Valuation of Multi-Residential Apartment Buildings

08 January 2015
REMAX Realtron Realty Inc

There are generally three methods espoused for the valuation of real property: 1) income approach, 2) comparative approach, and 3) cost approach.  This blog entry mainly focusses on the first approach with some detail about the second approach as well.

Multi-residential apartment building ("multi-res") applies to real property that is residential and has multiple units.  In fact, whether the real property has 1 or 1,000 residential units, the following valuation methods apply.

Income Approach to Value

The formula to value real property based on the income approach to value follows:

Value = Net Operating Income ("NOI") / Capitalization Rate.

Net operating income is the free cash flow of the property; in essence, revenue, less provisions for vacancy and bad debt, less operating expenses, but before income taxes, interest and depreciation.  

We have seen some definitions of NOI that include a deduction for depreciation.  This is not technically correct.  Depreciation is a non-cash item that is based on the original investment or purchase price of the property plus additional capital investments over time.  What you would include however, is the additional capital investments over time.  This would be deduced in the year the investments are made off of the cash flow for the property.  So when someone deducts depreciation in their NOI calculation, they are using the depreciation amount as a proxy for the additional investment in capital funds required in the property over time.

The capitalization rate is a combination of the cost of debt and cost of equity.  The cost of debt is the interest rate that is to be charged by the lending institution on the debt (typically a mortgage) to fund the purchase of the property.  The cost of equity is the required return on equity that the individual investor requires for the risk/return of the investment.  The higher the risk, the higher the cost of equity.  The capitalization rate is the weighted average cost of debt and equity (i.e. if the property is funded 85% by a mortgage and 15% with equity and the mortgage rate of interest is 6% and the required equity rate is 10%, the capitalization rate would be 6.6% ((85%*6%) + (15%*10%))).  Given today's low cost of debt capital, capitalization rates for multi-res properties in larger urban centres in Canada can be as low as 4%-5% for some properties.

Comparative Approach to Value

Comparative approach to value is based on taking the subject property and comparing it to other similar properties that have sold recently and making adjustments to the sale price of those comparable properties to determine the value of the subject property.  This is the main approach to valuing non-income producing residential properties (single family, owned homes).

A comparative approach for multi-res is useful as a benchmark or rule of thumb.  It does not and cannot replace the income approach to value.  It is just a proxy.  For multi-res, the proxy is a value per unit (i.e. the property is worth $150,000 per unit).

Written by:


Cam Forbes, MBA, CPA, CMA

General Manager / Broker

Director, Commercial Division

RE/MAX Realtron Realty Inc., Brokerage.