Value

Mastering the art of evaluating apartment buildings not only saves time, money, and effort for yourself but also for potential buyers. Accurately assessing value significantly increases the likelihood of a smooth Agreement of Purchase & Sale process without any unwelcome surprises. By crunching the numbers correctly, you can estimate the value of your building(s) with a high degree of precision. This allows you to identify which properties yield robust cash flow and which may underperform. As part of your strategy, addressing any underperforming buildings and rectifying their issues prior to listing can maximize your returns. Armed with this knowledge, you approach negotiations with confidence, aligning your expectations with reality and minimizing the potential for disappointment during the sales process.

Investing in an apartment building is a business endeavor, and staying abreast of the prevailing principles can benefit you as the seller. Even if it’s been a while since you made a purchase, familiarizing yourself with the current guidelines that buyers adhere to can elevate your expectations.

Acquiring insight into the diverse industry approaches to valuation and comprehending their rationales will aid you, the seller, in identifying qualified buyers with realistic goals and the determination to finalize the transaction. Familiarizing yourself with these four values will enable you to set an appropriate asking price and establish a final selling price expectation. When faced with multiple offers, this understanding of values and attainable outcomes will guide you in selecting the most suitable buyer – one who is committed to collaborating with you and seeing the deal through to completion.

1. What the building is worth to you

2. What the market value is

3. What the financing value is

4. The expected Loan to Value Ratio

Yet another common oversight I observe is the omission of certain expense figures or a lack of comprehension regarding which industry-standard numbers should be incorporated into the expenses. This is crucial for accurately determining a net operating income that meets the criteria of lending institutions.

Canadian mortgage insurers offer highly flexible and appealing financing options for these properties, often requiring as little as a 15% down payment. However, achieving this ratio isn’t guaranteed for every building or buyer. Therefore, having a clear understanding of what is realistically attainable will assist you in determining your final selling price and in qualifying potential purchasers.

Having an accurate snapshot of your income and expenses for the past twelve months (current up to the date of analysis) is paramount as applying a cap rate to a net operating income that is incorrect produces an incorrect value and will always motivate the Buyer to come back to you looking for a haircut, or price reduction abatement. Financing will verify expense numbers during the due diligence to satisfy themselves, so why not start with the correct numbers? You must be aware that for every $1,000.00 in net operating income, the value of a building is affected by $14,000.00 at a 7% cap rate and, if the cap rate is even lower the value is higher.

The formula is simple $1,000.00 / .07 = $14,285.71.

CMHC and the lending institutions will plug in their numbers for vacancy, management, superintend and maintenance if you have accurately represented a number for these expenses the lending institutions will use their numbers depending on the size of the building. For example, you may have a great deal with the superintendent below market value in the eyes of financing. It doesn’t mean their numbers are a more accurate representation of your building it just means you and the Buyer will see a potential variance and knowing this in advance is power.

Any capital item improvements should not be used in the expense Column as these expenses improve the value of the building and including them in the NOI will decrease the value of a building. Capital item expenditure should not be confused with ongoing maintenance. Any capital item improvements are a benefit the buyer will be inheriting so if you use these numbers in the cash flow proforma you will be decreasing the value of your building, when these expenses increase the value.

You may be saying to yourself, well who cares I do all my own property management and superintendent duties. This is ok but if the Buyer doesn’t understand the lending procedure and is working with a different net operating income than his lenders when he receives his letter of commitment the loan to value and the down payment, he was expecting may be different and this makes a difference to all Buyers. Having and projecting correct expectations will reward you with a fruitful outcome.

For example, If a Buyer was expecting to make a down payment of $250,000.00 and he is informed by his lenders (potentially 30 days into the conditional period) that he now needs $300,000.00 or $350,000.00 for a down payment there is a remarkably high probability that your deal is going to fall apart, you will have just wasted 30 days of critical marketing time.

When a building is under evaluation for value it is vitally important to understand the condition of the building and any capital items that may require repair or replacement. Even if conditions won’t affect value due to extenuating circumstances it is vitally important to disclose these items at the beginning of any sales cycle for two reasons. When a Buyer determines their offering price this price will reflect these items and eliminate any possibility of a price reduction during the due diligence period secondly if the Buyer is using CMHC when the building is inspected by CMHC any holdback of funds for mandatory repairs (condition of advancement of funds) being advance will be expected and budgeted for. This is all part of qualifying the Buyer and their motivation to close. If they don’t have the funds in reserve to complete repairs dictated by CMHC, it will be exceedingly difficult for the buyer to close.

The value of an income property is Net Operating Income (NOI) divided by the Capitalization Rate; however, first, let’s explore what a capitalization rate is as there is a lot of confusion over this number.

First, the capitalization rate is determined by the market, not the Seller, Buyer, or Real Estate Representative individually.

It is a number used to determine value when applied to the Net Operating Income. The only time it is an actual return on investment is when you pay cash (zero financing) for a building.

We need to look a little closer at what numbers will be included in the number-crunching process to satisfy both the Buyer and lending institutions. The obvious ones are gross revenue minus a vacancy & bad debt giving you effective revenue, and a current snapshot for the past 12 months for taxes, gas, electricity, water & sewer, insurance, superintendent, management, and maintenance.

For the taxes and utilities, you must have the current and accurate numbers representing the past twelve months (not last year) when the Buyer applies for financing the lending institutions. CMHC wants to see a snapshot of these expenses for the past twelve months’ current up to the month of the agreement of purchase and sale date and beyond if there is a long closing period. If you experience a long closing period due to unexpected or expected reasons, these figures will have to be updated.

When analyzing numbers, you need to think with two hats on. First, you must make sure your numbers are accurate and at the same time find areas where an industry standard number acceptable to the lending institutions may allow you to achieve a higher selling price.

I see proformas without any numbers for superintendent, management, and maintenance. These are standard numbers the lending institutions use when analyzing a building for a loan to value and must be represented in the Buyers’ proforma when applying for financing.

Insurance is a good example of a number being reported by sellers that can potentially increase the value of a building. Over time insurance brokers increase the amount they charge on each renewal period and over a few years this number will be much higher than what you will achieve when shopping for new insurance. Insurance is not assumable so getting a new quote from an insurance broker is acceptable to the lending institutions.

Your goal is twofold, one is making sure the numbers for utilities and other expenses are accurate and you understand the effect of increased cost over time. Second, is finding areas where an industry number may represent the building better for achieving your highest amount of loan-to-value financing. Some of these numbers can be moderately adjusted to represent the building in the best scenario and enhance value.

Once you have and feel comfortable with all the numbers the formula is as simple as dividing the net operating income by the purchase price for determining a cap rate; however, when looking at the analyses you must take into consideration the cost per door, cash on cash return, return on investment and debt service ratio.

Property valuation is simple and as a Seller, you need to step into the position of a Buyer and represent the numbers fairly while maximizing value. One of the first lessons a Buyer must learn is never to trust the numbers supplied. This is an opportunity for a Seller to win the buyer’s trust and have a great working relationship with him/her. As a Seller, it is your responsibility to have a full and accurate understanding of the numbers being represented. The time to organize yourself for the potential sale is now.