Small multi-family property appreciation

[BrianJamieson]

Recently a real estate agent told me that the appreciation on small multi-family (2-4plex) properties was limited to the local government rental increase guidelines - ~2% in ON.

Is this true? Is this what people are seeing? Or are these properties following the general appreciation rate within their area?

On one hand I could see this because rental revenue drives cap rates, borrowing capability, etc. but on the other hand if they were only appreciating by 2% (approximate rental increases available in ON at the moment) I would expect prices to be lower than they currently are.

Any feedback would be greatly appreciated.


Thanks
Brian

 

[Thomas Beyer]

2% on unrenovated occupied suites .. and 10-50% on suites that are being re-rented after a vacancy .. depending on upgrades !

Assuming an average 33%/year turnover and 25% rent increase with some modest upgrades I arrive at 2% for 2/3 of the building + 25% for one third = 10% average rent increase .. which is our target: 50% in 5 years !!

And being levered 25/75 and assuming a 50% rent increase translates into a 50% value increase you arrive at a 200% ROI cash-on-cash, assuming no cash-flow (i.e. all cash is plowed back into the asset) .. plus mortgage paydown .. and our investors get 505 to 60% of it for a target ROI of 100% in 5 -6 years .. doable .. repeatable even in BC or ON with rent control !!

 

[Nir]

Thomas,

The average rent increase is unfortunately significantly lower.

In order to calculated the appreciation correctly we need to answer the following question:
- Out of 100 units how many do you expect to renovate within 5 years? 33 units? 90 units? Answering this question will help understand the first issue with the calculation.

In addition, I`m sure you do not plan to renovate the same unit twice within 5 years (and for sure not 5 times!). Therefore even if you renovated ALL 100 units you would still be getting:
1.02 ^4 * 1.25 = 1.35 ---> 35% appreciation in case ALL units were renovated!

Since you mentioned 33% being renovated the actual appreciation in 5 years is:
1.02^5 * 0.66 + 1.02^4 * 1.25 * 0.33 = 17.5% appreciation only

Either way it`s not going to be 50% unfortunately.

The source of the error is you assumed those unit being renovated generate 25% increase annually which is not the case. They generate 25% rent increase only once in 5 years.

Regards,
Neil

 

[Thomas Beyer]

QUOTE (investmart @ Jan 30 2009, 07:03 PM) Thomas,

The average rent increase is unfortunately significantly lower. ... - Out of 100 units how many do you expect to renovate within 5 years? 33 units? 90 units?
33 in year one, 33% of 2/3 in year 2, i.e. 2/9s, i.e. 22, 33% in year 3, i.e. 15, 9 in year 4, 6 in year 5 .. more or less .. of course !! Plus you will re-do a few units with minor stuff such as a carpet, a new bathroom vanity, new light switches .. and always adjust rents to market in vacant suites !

There is inflation or rent control in some places. Even if you did NOTHING in BC for example you`d get 20% in 5 years, and yes, only 10% in Ontario. In fact, if you get only 2%/year the ONLY way to make money is doing nothing, also referred to "slum lording".

Thus, using average upgrades and inflation 50% in 5 years on an older building (class C asset) in an average neighborhood (class B area) is VERY doable and should be a selection criteria for area, property and property manager .. plus a useful budget planning tool for cash-flow planning purposes.

Yes, harder in ON .. and hence the going in price must be lower than in BC or certainly AB or SK to make up for it for a comparable asset !!

This is what rent control means: lower asset values, less upgrades (and thus less economic stimulus for plumbers, painters, carpet installers, Rona, ..) and deteriorating buildings.

 

[OlegP]

QUOTE (investmart @ Jan 30 2009, 08:03 PM) Thomas,

The average rent increase is unfortunately significantly lower.

In order to calculated the appreciation correctly we need to answer the following question:
- Out of 100 units how many do you expect to renovate within 5 years? 33 units? 90 units? Answering this question will help understand the first issue with the calculation.

In addition, I`m sure you do not plan to renovate the same unit twice within 5 years (and for sure not 5 times!). Therefore even if you renovated ALL 100 units you would still be getting:
1.02 ^4 * 1.25 = 1.35 ---> 35% appreciation in case ALL units were renovated!

Since you mentioned 33% being renovated the actual appreciation in 5 years is:
1.02^5 * 0.66 + 1.02^4 * 1.25 * 0.33 = 17.5% appreciation only

Either way it`s not going to be 50% unfortunately.

The source of the error is you assumed those unit being renovated generate 25% increase annually which is not the case. They generate 25% rent increase only once in 5 years.

Regards,
Neil

Neil,

I am lost in your math - would you mind elaborating on your calculations?

Thank you.
Oleg

 

[Nir]

Good Thomas, now you have an estimate for Ontario too:

Around 85 units expected to be renovated in 5 years: 0.85 x 1.02^4 x 1.25 + 0.15 x 1.02^5 = 31.5% ... so around 30% for Ontario

And yes, close to 50% in BC: 0.85 * 1.2 * 1.25 + 0.15 * 1.2 = 45% Cheers.

Oleg, no problem. can you be more specific - first or second formula? first is a little more basic so would be a different explanation..

Neil

 

[ChrisMewhort]

QUOTE (investmart @ Jan 30 2009, 09:58 PM) Close to 50% in BC: 0.85 * 1.2 * 1.25 + 0.15 * 1.2 = 45% Cheers.

Neil

Hi Neil,

I`m confused with the numbers as well. Where are you getting the 25 (I`d assume percent) that you`re tacking onto the .85? Why only .02 increase per year? Isn`t that quite low?

 

[Thomas Beyer]

QUOTE (devc @ Jan 31 2009, 12:43 AM) I`m confused with the numbers as well. Where are you getting the 25 (I`d assume percent) that you`re tacking onto the .85? Why only .02 increase per year? Isn`t that quite low?
2% is the rent control limit in ON (actually I think it is lower @ 1.7% in 2009) .. 4% in BC ..

25% is a guess .. could be 50% to 75% rent increase on turnover .. depending on as-is rent, location, upgrades, building curb appeal etc. ... hence more site specific due diligence is obviously required ..

 

[Nir]

QUOTE (thomasbeyer2000 @ Jan 31 2009, 09:51 AM) 2% is the rent control limit in ON (actually I think it is lower @ 1.7% in 2009) .. 4% in BC ..

25% is a guess .. could be 50% to 75% rent increase on turnover .. depending on as-is rent, location, upgrades, building curb appeal etc. ... hence more site specific due diligence is obviously required ..
Exactly.

Chris, Oleg,
To clarify one more thing, in case that is the source of your confusion:
Note that in the case of PLEXES there is a basic assumption Thomas and I use in our calculations in order to estimate future property value:
Any increase in rent (say 10%) increases the property value by the SAME percent (10%). There is a hidden assumption here that expected CAP (expected by future buyers) will not change - the most reasonable assumption when no information exists to suggest otherwise.

In reality, any increases in rent increases the CAP by the same % if property value does not change. However, in order to bring the CAP down to the initial CAP the property was purchased for, we assume the same increase in property value – meaning no change in CAP.

That`s why you can look at the rent increase only to estimate the increase in property value.

 

[Dan_Eisenhauer]

Brian, your comment about rent control affecting cap rates, and therefore, values of controlled properties illustrates one of the negatives of rent control.

Multi family values depend entirely on income. Because rent control arbirtarily keeps rent "below market rent", thye value of all rental properties is less. The municipality cannot collect taxes based on a "real market value", and therefore, ALL other properties subsidize the tenants in a rent controlled property.

Rent control is a short sighted solution that ultimately has hurt tenants by landlords not maintaining their properties, thus affecting every tenant in that building, and short falls in tax revenue, which affects everyone.

 

[Thomas Beyer]

QUOTE (Dan_Eisenhauer @ Jan 31 2009, 10:00 AM)
Brian, your comment about rent control affecting cap rates, and therefore, values of controlled properties illustrates one of the negatives of rent control.

...



Rent control is a short sighted solution that ultimately has hurt tenants by landlords not maintaining their properties, thus affecting every tenant in that building, and short falls in tax revenue, which affects everyone.


Indeed Dan ! More discussion on rent control is here: http://myreinspace.com/public_forums/Real_Estate_Discussion/62-9422-Rent_Control_-_Who_Benefits_.html

 

[OlegP]

QUOTE (investmart @ Jan 31 2009, 09:52 AM) Exactly.

Chris, Oleg,
To clarify one more thing, in case that is the source of your confusion:
Note that in the case of PLEXES there is a basic assumption Thomas and I use in our calculations in order to estimate future property value:
Any increase in rent (say 10%) increases the property value by the SAME percent (10%). There is a hidden assumption here that expected CAP (expected by future buyers) will not change - the most reasonable assumption when no information exists to suggest otherwise.

In reality, any increases in rent increases the CAP by the same % if property value does not change. However, in order to bring the CAP down to the initial CAP the property was purchased for, we assume the same increase in property value – meaning no change in CAP.

That`s why you can look at the rent increase only to estimate the increase in property value.


Neil,

The first formula seems to take 2% of rent increase to the power of 4 (why not 5? are we not trying to estimate a 5 yr appreciation?), and times 1.25 which is a turnover increase, or as you explained above a one time reno in 5 years. Am I on track so far?

The second formula is where I am confused. (1.02^5 * 0.66 + 1.02^4 * 1.25 * 0.33 = 17.5% appreciation only). What does 1.02^5*0.66 means? Why do you use ^5 in this case?

Thanks.Oleg

 

[Thomas Beyer]

QUOTE (OlegP @ Feb 2 2009, 08:11 PM) Neil,

The first formula seems to take 2% of rent increase to the power of 4 (why not 5? are we not trying to estimate a 5 yr appreciation?), and times 1.25 which is a turnover increase, or as you explained above a one time reno in 5 years. Am I on track so far?

The second formula is where I am confused. (1.02^5 * 0.66 + 1.02^4 * 1.25 * 0.33 = 17.5% appreciation only). What does 1.02^5*0.66 means? Why do you use ^5 in this case?

Thanks.Oleg
the math doesn`t really matter .. what matter is the fact that
a) you will have normal turn over, and rents can be set to market .. which is a function of location, suite size, balconies, view, sun exposure, in-suite upgrades, building curb appeal, common areas and local rental unit supply & demand

what is "normal" turnover: people die, they get divorced, they get evicted due to non-payment of rent, they get evicted due to noise or drugs, they move to another city, they buy a house or condo, they move back to parents, they decide to shack up with boyfried or buddy etc. .. this is about 33% as a good rule of thumb, lower perhaps in BC with many seniors

b) some folks stay and there is rent increase

so, if you use ON AVERAGE , ROUGHLY a rent increase of 25% to 40% on 1/3 and 2% on 2/3 .. times 5 years .. you get ROUGHLY a 50% overall rent increase in 5 years .. sometimes a bit less .. and sometimes on a good "class C building in a class B area" more ..

 

[Nir]

QUOTE (OlegP @ Feb 2 2009, 09:11 PM) Neil,

The first formula seems to take 2% of rent increase to the power of 4 (why not 5? are we not trying to estimate a 5 yr appreciation?), and times 1.25 which is a turnover increase, or as you explained above a one time reno in 5 years. Am I on track so far?

The second formula is where I am confused. (1.02^5 * 0.66 + 1.02^5 * 0.66 + 1.02^4 * 1.25 * 0.33 = 17.5% appreciation only). What does 1.02^5*0.66 means? Why do you use ^5 in this case?

Thanks.Oleg
Hi Oleg,
I used 33% initially before Thomas provided additional information explaining he actually expects around 85% of the units to be renovated.
so the new more correct formula I used later was: 1.02^5 * 0.15 + 1.02^4 * 1.25 * 0.85
(In order to answer your question about the formula itself, it does not matter if it is 85% or 33%) Here is the explanation:
85% is the percent of units with a one time increase of 25% exactly as you mentioned, therefore 1.02^4 * 1.25. ---> 4 years with 2% rent increase and one with 25% increase.
The other 15% will not be renovated, therefore, in Ontario, will increase by 2% each year in ALL 5 years hence: 1.02^5.

The bottom line number we got (initially 17.5% and then around 30%) is the WEIGHTED AVERAGE RENT INCREASE IN 5 YEARS for the entire building, for all 100 units. As explained later, it is also the appreciation in 5 years. We used 0.85 and 0.15 in the formula to give the right weight to each type of unit (renovated VS. non-renovated) - the weights are what allowed us to calculate a WEIGHTED AVERAGE for all 100 units.

As Thomas mentioned, these are all estimates of course. However whether or not it is important to be able to estimate correctly your own
performance is subjective

Hope this helps. Cheers.
Neil

 

[OlegP]

QUOTE (investmart @ Feb 2 2009, 09:01 PM) Hi Oleg,
I used 33% initially before Thomas provided additional information explaining he actually expects around 85% of the units to be renovated.
so the new more correct formula I used later was: 1.02^5 * 0.15 + 1.02^4 * 1.25 * 0.85
(In order to answer your question about the formula itself, it does not matter if it is 85% or 33%) Here is the explanation:
85% is the percent of units with a one time increase of 25% exactly as you mentioned, therefore 1.02^4 * 1.25. ---> 4 years with 2% rent increase and one with 25% increase.
The other 15% will not be renovated, therefore, in Ontario, will increase by 2% each year in ALL 5 years hence: 1.02^5.

The bottom line number we got (initially 17.5% and then around 30%) is the WEIGHTED AVERAGE RENT INCREASE IN 5 YEARS for the entire building, for all 100 units. As explained later, it is also the appreciation in 5 years. We used 0.85 and 0.15 in the formula to give the right weight to each type of unit (renovated VS. non-renovated) - the weights are what allowed us to calculate a WEIGHTED AVERAGE for all 100 units.

As Thomas mentioned, these are all estimates of course. However whether or not it is important to be able to estimate correctly your own
performance is subjective

Hope this helps. Cheers.
Neil
PS. Any REIN MEMBER who wants additional info on the calculation method or personal advice on a similar topic, feel free to send me a personal message to [email protected]


Thomas/Neil:

Thank you for your explanation. I finally got it now!!

 

[NorthernAlex]

QUOTE (OlegP @ Feb 3 2009, 01:08 AM) Thomas/Neil:

Thank you for your explanation. I finally got it now!!
Thanks from me too. I enjoyed reading this informative thread.

Best regards,

Alex.