How Apartments are Valuated

Apartments and single-family assets follow distinct valuation methods. While single-family properties are typically assessed based on recent sales of similar properties in close proximity, apartments are primarily evaluated using the Net Operating Income (NOI) and capitalization rate (cap rate). This approach grants investors a higher degree of control over the asset's value compared to single-family properties.

Let us begin by clarifying what qualifies as a multifamily asset. Properties with more than four units are categorized as multifamily assets, while those with four units or fewer are treated as single-family properties when it comes to securing loans or mortgages.

You may be familiar with the equation Profit = Revenue - Expenses, which is synonymous with Net Operating Income. For multifamily assets, the Net Operating Income is determined by deducting all losses related to lease, vacancy, bad debt, concessions, and operating expenses from the monthly revenue. To provide an example, suppose a multifamily property generates $11,000 in monthly revenue while incurring $6,000 in expenses. In this case, the resulting Net Operating Income (NOI) would amount to $5,000.

NOI = Revenue - Operating Expenses

Once the NOI is determined, it is essential to establish the Cap Rate. The Cap Rate represents the expected annual net profit or loss on an investment. If an asset were purchased outright with cash, the Cap Rate would reflect the cash-on-cash return. This rate is expressed as a percentage and is compared to similar properties in the area that have recently been sold. Thus, while market factors still influence the valuation of multifamily assets, their impact is relatively less significant compared to single-family properties since we have a certain level of control over the NOI.

Once the NOI and Cap Rate are established, the value of the multifamily asset can be calculated.

Value = NOI / Cap Rate

For instance, if an asset generates $100,000 in annual NOI and the prevailing Cap Rate in the market is 5%, the value of the asset would be calculated as $100,000 / 0.05, resulting in a fair market value of $2,000,000. This example highlights the importance of effectively managing the NOI for multifamily assets. A mere $25,000 increase in NOI per year would translate to a $500,000 increase in value with a 5% Cap Rate!