Thread: Advice on Evaluating Multi-Family Units

Very good question indeed Jesse. Have you been able to look closely at the rental demand and average rents in those areas? Maybe it is just here in Minnesota, but the Twin Cities and Minneapolis specifically has seen a very strong surge in rental demand. With the ability to get financed much more difficult for buyers in today's market, more people are renting. This is driving up rents of course.

I guess if you feel that the population is going to continue to drop, that could be an issue. However, I personally would look at average rents and overall rental demand. With the way things are in the financing world, I would not anticipate a major drop in people looking to rent nationwide.

I hope this helps.

That is very helpful. How though would I be able to check rental demand? Is it as simple as looking to find a room to rent in the area? Are there any sites or alternate means in order to find hard numbers on the issue?

I've done some very rough math to try to come to a valuation of the property. Can someone tell me if I'm doing this right?

The main difficulty is trying to come up with a projection of earnings given a declining population. I decided to try to do the math using vacancy rate.

The local government census for the area I'm looking in stated that in 2000 there was a 4.3% vacancy rate, and in 2008 it was 6.1%. That's a change of 0.225% more vacancy each year.

Looking at the profit and loss statements of the property, I saw that it was claiming a loss of $33,753.75 due to vacancy yearly. This worked out to 8.5% of gross potential rent lost due to vacancy.

If I take the change in vacancy rate from the local census--0.225% per year--and use that to project the vacancy rate for this property in 2018 (ten years from now) I get a vacancy rate of 10.75%. That works out to a cash loss of $42,672.13.

Given which, my attempt to value the property will be based on my projections of its performance ten years out. I will use this number, the gross potential rent, and the stated CAP rate to backwards calculate my offer.

Does that make sense?

Originally Posted by Jesse Wonder Clark

How do you project earnings for a multi-unit apartment building in an area with declining population?

Recently I have been looking at several properties in the areas surrounding Detroit. The properties and pro-forma numbers for the properties are adding up well. The main difficulty comes when looking at the population numbers of the surrounding areas. The numbers are declining, not at any alarming rate, but steadily.

How am I to be sure of the maintained value and productivity of the property? Is there any way to reassure myself in a situation of this type? Any further research or questions I can ask?

Any and all suggestions would be greatly appreciated.

First in an area that is economically depressed and declining in population is a very high risk investment as someone with good credit performance today still has a high probability of being deliquent in the future. As long as you enter into this investment knowing that you are going to have a much higher default rate than average and understand that you will experience a higher vancancy rate than the average you can calculate the numbers to assure a profit. However, you would most likely be better off investing in another low cost area with strong rental rates. These do exist in other metros. Primarily in S.C., N.C., and Texas.

So, with that said lets use a model for setting up our calculations. A great model for what may happen in Detroit would be Syaracuse, New York from the early 90's until 2007. Syaracuse in the 80's was a booming manufacturing and steal (and other metals) producing city. The syaracuse MSA was not quite as large as the Detriot MSA, yet at one point it was just over 750,000 and today has declined to about 645,000 as of July 2007. But, now has started growing in population once more.

Currently rents are 9.6% less in nominial terms than what they were in 1993. Using Syracuse as a model you can estimate the rents in the Detriot region to decline by about 0.7% per year when calculating your Internal Rate of Return. Now remember that we will be going into a higher than normal period of inflation. So, to be safe you should calculate your expenses to rise around 5% or more per year during your holding period. Vacancy rates hit a peak of 13% and I do not have any numbers for default rates just expect them to be higher than on a normal property.

Using Syracuse as a model I would say that as long as you still have an investment that makes sense with a 13% vacancy rate, 50% higher expenses than today and a 9.6% lower income than today you will be fine. In your calculations you should expect to recieve no appreciation for your holding period. All of your profit will have to be calculated as comming from your rental income to be safe in your evaluation.

If the numbers do not work out but you would still like to find an investment I suggest Houston, Texas. Not just because I work in that market but because we are positioned for strong appreciation after this mortgage mess and our rental rates versus property values is very strong. It is common to have a 10% NOI and even more suprising is that rental rates in this area have increased 11% just this year. Furthermore Houston has been estimated to be between 9-19% under valued by different analysts and we have not seen a decline in property values up to this point in the mortgage mess.

Dallas, Texas has strong investment opportunities and the strongest appreciation in the nation has been seen in the McAllen-Brownsville MSA here in Texas as well. Through contacts I have been informed of good opportunities in South and North Carolinia. They are seeing a very strong job growth market similar to that of some of the Texas metro areas. Although Houston has the strongest job market in the country. Let me know if you have any more questions or if you do not know how to do IRR calculations. As I may be able to teach you that in a simple manner.

jamesww,

What an in-depth and helpful response. I'm very grateful, that's given me a great place to start from, and a solid conceptual framework on which to base an offer.

When making a presentation to the seller I'd like to be able to show that my calculations are based on real data. Could you direct me to the sources you used for your numbers on Syracuse?

And you end by referring to IRR calculations. I do not know what those are. I'd love to learn.