It’s no secret that the Multi-family investment sector has been a strong, solid, stable performer in most marketplaces for more than a decade and it does not appear it will change in the years to come. However, most sellers have yet to adjust their mindset towards proper valuations as interest rates rise. Over the past year, the 10-year Treasury, which has been as low as 2.02%, is now hovering in the 3% +/- range. When you couple this with a lender’s upward trending interest rates, the lender’s underwritten NOI compared to a seller’s provided income and expenses, there is a disconnect between bank valuations and seller’s expectations. Recently, these factors have had a negative effect on underwriting and ultimately on the perceived asset value.
I’ve seen this in smaller properties, as well as properties that are operated with a seller’s staff that are shared over multiple sites. It is quite common for the allocation of salaries to be reported artificially low on the property being sold, which is a significant piece of the underwriting process.
In a recent multi-family transaction, I submitted the seller provided income and expenses to my buyer’s lender once we went under contract. The bank took an entirely different view of the property’s financials than the seller did. The bank’s value was over $700,000 lower than the seller’s expectation of value. The underwriters were actually quite fair in their assessment as it really would cost more to operate the property than stated. At the end of the day, the bank determined the following: 97.05% of the income stated, realistic expenses came in at 114.38% of stated amount which resulted in a 11.1% lower Net Operating Income or NOI, which the property value was based on. During this valuation period interest rates ticked upward as well, yet the seller was insistent that his property was worth $400,000 more than the lender. Considering the 25% down payment required of my buyer, his pre-tax cash on cash return would be under 4%. The seller’s original targeted sale price, which was becoming increasingly unrealistic, would have also created a neutral leverage situation for the buyer, whereby the interest rate and cap rate are essentially the same.
Shy of a buyer parting with considerably more cash up front and being content with a 5% pre-tax return or deferring potential capital gains by means of conducting a 1031 tax deferred exchange into the property being discussed, it simply doesn’t make sense for a local apartment investor to acquire a multi-family investment at a sub 7% CAP rate.
Jay Verro, CCIM
14 Corporate Woods Blvd.
Albany, NY 12211
Direct: 518-465-1400 ext:214