When you ask a Commercial Real Estate professional, “How do you value an apartment building?” you are going to get an answer that will be centered around Cap Rates or Capitalization Rates.  I published an eight-page paper on Cap Rates on this site over the past couple of months so you should have some understanding of the calculation.  Basically, it is taking the Net Operating Income and dividing it by the Value of the Subject Property.  What is net operating Income you ask.  Net Operating Income is the Rent Income for a year, the last year, less all of the expenses related to renting out the apartments and keeping up the property excluding Mortgage Interest Expense and Depreciation.

The Real Estate professional is giving you the “Real Estate Professional’s” answer.  You have to remember that I was a practicing Certified Public Accountant for over 50 years before becoming a Realtor.  So, I look at an apartment building as a Business and as Real Estate.  Net Operating Income (NOI) is just a profit and loss statement excluding the Mortgage Interest deduction and Depreciation.  As a Certified Public Accountant part of my practice was doing “forensic” accounting.  The word forensic means “dealing with the courts.  So, I worked with attorneys on civil lawsuits determining damages and valuing lawsuits.  I also worked on divorce cases and in many instances in these types of cases I had to value a business and then testify in court as to how I reached my conclusions.  An apartment building is a business!!!  So, according to the textbooks, you take the projected cash flow for the next 5 years and bring it back to present value using a reasonable interest rate and add that number to the value of the assets and you then have a business valuation.   

Now, I just want to add something about valuing single family residences.  You value a single family residence, in almost all cases using “comps” or comparables.  You look at the sales of similar residences for the last 30 to 90 days and compare those homes to the home you are valuing.  You make adjustments for the differences in square footage of the home, number of bedrooms and baths, square footage of the lot, and amenities such as a pool or a spa, etc.  In valuing an apartment building you also use “comps” but you use comps for the cap rate.  The cap rate will be different in different neighborhoods, it will be different based on the size of the apartment building and the amenities in the apartments as well as the size of the apartments.

But there is one thing that I cannot put in this blog and I cannot teach you and that is JUDGEMENT!!!  When you value a business or an apartment building you do it using the replacement cost method, the income approach and other computations that fit that certain type of business.  Accounting practices are valued based on a factor of Gross Income as are doctor practices.  You take the gross income and multiply it by 100% to 150% and add the tangible personal property and you get a value.  So, you end up with 3 or so values that should be similar but may, in some cases, not be similar.  That is when JUDGEMENT or EXPERIENCE comes in.  As a professional you have to look at all of the different calculations and see which best applies to the situation and weigh the values based on the method of computation.  You gain that insight by education, by doing it over and over again and learning each time you do a valuation.  That is because no two valuations are the same.

If you ask someone without foresight, they are going to tell you that you can value an apartment building, an accounting practice or a grocery store by plugging numbers into a formula.  Unfortunately, that’s the way many accountants and valuation people do it.  But, in reality there are differences, although sometimes subtle, between every business.  No two businesses are exactly the same and that means that you CANNOT just plug numbers into a formula, you have to evaluate the differences in the different entities that you are valuing to come up with a correct or proper valuation.

My name is Paul Levine and I am the Commercial Real Estate Manager of CROWN REAL ESTATE & FUNDING, INC. and you can reach me at (818) 298 – 4000.  The one thing I did not mention in this article is that I was an Associate Professor of Accounting at California State University – Los Angeles for six and a half years so I can teach you how to do this, but you need creativity, foresight, patience and initiative to learn it.