Your client
is purchasing an average quality 20 unit garden type apartment complex that
needs major remodeling due to its current age and poor condition. Total gross
square footage for the complex is 17,700 SF on a 70,800 lot. The complex has
seven studios, seven 1-bedrooms, and six 2-bedrooms units. Tenants pay their
own personal gas, water, and electric utilities. Your contractor has quoted you
direct costs of $12,500 per unit or $250,000 and $10,000 in landscaping and
pool upgrades.
The contractor estimates the total completion of this remodeling
job will take 4 months. The contractors fee to complete this job is $35,000.
After the remodeling is complete, your rental survey indicates market rents
will be $750/month for the studios, $1,080/month for the 1-bedrooms, and
$1,380/month for the 2-bedrooms. Once remodeling is completed, it is expected
to take 8 months to reach stabilized occupancy at 5% vacancy and collection
loss. Market rents are expected to
increase 2% annually during a typical seven year ownership holding period.
During the remodeling phase, existing tenants are expected have a 2% collection
loss. Other monthly income includes $20/month per occupied unit for laundry;
$10/month late fees per occupied unit; and $10/month other income per occupied
unit.
Based on the
owners coordination and planning expected to take in organizing the project and
implement the remodeling, the owners entrepreneurial profit expectation is
$35,000. In addition, the effort or cost the owner will incur in leasing the
remodeled complex back to stabilized occupancy is expected to add another
$25,000 in entrepreneurial profit.
Ten units are
currently rented at an average rent of $750 per unit. The remaining 10 vacant
units will be remodeled first taking four months to complete. Seven of the 10
existing tenants have agreed to move
into the newly remodeled finished units. Remodeling the remaining 10 units will
take another four month. During this time, you have agreed to keep the 7
remaining tenants average rent at $750/month per unit. Once the final ten units
are complete, all rents, including the 7 transplanted tenants, will accelerate
to market rents as outlined earlier.
When remodel
is 100% complete and at stabilized occupancy, variable expenses are estimated
as follows:
1. Off-site
management costs: 4% of gross income collected (even if the owner manages the
complex himself)
2. Landlord’s average natural
gas monthly expense (mainly house meter and vacant units):
$50/month total landlord’s
cost.
3. Landlord’s average electric
monthly expense: $200/month
4. Landlord’s average
sewer/water expense: $100/month
5. Landlord’s trash removal:
$50/month
6. Landlord’s interior cleaning
expense: $150/month
7. Landlord’s landscaping
expense: $300/month
8. Landlord’s average
maintenance and repair expense: 4% of gross income collected
9. Landlord’s pool expense:
$150/month
10. Landlord’s
pest control: $50/month
11. Landlord’s
advertising expense: $75/month
12. Landlord’s
legal/accounting expense: $100
13. Other
monthly expenses: $100/month
14. Variable
expenses are expected to increase an average of 2% annually for the next 7
years.
When remodel
is 100% complete and at stabilized occupancy, fixed expenses are estimated as
follows:
15. Estimated
property taxes when complex is 100% remodeled is estimated at $31,250/year
16. Property
taxes during the construction and lease-up timeframe are going to be
$18,750/year
17. Fire and
Liability insurance when complex is 100% remodeled are going to be $3,500/year
18. Fire and
liability insurance during the construction is $2,500/year
19. Fixed
expenses are expected to rise 2% annually during the next 7 years.
When remodel
is 100% complete and at stabilized occupancy, reserves and replacement expenses
are estimated as follows:
20. Carpet
and drapes: $2,500/unit (8 year life)
21.
Disposials: $250/unit (8 year life)
22.
Refrigerators: $1,500/unit (8 year life)
23. Stoves:
$1,500/unit (8 year life)
24.
Microwave: $500/unit (8 year life)
25. HVAC
short lived items: $2,500/unit (8 year life)
26. Roof
cover per unit: $3000/unit (20 year life)
27.
Dishwasher: $1,500/unit (8 year life)
28. Other:
$500/unit (8 year life)
Based on the
risk to remodel and lease to stabilized occupancy, an owner/remodeler would
expect a 9% all cash annual yield on his invested cash in the project (not
including his entrepreneurial profit
expectation) and an opportunity cost of 2%. Current cap rates from sales of
similar remodeled properties are 6%. This “going in” cap
rate is estimated to be applicable to subject “going out” cap
rate when the property is 100% remodeled and at stabilized occupancy in the
next 12 months. From that point forward, the owner would expect a 7% all cash
annual yield based on alternative
investments with similar risks. This annual yield includes the final selling
price recapture at the end to a seven year typical ownership holding period.
The owner is expecting a 6% selling cost.
Once property
is 100% remodeled, there is estimated to be approximately $100/month in “below
the line leasing expenses” from outside leasing agents in order
to achieve stabilized occupancy. This monthly expense is not expected to
continue after stabilized occupancy is achieved.
How to input
this data into Valuexpose…..
1. In your user dashboard select “Create
new project”
2. In the decision tree select:
a. Property WITH reversion
b. Residential classification
c. Existing or proposed multi-family
dwellings
d. Garden/Low Rise
e. Average Quality
f. Module 3 - Partially Finished or
Needs Remodeling (Might have existing income)
3. Fill out the wizard questions with the above
case study data and hit the finished button.
4. The
timeline shows your client should not pay more than $1,878,744 (see left side
of the timeline graphic) if his wizard question forecasts are to be achieved.
The right side of the timeline indicating $2,528,088 is what the complex is
expected to sell for in 8 months when the complex is 100% remodeled and at
stabilized occupancy. The middle value
on the timeline of $2,258,501 is the 100% complete non-stabalized value before
the complex reaches stabilized occupancy. This value is used to compare to the
subject’s cost of
production which is the value of $2,211,017 directly above the non-stabilized
value on the timeline. If the non-stabilzied value of $2,258,501 is equal or
greater than the cost of production of $2,211,017, then the project is
considered financially feasible to begin the remodeling project. Due to this
relationship, notice this proposed remodel is economically feasible as
indicated by the green highlighted context above the timeline.
5. Now press the “Economic Fabric Graph” (button on the upper right hand side of the timeline
graphic page). This EFG graphic
shows the subject’s 100%
complete market value of
$2,528,088 at stabilized occupancy
(right hand side previous timeline value as of the
stabilized completion date of
8/7/16). In order for the owner to achieve a 7% annual yield during the 7 year
ownership holding period, the property must have an ending sale price of
$2,798,486. These two EFG timeline values are superimposed together with the
subject’s current
fundamental/intrinsic value of $2,471,960 and its ending sale price of
$2,702,604.
6.
In the upper right hand corner of the “Economic Fabric Graph” (EFG), press the “Show Market Cycle Button” to overlay the economic wave cycle. In this particular
scenario, the wave cycle is indicating the subject’s remodeled sale price of
$2,528,088 is sustainable during a typical seven year ownership holding period.
This means the remodeled sale price/market value is reasonable and aligned with
the property’s economic
fundamentals values. Based on the property’s completed market value of $2,528,088, the market is
estimating the property will sell for $2,798,486 to achieve a 7% annual yield.
At the same time, the property’s
fundamental/intrinsic completed value of $2,471,960 must sell for $2,702,604
also achieve a 7% annual yield. Both of these ending value targets are above
the subject’s completed
market value of $2,528,088. Consequently, the subject’s completed market value of $2,528,088 is sustainable over
the seven year holding period.
Please note you will find on the right
hand side of the EFG graph the annual household income of $43,780 needed from
each tenant to pay the average $1,095/month market rent. Consequently, the
household family income needed to pay the average market rent indicates 30% of
the household income. For the subject’s
neighborhood, $43,780 annual household income coincides with the demographic
households that occupy dwellings in this neighborhood (Can check census data at
http//eddm.usps.com to
validate neighborhood’s
household income). This household annual income and ability to pay $1,095/month
average rent coincides with the subject’s
current remodeled market value of $2,528,088 which further coincides with the
subject’s
fundamental/intrinsic current value of $2,471,960. In both cases, the remodeled
market value of $2,528,088 and its ending sale price of $2,798,486 as well as
the fundamental/intrinsic current remodeled value of $2,471,960 and its ending
sale pice of $2,702,604 both produce a 7% annual yield rate (present value of
net rental annuities plus net ending sale price reversion after selling
expenses are deducted). This 7% annual yield rate is what the market is
expecting if investing in the remodeled property (see original forecasts in
this case study).
7. While still in the EFG graphic, press the
timeline button in the upper left hand corner and go back to the remodeling
timeline. Let’s say the
market supports a cap rate of 4% based on
recently sold remodeled apartment complexes (we initially indicated a 6%
cap rate in our original scenario). This lower cap rate is possibly due to an
increase in demand for properties like the subject. Scroll down from the
timeline graphic to the grouping box labeled “Rates and Other Information”. The first questions has to do with a forecast of what the
subject’s going out cap
rate will be. In our first scenario, we used 6%. In this scenario, let’s use 4% and substitute the 4%
for the 6% in the adjacent box. Now press the “update” button
at the bottom of this grouping to recalculate the remodeling timeline values.
8. In the revised timeline values, notice the
100% remodeled complex at stabilized occupancy has changed to $3,792,133 (right
hand side of timeline). Also, this new finished value has changed the other
values above and below the timeline. The potential remodeler can now reasonable
pay $2,965,043 for the “as
is” property (the far left
side value of timeline). You also might notice the project is still
economically feasible at the “as
is” value of
$2,965,043.
9. Now press the EFG button on the upper right
hand corner of the timeline graphic. Notice the subject’s $3,792,133 finished market value has detached 53.41% above
the property’s
fundamental/intrinsic finished value ($2,471,960).
10. Now press the “show market cycle” button in the upper right hand
corner of the EFG graphic page. This resulting graphic overlay indicates the
finished market value of $3,792,133 is not sustainable over a typical seven
year ownership holding period. The reason being the $3,792,133 finished market
value is not sustainable is because over the seven year ownership time period
the value of the property tends to gravitate towards equilibrium or the
fundamental/intrinsic ending value of $2,702,604.
Also notice on the right side of the EFG
model the household annual income of $67,161 is needed to support a sale price
of $3,792,133. This household income is above the demographic income of $43,780
associated with the subject’s
$2,471,960 fundamental/intrinsic finished value.
Lastly, notice in both these scenarios
the $3,792,133 current market value and its needed ending sale price of
$4,957,825, and the $2,471,960 current fundamental/intrinsic value and its
ending sale price of $2,762,604 both have 7% annual yield rates (or discount
rates) during the seven year ownership holding period. Consequently, the market
is irrationally speculating on the property’s ending sale price of $4,957,825 that would need an annual
household income of $87,806 to support this ending sale price. If Valuexpose
was available for this scenario, the user of this software would have been
aptly warned as the subject’s
remodeled market value of $3,792,133 has significantly detached from its
remodeled fundamental/intrinsic value of $2,471,960 and this value is not
sustainable over the seven year ownership holding period. The remodeled
$3,792,133 value will most likely gravitate toward the fundamental/intrinsic
ending sale price of $2,702,604 during the seven year ownership period. This
scenario will lower the subject’s
expected annual yield of 7% to minus 0.38% (scroll down from EFG graphic to see
this yield difference).
11. Valuexpose also indicates
buyer opportunities. For the same property example, let’s say well supported cap rates indicates a 7.5% for recent
sales of remodeled properties similar to the subject. Once again, go to the
timeline graphic and scroll down to the grouping labeled “Rates and Other Information”. Substitute 7.5% into the
first answer box for the first question regarding going out cap rates and press
the update button.
12. In the revised timeline
values, notice the 100% remodeled complex at stabilized occupancy has changed
to $2,022,471 (right hand side of timeline). Also, this new finished value has
changed the other values above and below the timeline. The potential remodeler
can now reasonably pay $1,444,224 for
the “as is” property (the far left side
value of timeline). You also might notice the project is still economically
feasible if the property can be purchased at the “as is” value
of $1,444,224. This is because the remodeled value at non-stabilized occupancy
($1,810,798) is greater than the cost of production ($1,773,600).
13. Now press the EFG button on
the upper right hand corner of the timeline graphic. Notice the subject’s $2,022,471 finished market
value has detached -18.18% below the property’s fundamental/intrinsic finished value ($2,471,960).
14. Now press the “show market cycle” button in the upper right hand
corner of the EFG graphic page. This resulting graphic overlay indicates the
finished market value of $2,022,471 is sustainable over a typical seven year
ownership holding period and will most likely gravitate toward the fundamental/intrinsic ending sale
price of $2,704,604 over the course of a seven year ownership holding period.
On the right side of the EFG model the household annual income of $35,019 is
needed to support a sale price of $2,022,471 which is well below the family
income that occupy apartments in this neighborhood. ($43,780).
15. Also notice in both these
scenarios the $2,022,471 current market value and its needed ending sale price
of $1,934,791 and the $2,471,960 current fundamental/intrinsic value and its
ending sale price of $2,702,604 both have 7% annual yield rates (or discount
rates) during the seven year ownership holding period. Consequently, the market
demand for this property is below normal and represents a buying opportunity.
If the property’s finished
market value of $2,022,471 gravitates toward the fundamental/intrinsic ending
value of $2,702,604, the owners annual yield will be enhanced from 7% to
10.77%. If Valuexpose was available for this scenario, the user of this
software would have been alerted to a very good buying opportunity.
16. The above demonstration shows
you how Valuexpose isolates a property’s
finished fundamental/intrinsic value from whatever the property’s finished market value happens
to be as of the same date of value. This new category of valuation analysis
prevents you from making critical decisions in a vacuum based on the
traditional single-point-in-time appraised market value. Comparing finished
market value of a property to its fundamental/intrinsic finished value flushes
out hidden risks.
17. For properties, like this
example, that need to be remodeled or developed from scratch, Valuexpose has
another valuable feature that will prevent the premature start of a project if
Valuexpose indicates the proposed remodeling or development is not economically
feasible to begin right a way. For instance in our last example timeline
indicated the current “as
is” value (before
remodeling) of $1,444,224. However, lets say the seller wants $1,900,000 for
his property. On the left side of the timeline underneath the far left value is
a button labeled “input
your value”. Simply press
the button and insert the seller’s
asking price of $1,900,000 in the pop-up window and press “update” button.
18. Notice the proposed remodeling
project is not economic feasible because the Cost of production value is higher
than the 100% remodeled property at non-stabilized occupancy. Valuexpose
substitutes the $1,900,000 asking price into the cost of production instead of
the $1,444,224 “as is” value Valuexpose was
indicating what you would have to buy the property for to be economically
feasiable. If the analysis is indicating the project is not economic feasible,
Valuexpose allows you to determine when the market is forecasting the time will
be right to begin the remodeling process.
19. Let’s assume the seller’s
$1,900,000 “as is” market value is correct and
can be sold to a speculator at that price based on recent comparable sales.
Upon further investigation, it is determined market rents for our remodeled
property are not achievable in the foreseeable future due to negative job
market and high unemployment. Because a buyer is going to have to hold and
manage the property in its “as
is” condition until the
job market improves, he will incur more risk during the holding period because
of unknowns. Consequently, lets go to the “Rates and Other Information” grouping box below the timeline graphic. Let’s substitute the third
questions of 9% to 13% for increased risk due to holding the property. Press
update button.
20. When the analysis indicates
the remodeling project is not economically feasible, a button will appear on
the upper left side of the timeline graphic labeled “add holding period”.
Pressing this button will indicate a pop-up window to insert the number of
months the market expects it will take before market rents are high enough and
lease absorption is fast enough to begin the economically feasible remodeling
process. In the case of our subject property, the market is expecting a two
year hold before it becomes economically feasible to start the remodeling
project. This means you will be delaying the delivery into the marketplace by
two years the finished remodeled property at stabilized occupancy.
Consequently, in the pop-up window insert 24 months and press the process
button.
21. You are delaying the start of
the remodeling project by two years in an effort to deliver the finished
property into a market that has normalized. Like the first scenario we used in
the beginning of this case study, a normalized market for this property
indicated a 6% cap rate for our remodeled property. Scroll down from the
timeline to the grouping “rates
and other information”.
Change the “going out” cap rate from 7.5% back to 6%.
22. Before you can see the
recalculated timeline values, you must now eliminate the owners asking price of
$1,900,000 that is appearing on the timeline. Simply press the “remove/update your value” button and toggle to “no” in the pop-up window and press the “update” button.
Once recalculation is complete, notice the remodeled and stabilized market
value of $2,528,088 is indicated on the right hand side of the timeline. This
will be the subject’s
finished market value if you are delivering this product into the marketplace
two years later due to your holding period. By deliberately delayed the
remodeling for two years anticipates a more normal market if you delivered the
remodeled property two years earlier. The revised timeline values indicate the “as is” value of $1,525,955 on the left side of the timeline.
This is the value you should pay for the
property in order to achieve a 13% annual yield if you sell the property in two
years. If you decide to proceed with the remodeling project yourself, your
annual yield will be 13% for the first two years of ownership (holding period)
and 9% annual yield until the property is complete and at stabilized occupancy.
If you further decide to hold the remodeled property as an investment for a
typical seven year ownership holding period, your annual yield for this time
period will be 7%.
23. The trick to giving you
confidence the $1,525,955 “as
is” market value (with a
two year holding period) you are paying for the property is a fair price is
decided by the $2,528,088 remodeled market value expectation. By pressing the
EFG button on the timeline graphic, you can see the $2,528,088 remodeled market
value is very close to the property’s
fundamental/intrinsic remodeled value. Consequently, the $2,528,088 remodeled
market value is sustainable and so is your $1,525,955 purchase of the “as is”.
24. Let’s say the current owner of the property insists the “as is” value of his property is $1,900,000. To test if this is a
fair price, go back to the timeline graphic and scroll down to the grouping
labeled “rates and other
information”. Start
testing lower “going out” cap rates by pressing this
grouping’s update button
after each cap rate change. Do this until the timeline “as is” value
equals $1,900,000 (the owners asking price). In this case, the revised going
out cap rate is 4.87%. Notice this revised cap rate increases the remodeled
market value (right side of the timeline) to $3,114,688 which in turn increases
the “as is” market value to $1,900,000 (+
or -).
25. To see if the $1,900,000
asking price is reasonable, simply press the EFG button on the upper right hand
side of the timeline graphic. You can see the $3,114,688 remodeled market value
has detached 26% from its fundamental/intrinsic remodeled value. This means the
$3,114,688 finished market value is not sustainable and that you are paying too
much for the current “as
is” market value at
$1,900,000.
26. We are currently working on a
report you can print out for Modules 3 remodeling projects. In the meantime,
and as an alternative, you can input the same data in a Module 5 for
multi-family property types based “as
if” your property were
already remodeled and at stabilized occupancy. From the module 5 model, you
might want to print out two versions based on the remodeled value of $2,528,088
and the $3,114.688. The report based on the $2,528,088 remodeled value will
show the property owner this value is sustainable which would support your
offer os $1,525,955. The other report based on the $3,114,688 remodeled value
indicates this value is not sustainable and would not support his $1,900,000
asking price. This is a wonderful tool to bring a sellers and/or buyers price
expectations in line with the market.
27. The above demonstration shows
you how Valuexpose isolates a property’s
remodeled fundamental/intrinsic value from whatever the property’s remodeled market value
happens to be as of the same date of value. This new category of valuation
analysis prevents you from making critical decisions in a vacuum based on the
traditional single-point-in-time appraised market value. Comparing current
market value of a property to its fundamental/intrinsic value flushes out
hidden risks.
28. There are other important
analysis features associated with multi-family properties that need remodeling.
Getting back to our example, go to the timeline that shows the last “as is” market value at $1,900,071 with a holding period. Scrolling
down from the timeline graphic shows all the components of value (or forecasts)
associated with this property for its current “as is” market
value to equal its $1,900,071. Notice in each grouping you can change forecasts
within that grouping. You must push the “update” button
for that grouping after you have changed any of the forecasts in that grouping.
Any changes to other groupings must also hit the “update” button
for that grouping before you proceed to the next grouping changes. Once all
forecast changes in each grouping have been made and updated, notice that
Valuexpose has recalculated your $1,900,071 market value (or sale price) as
well as all the other values along the timeline graphic.
29. One limitation you might
notice when changing forecasts pertaining to average forecast changes in annual
market rent is that the percentage changes to your property’s market rent cannot be less
than the annual percentages indicated in the fixed and variable expense
groupings. We are working to solve this limitation.
30. Another important analysis
feature is adding financing (or leverage) to the analysis to find the optimal
annual equity yield. Using our former example based on a $1,525,955 “as is” market value, let’s
analyze a loan of $800,000 at 3.5% fixed annual interest including $2,500 in
closing costs. First change the cap rate in the “rates and other information” grouping from 4.87% to 6% to return the timeline value of
$1,525,955. Underneath the timeline graphic press the button labeled “Remove/Update Financing”. Fill in the pop-up window
with the above financing information and hit the “update” button.
Valuexpose then recalculates and indicated the property’s equity yield displayed to the immediate left of the “Remove/update Financing” button. In this scenario, the
equity yield indicates 18.65% (this result might be a little different if you
changed some of the original forecasts in the forecast groupings below the
timeline). You can continue testing different financing scenario to find the
optimal equity yield before a subsequent financing scenario results in a
declining equity yield rate. If the financing scenario results in a negative
equity yield rate, Valuexpose will show “Caution”.
31. Unlike most valuation
software, Valuexpose provides all Discounted Cash Flow (DCF) analysis for all
value results. On the left side of the timeline graphic (underneath), you will
see buttons labeled “DCF
as is” and “DCF as is-financed”. Pushing these buttons
displays the customized intricate DCF models so the user can verify the value
results. You will also see DCF buttons underneath other values on the timeline.
32. Another interesting analysis
feature is being able to access the property’s ending stabilized income and expense statement used to
calculate the property’s
annual net operating income. You will find a button on the right side of the
timeline graphic labeled “stabilized
operating statement”.
Pressing this button provides you with the stabilized income and expense
statement.
33. Once you have completed your
analysis on your particular property and are satisfied with the results, scroll
down underneath the timeline graphic to see the “units of comparison”
grouping. This grouping box summarizes all the metrics associated with
your property.
34. The above demonstration
represents only one real estate classification (residential), one property type
(Multi-family), and one “state
of its building existence” (partially
complete and/or needs remodeling). Valuexpose can analyze 13 different real estate
classifications (ex. residential, retail, industry, office, etc.) that include
a potential of 320 property types; each in five different states of building
existence (100% complete stabilized; 100% complete at non-stabilized; partially
complete or needs remodeling; and properties that are to be developed with and
without entitlements.
35. Valuexpose is the first patent
pending commercial automated valuation model (AVM) that uses comparable sales
with very similar highest and best uses located in markets that are similar to
the subject’s market.
Valuexpose uses the comparable sale properties components of value forecasts
(that make up their sale prices) to value the subject properly if its value is
unknown. Now dozens if not hundreds of comparable sales can be automatically
used to value your property’s
current market value. This gives a more accurate valuation than the traditional
comparable sales analysis that is time consuming, expensive and potentially
biased. This new category of valuation
analysis further eliminates appraisers logic inconsistencies and incompentency
problems due to lack of experience. All valuation results are compared to the
property’s
fundamental/intrinsic value to flush out hidden risks and keeping you from making important
decisions in a vacuum.
36. Valuexpose financial reporting
option allows the user to initially analyze portfolios of properties on a
property-by-property basis. The user can set Valuexpose to update any or all of
the properties in the portfolio to update each property’s current market value on a daily, monthly, semi-annual or
annual basis (or anything in-between). This analysis feature will also track
the relationship of a property’s
current market value with its fundamental/intrinsic current value. This
relationship tracking will give the user a better strategic management and exit
advantage.
37. If you would like to see
another case study on a different property type and/or in a different state of
existence (existing building or to be developed/remodeled), you can personally
call the founder Ray Dozier, MAI at (760) 413-5011 for a demonstration.
