Tips for Buying Multi Family / Commercial Property in Vermont
Whether your specialty is commercial or residential property it is extremely important that you do not overpay for your investment property. By overpaying, you have just made your job a whole heck of a lot harder. Buying a property at the right price allows you/your property manager to get creative in ways that you can create some instant equity though methods such as forced appreciation. Before we can break down exactly what forced appreciation is, we must first understand how investment properties are valued. If you were to ask an appraiser to value your single-family home he/she would use what is called a comparative market analysis (CMA). A CMA is the process of comparing and contrasting sold properties of similar quality, within similar geographic areas, while making slight adjustments for amenities and square footage. If you asked the same appraiser to come value your multi-family or commercial property he/she will value your property based on the net operating income (NOI).The net operating income is the amount of money you are left with after you collect all the rent and pay out all operating expenses such as heat, water, trash, etc. So essentially you are not purchasing a "property" but rather you are purchasing the income (NOI) it is producing. There is a simple calculation you can use to help you determine a fair purchase price. This calculation uses the NOI and the market capitalization rate to calculate the purchase price. If you ask your local mortgage broker what the market capitalization rate is they should tell you somewhere between 8-10%. The calculation is as follows:
Purchase Price = Net Operating Income / Market Capitalization Rate
If you are looking at a property that is producing a net operating income of $50,000 with a market capitalization rate of 10%, you can safely determine that a fair asking price would be somewhere around $500,000. From here you can then adjust your price based on the condition of the property, repairs needed, etc.
$500,000= $50,000 / .1
When determining whether or not you should buy a property you should ask yourself "Is this property under performing?" Maybe the current owner has not raised rents in the last five years, or maybe all the utilities are metered separately but the owner still pays for all utilities. Remember the concept of forced appreciation I introduced earlier? This is where that comes into play. Say you're looking at a 10 unit property that currently produces a net operating income of $50,000 but you know that you can raise rents by $50/month and still be charging a fair rental price. $50 x 10 units x 12 months in a year= $6000 extra per year. If your expenses remain the same you have now increased your net operating income from $50,000 to $56,000. Let's use our nifty capitalization rate equation again.
Purchase Price= Net operating income / Capitalization rate.
$560,000 = $56,000 / .1
If you purchased the building for $500,000 and manage to raise rents by $50 over time, you have just raised your property value to $560,000 and created $60,000 worth of equity. Pretty nice huh?
A good property manager can play a vital role in this process. Your property manager should have a strong understanding of fair rental rates and expenses involved with rental property. They should have the ability to fill vacancies quickly with professional and reliable tenants that will stay for long periods of time. All of these things effect your properties' net operating income and if you have followed along with this blog you know that any effect on the net operating income have a direct effect on the properties overall value.