Deal Or No Deal: Valuing A 24 Unit Multi-Family
Deal or No Deal: An ongoing series where I value a specific property. This property is a 24 unit apartment building listed for $4,500,000 in Charleston, SC.
A regular feature I do is called “Deal or No Deal”, where I find a random property on the internet and go through my underwriting process to determine if it is worth buying.
In previous articles, I outlined how-to:
If you have investors: Setting up an apartment syndication
This article will go through step-by-step the napkin math valuation and then the full underwriting valuation of a random property for sale.
Spoiler alert for today’s property:
Property: 24 Unit Multi-Family Building
Source: Loopnet
Address: 1251 Sumner Ave, Charleston, SC
Units: 24
Asking Price: $4,500,000
Step 1: Does this generally meet my screening criteria?
Yes, so I will go to step 2. (Typically the properties I will evaluate for these articles don’t meet my personal criteria that I listed in this article, but maybe they will meet yours.)
Step 2: What is the back of the napkin math?
Information I need:
Unit breakdown
• 3 bedroom = 24
Market rents (HUD Fair Market Rent)
• 3 bedroom = $1,721/month
Market cap rate (Internet research)
• 6.0%
Napkin math:
Gross potential rent (GPR): $1,721/month/unit x 24 units x 12 months = $495,648 annual GPR
Potential actual rent (6% vacancy/credit loss assumption): $495,648 x 94% = $465,909
Potential NOI:
• 30% expense ratio: $465,909 x 70% = $326,136
• 40% expense ratio: $465,909 x 60% = $279,545
Estimated value range
• High: $326,136 NOI / 6.0% market cap rate = $5,435,606
• Low: $279,545 NOI / 6.0% market cap rate = $4,659,091
Selling list price: $4,500,000
• The list price is below my low value estimate. This has the potential to be a good deal! But remember, the estimated value range is going to always skew a bit high as it assumes all units are at market rent, which is never true. So don’t pitch a tent just yet.
Step 3: Determine offer price based on full underwriting
If this was a deal I was actually pursuing, I would call the listing broker and possibly set up a property visit to assess the general condition. For the purposes of this article, I will use the broker provided info and general assumptions of condition based on the age and property class.
The underwriting model I use is the Apartment Acquisition Model with Monte Carlo Simulation from A.CRE. I will estimate property value using two scenarios:
Property value with in-place financials
Property value with year 2 or so financials I believe are realistic
Scenario 1: Value with in-place financials
1. Determine adjusted NOI from in-place financials
From the broker financials, the following are the in-place expenses:
Taxes: $24,645
Insurance: $19766
Repairs & Maintenance: $1,000
Trash: $1,620
Water: $10,421
Electric: $4,907
Internet: $1,188
Supplies: $450
Lawn Services: $4,000
Pest Control: $1,400
Management: $0
Income: The current rent roll is $321,720 and I will apply a 6% vacancy/credit loss rate. (Ruh roh - This income is way below my napkin math income. :nervously bites nails that I’ve chosen a total loser property for this article:)
Marketing: There is no in-place marketing expense. I will use $500 and try to find better tenants through paid advertising rather than free websites.
Administration: There is no in-place administrative expense. These are things like tax returns, your asset management time, etc. I would assume $3,000 for this expense (about 1% of collected rents).
Utilities: I will use actual of 18,136 plus 3% for inflation, as the property is currently 100% occupied.
Payroll: A small property like this requires no payroll.
Repairs & Maintenance: The in-place R&M of $1,000 seems very low (0.33% of gross rents), even given this property has recently had 22 of 24 units fully rehabbed. I will assume an R&M expense of about 3% for $9,000.
Management Fee: The seller shows $0, but I would not be managing this property myself (I’m not mentally ill), so I need to add an expense for this. I would normally expect a 3rd party management fee to be 6-8% of collected rent for a property like this. I’ll split the difference and assume 7%.
Property Insurance: Current property insurance is $824/unit, which seems a bit high for a property that has been rehabbed to the extent this one has. I don’t know this area at all, so maybe Charleston has crazy high rates due to hurricanes. Anyway, I’ll YOLO and assume I can bundle with my other properties and get some economies of scale at $750/unit for a total of $18,000. Normally you would want to receive a quote from an insurance agent at this stage since insurance expense can be a total crap shoot sometimes.
Property Tax: Per the current tax bill, the 2022 taxes are $24,999. Let me do some digging on the assessment just to make sure it’s in the ballpark of what I’d pay. Nobody has ever been burned on a property tax increase, so I’m sure it’s fine…
Charleston has a nice tax estimator on the assessor’s site. It would be awesome if every municipality had one of these available. Maybe in year 3083 that will happen.
So, plugging in an appraisal value of $4,500,000 (my potential purchase price), I get this:
This is estimating my tax will be $73,500, a 3x increase over the current owner. A giant pit has developed in my stomach as I’m now feeling like I’ve seen this movie before, like more times than I’ve watched Caddyshack times (a lot).
Property tax increases can be a huge trap for a new buyer. Do your homework on what your assessed value will be in the future.
This is what my year 1 operating expenses look like after making these adjustments:
Looking at my total expenses, my estimated OpEx ratio is 48%. Dang, that’s no bueno. This is very high as typical is 30-40%. I feel like this deal is hanging by a thread at this point, but I will soldier on for the people.
Adjusted NOI = $302,417 revenue less vacancy - $137,852 adjusted expenses = $164,565
Estimated value = $164,565 NOI / 6.0% market cap rate = $2,742,750
This is brutal relative to the $4,500,000 asking price. And there isn’t a huge value add plan that could be done to get closer to asking since 22 of 24 units have been fully rehabbed. There is zero point in continuing on with this analysis at this point since I’m only at 60% of asking price.
Normally I don’t care what the asking price is from a valuation perspective, but I’m obviously so far off the expectations of the seller, it would be a complete waste to spend any more time on this.
Napkin Math Failure
The 10 minute napkin failed miserably on this one. The HUD Fair Market Rent for a 3 bedroom is 35% higher than the in-place rents. These units have been all fully rehabbed and look pretty good on the inside, so this seems strange.
My guess is maybe that this building is in an atrocious area of Charleston and rents are super low. It’s the only reason that makes sense to me as the current owners - who dumped a ton of money into this and probably aren’t complete morons (did I just make a worse assumption than underwriting cap rate compression?) - can’t possibly be 35% below market.
And of course, our old pal Property Tax Increase reared its ugly head and did us no favors either. Such a buzzkill, that guy. Always ruining good deals.
And with that, keep grinding to find those deals that supposedly exist in this ridiculous market.
Pro Tip: Remember that I’m a simpleton buying properties in very small markets. Do not assume I actually know anything about anything. Caveat emptor with everything you read from everyone on the interwebz.