Property valuation Archives

Firms often choose one of three common real estate valuation methods for fair valuing their properties. Do you know what they are? If not, you should.

The most common real estate fair valuation methods include the income approach, sales comps, or the bid on value (BOV) method. Most opt for the income approach, which gives you a clear estimate of the specific investment’s value based on actual net operating income and recent sales.

The Income Approach

The income approach involves three crucial steps:

Projecting Future Net Operating Income: Start by creating a discounted cash flow model to predict the net operating income (NOI) for the next 12 months. NOI, not to be confused with net income, is the linchpin of real estate valuations. It encapsulates the property’s cash flow by considering operating revenues and expenses.
Determining Market Cap Rates: You must gauge the specific investment’s market cap rates. Cap rates, or “capitalization rates”, are typically calculated as the sum of forward 12 months’ NOI divided by the property’s purchase price or valuation. Cap rates differ greatly by market, property type, vintage, and more. You must research each property’s cap rate and consult third-party data sources for accurate, recent, and property-relevant cap rates.
Calculating Property Value: Armed with NOI projections and cap rates, you can unravel the property’s true value. Divide the investment’s projected 12 months’ NOI by the market cap rate, and you’ve got the value of the property if it were to sell today.

Sales Comps

If properties sold recently near yours, then you could argue that your property would sell for around the same price. That said, you need to ensure comparability of properties via:

vintage,
construction,
size,
composition, and
other reasonable forms of comparison.

Typically, firms will gather as many recent comps (comparable sales) as possible. Then, they will divide each purchase or sale price by the property’s square feet, units, beds, etc.

Next, they will average the purchase price per square foot, units, beds, etc. and then multiply it by your property’s square foot, units, beds, etc. This allows you to calculate your property’s relative value.

Finally, this valuation method is tricky not because of the math, but because many states are what’s called “non-disclosure” states. In these states, parties to a real estate sale are not required to disclose price information. That makes accessing recent sale comps challenging.

BOVs

Another common real estate valuation method is BOVs, or broker opinion of value. I rarely see this method used in isolation to value a property. Normally, you request BOVs to support the sales comp method of valuation or your income approach valuation. That’s because a BOV is exactly what it sounds like: a broker’s opinion of your property’s value. Most brokers will provide you with a higher-than-actual BOV to entice you to sell. As such, it’s not considered as reliable as the other two valuation methods.

Great! We’re done now, right?

Not so fast.

Get the Full Details on Real Estate Valuation Methods

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I hope you use your real estate valuation methods knowledge to make improve your valuations. Let me know if you have any questions or edits. I always love hearing from you.

NOI is one of the most common requests by institutional and family office investors. What does NOI mean? It means “net operating income”.

Most real estate firms use NOI to value properties. NOI gives a true sense of the cash flow at the property by using operating revenues and operating expenses. Anything below the line, meaning below NOI, is not in the normal course of operating the property and therefore, not used in the property’s valuation.

Let’s take a hypothetical situation to better understand what NOI means.

New Investor Requests NOI Details from Real Estate Firm

Perhaps you landed a job at CALPERs. You go, Glen Coco! That’s a huge win.

As part of your job, you need to assess GPs, aka real estate firms, to understand potential investment opportunities in their funds or other vehicles. You will want to understand the investment vehicle’s overall returns as well as individual real estate investments’ performance. That’s because different funds or vehicles will have unique waterfall structures that impact how much you, the investor, get paid.

These waterfall structures are up for renegotiation anytime you invest in a new vehicle. As such, it’s important to understand how well the actual real estate performs, as that could potentially result in higher returns for you. It’s also easier to compare across other real estate firms’ vehicles, as the waterfall structures will vary.

Most new institutional investors (such as yourself in this scenario) make a HUGE mistake here. They know that NOI is important, but they fail to specify what kind of NOI they want. Instead, they send an Excel table with column headers for “Property Name” and “NOI”.

As a GP, I’m freaking out! Here’s what runs through my head:

12 Questions to Understand NOI

Did you mean NOI at acquisition?
Or NOI at exit?
Maybe you meant current NOI?
Or maybe base case underwritten?
Current projected?
What about the time frame? Did you mean trailing 12-months?
Current month (T1) annualized?
T6 annualized?
Or projected 12-months?
If trailing or projected, do I include the current month or start with the month prior or after?
What GL accounts should be included per their definition of NOI?
Is that consistent across all of my property types?

Trust me, these questions could go on and on. Most new institutional investors don’t know what they’re looking for, and many a real estate firm throws darts at a dive-bar decades-old dartboard blindfolded and milk-drunk from the fact that they finally landed an institutional investor.

How Real Estate Firms Should Present NOI

As a GP, I recommend presenting the version of each metric that shines your firm in the best light, as long as you’re consistent across all investments or properties. Then, leave your investor with a list of footnotes explaining what you did. You’ll want this anyway to document and train someone else to help you someday.

How Investors Should Request NOI

As an investor, you’ll want to clarify at least some of the 12 questions above. Otherwise, the data that you receive back won’t be comparable across GPs. And if that’s the case, what’s the point of requesting that data anyway?

What Actually Happens...

Now, let me let you in on a dirty little secret… most institutional investors rarely scrutinize these reports in detail. They will check to make sure that GPs filled them out at least partially. And that’s about it. That said, an investor will – perhaps a new one who read this article – review these reports line by line. They will ask detailed questions and send the report back to the GP, redlined and asking for explanations.

As a GP, you should complete these reports in the same way you do for your regular performance updates; provide just enough information that doesn’t beg additional questions. That may mean filling out all required information, or that may mean filling out what you feel most confident in. I’ll leave that up to you.

Now you know the 12 questions to ask about NOI as a GP and as an institutional investor. I hope you use this knowledge to make improved investment decisions and sharpen your portfolio’s performance. Let me know if you have any questions or edits. I always love hearing from you.