Like so many things in life, there is no “one size fits all” approach to determining the value of an apartment building. Many factors can influence the value of an income property, including: location; security of the income stream; local economic and market conditions; deferred maintenance issues; upside potential from future physical or operational improvements; and even the specific goals or priorities of individual investors. But, to a large degree, the value of an investment property is a function of the quantity and quality of the income stream. Capitalization Rates (Cap Rates) are among the most widely used analysis tools for estimating the value of an income producing property, based on the amount of Annual Net Operating Income (NOI) a property will yield, in proportion to the purchase price (or assumed value) of the property.
Cap Rate = Annual Net Operating Income (excl. mortgage payments) Purchase Price (or Market Value)
For investment real estate, Cap Rates create a basis for comparing the return on investment for properties with diverse characteristics. By applying a derived “Market Cap Rate” based upon the sales of properties of comparable quality and location, an investor can estimate the market value of a particular property, by simply dividing the NOI by the Market Cap Rate.
Market Value = Annual NOI (excluding mortgage payments) Market Cap Rate
While “Market Cap Rates” can vary over time, and depend upon specific property characteristics, such as building age, quality and location, tenant profile, and unit mix…Cap Rates allow investors to assess different properties on an apples to apples basis. Cap Rates also reflect the level of risk associated with generating a reliable income stream from an investment. For example, a newer property in excellent condition, where tenants have strong credit scores and solid employment, will generally trade at a lower Cap Rate than an older building with deferred maintenance in an area with high unemployment or high crime.
Increasing the NOI generated by a property is a key factor in enhancing the property’s value, in relation to other similar assets. Since NOI is affected by both income and expenses, any effort to enhance the value of your property must consider both sides of the ledger.
Net Operating Income = Gross Scheduled Income - Vacancy & Credit Loss - Total Operating Expense
Strategic assessment of all aspects of your building’s operations, facilities, policies, and amenities can help maximize its potential, by increasing your NOI. Income can be improved by ensuring rents are competitive in the market; adding other income streams like laundry, parking or vending machines; and enhancing tenant retention.
Owners can also enhance NOI by streamlining operations, or making other improvements that reduce expenses, such as: carefully screening applicants; regularly monitoring management and maintenance reports; investing in preventative maintenance; sub-metering utilities; launching a crime prevention program; staff training; sub-metering for water; and conducting annual walk-through inspections of every apartment.
Analyzing the potential impact on NOI is important when considering the benefit of property improvements, or operational changes, that are being contemplated. When adding new facilities or services, tailor them to your tenant base, like adding a tot lot if you have lots of families, or offering bridge club at senior apartments.
These are just a few of the ideas we will be exploring in more detail when we present Maximizing Your Building’s Potential, at the next installment of our Apartment Investor Academy, on May 19th in Camarillo. For more information, or to register for this free seminar, please contact Emily@DyerSheehan.com.