Apartment ValuationNovember 19, 2018
IT'S ALL ABOUT NUMBERS
Apartment buildings aren’t like houses. You don’t buy them for the good times and memories you plan on having there. Nor are they valued the same way. While emotions can play a large part in valuing homes, apartments are valued differently because they are a business – and they generate profits. How are apartments valued, then?
CALCULATING THE VALUE OF AN APARTMENT BUILDING
There are many ways to calculate the value of an apartment, but the simplest way is by using this formula:
Using the income approach, the value of an apartment is determined by its profitability, which is largely based on the income it generates after expenses. (This is known as the NET OPERATING INCOME.)
First, let’s look at Net Operating Income …
Net operating income (NOI) is calculated simply by subtracting all the expenses from the total income.
Determining an apartment’s NOI:
Calculate Total Income
Gross operating income is the revenue (or income) generated from an apartment building, including things like:
- Rents from apartments themselves
- Laundry revenue
- Parking income
Calculate Total Operating Expenses
Operating expenses include every expense related to the day-to-day operation of the property and will include things like:
- Property tax
- Property maintenance
- Building insurance
Subtract all expenses from the total income to determine the NOI
Now, let’s look at Capitalization Rates …
The capitalization rate is one of the tools used to compare different buildings. The lower the cap rate, the more a building is potentially worth. Simply put, the cap rate is the net operating income divided by the sale price.
It is important to remember that monitoring cap rates can give you some information about where the real estate market might be heading, but it is not the only tool one should use when it comes to comparing individual properties.
Here is an example:
Calculating the NOI:
Total income = $1,217,00:0
Annual expenses = $617,000
$1,217,000 – $617,000 = $600,000
The NOI in this example is $600,000.
Calculating the Value:
Cap Rate is 10%
$600,000 / .10 = $6,000,000
The apartment building’s value in this example is $6,000,000
It’s Not Just Real Estate – It’s a Business
Unlike some forms of real estate assets, apartments have the additional benefit of being a business that generates income. Since the building's profitability determines its value, properties that have the potential for more profit can benefit an investor. Not only will the building produce more monthly income, but it will also appreciate more quickly. For this reason, through active management, one can influence the value of the property when revenue is increased and expenses are reduced, resulting in additional income.