VALUE ADDING COMPONENTS
It is vital for multi-family investors to understand how the value of each apartment complex is calculated. Unlike single-family houses, where the value of a subject property is determined based on the recent sales of comparable properties, the value of a multi- family property is based on the amount of income it generates each year. When it comes to calculating value, multi-family properties are best thought of as a business rather than a building. More revenue generated each year results in higher property values. When Ascendant Investments acquire apartment communities, specific opportunities to increase the cash flow in various areas are thoroughly analyzed. These are commonly known as “Value Plays” or “Value Adding Components”.
The following are some examples of value adding components:
- Increased rents to the current market rent levels. It is not uncommon to find apartments that are 10% below the current market pricing. This provides the opportunity for new management to increase the rents and immediately increase the value of the property.
- Enhanced curb appeal from improved landscaping, added carports, etc. Rents can be acceptably increased when a property is in better condition, has carports or security gates.
- Implemented back charges to the tenant for water and sewage. In many situations, the owner of an apartment will pay for all of the water expenses. If the tenants are back charged for their own water and sewage expenses, it will help offset those expenses and increase the Net Operating Income.
- Added coin laundry facility (This feature adds up quickly to the property’s cash flow)
- Rent growth increased by 3-4% each year. In an emerging market where employment opportunities are rapidly growing, the market rent generally increases by 3-4% each year to keep pace with the growing demand for housing.
On the next page, you will see the influence each of these value adding components can have on the value of a multi-family property. Each of these value adding components improves the property’s cash flow, which as we’ve already discussed, ultimately increases the property value.
On the left side of the diagram above, the purchase price is depicted with the Net Operating Income.
- The market for this deal sustained a 9.5% cap rate.
The value of this deal was calculated by dividing the Net Operating Income by the - Capitalization Rate for that local market. $156,600 (NOI) / 9.5% (Cap Rate) = $1,648,421 (value)
- The right side of the above diagram demonstrates how value adding specific components/amenities during the 3-5 year period enhances the property value. Take note of the significantly improved NOI at the end of 5 years. Increasing the NOI by $71,901 has dramatically raised the value of this multi-family asset.
New NOI of $228,501 / 9.5% Cap Rate = $2,405,274 (New value)
- In addition to increasing the value over 5 years, the mortgage has also been paid down, which builds more equity and boosts ultimate capital gains once the property is sold again.