maintenance, operating costs, or even taxes.
This is a great tool because everyone will talk cap rate when in the sales negotiation. The primary limitation of cap rate is that it doesn’t include financing costs in the calculation. For projects with traditional financing, this can be a huge cost that must be factored in.
3. Connect With A Real Estate Analyst for Expert Advice
A real estate analyst can tell you the appropriate cap rates for your market and they have access to a wealth of market research and analytics tools. By combining all of these resources your real estate analyst is able to distill all of that information down into an accurate, market-based valuation of the apartment building in question.
Make sure one of the real estate analysts you talk to is a broker active in the market. They can talk to you about recent sales trends and may be able to speak specifically to the person on the other side of the sale. If you're hoping to calculate the value of an apartment building to make a purchasing or selling decision, the process isn’t complete until you connect with an experienced professional.
Looking to buy or sell apartment buildings in Westside LA? RENDR can help. Our team of commercial real estate analysts work with investors looking to buy or sell. We can provide that context you need to navigate negotiations and make the best business decision for your unique goals. For more information and expert advice on commercial real estate in Santa Monica, Culver City, Venice, West Hollywood, Beverly Hills, or Century City, get in touch with the RENDR team!