Who is interested in learning about valuations?


#1

I was just curious as to the interest surrounding the topic of property valuation.

Mobile Home Parks

Apartments

Residential Homes

Office

Retail

Just let me know and I’ll create an article based on the feedback I receive here.


#2

Colby,

Yes, I am interested in valuation methods for MHPs. I have 3 appraisals on my various parks (from the same appraisal company), in which they use the Income Capitalization approach. specifically, they use the Debt Service Coverage Method. First they assume six numbers:

  1. Rate, 2) Amort period, 3) Mortgage constant - a number like .1045, 4) Debt Coverage ratio 5), LTV, and 6) Equity dividend rate, - a number like 12% or 14%.

Questions so far are: a)What is a mortgage constant and how do they calculate the number, b) What is the Equity Dividend rate, and how do they calculate the number? I’m okay with the other 4 itmes, except not sure how they know what numbers to assume - do they check with the bank on what the proposed deal is?

To get the Total Indicated Value, they then do some calculations with the above assumed numbers.

  1. NOI divided by DCR gives Income Available for Debt service. Divide that number by the Mortgage constant to get the Potential Loan Amount. Set that number aside for a moment. Get Pre tax cash flow by subtracting Income available for debt service (calculated above) from NOI. Divide the result by the Equity Dividend Rate to get a number they call Equity Investment. Then add Equity investment to Potential Loan Amount from above to get the total Value.

Questions: What is the general reasoning behind this method? Is this common or not for appraisers to use this method?

Please explain what you know about this. I have specific numbers if that makes it easier to discuss.

Thanks

BJY


#3

I have some interest in MHP & Apart. Valuations.

Bill


#4

Actually, it is not all that complicated and makes sense from the lender’s veiwpoint. They look at a debt to income ratio, typically 1.2 to make sure if your NOI goes down 20% you still have enough to pay the mortgage. Thus, if your net operating income is say $120,000. At best, the mortgage payments can’t exceed $100,000. But they also want collateral to cover the mortgage if you default and enough cushion in case values go down. So they look at the local cap rate to determine value. Say your NOI is $100,000 and 10% cap. They value the property at $1,000,000 and for cushion will only loan up to 80% of that. Thus, the mortgage is $800,000 maximum.

Colby knows more about it and can say it better than I, but that is it in a nutshell from my experience.


#5

I haven’t done any research and I thought you guys could save me some time. Which large national banks work in these type loans?


#6

I could try to explain the valuation method used in your appraisals BJY, but I think it would be much more beneficial to make the following statement…

Firstly, a “Debt Service Coverage Method” approach to value suggests that value has something to do with financing by definition.

DSC (Debt Service Coverage) - This is really two things combined together. Debt Service is the amount of payments due for a loan over a given period of time. i.e. My debt service for my house is $1,400/month. Coverage is an easy enough word, but in this context it means “ability to cover”. We put these two words together and get an extended version: “The ability to cover debt service.”

I do not believe this could be considered part of a true and accepted method to valuation as the logic that follows suggests that a property value may be different depending on how it was financed or whether it was financed at all. As of Jan, 8 2007 it is my understanding that there are only three standard approaches to real existing commercial property (does not consider construction, rehab, interim projects, etc. which rely on speculative methods). The income approach (also called capitalization approach), the cost approach (also called replacement or construction approach), and the sales comparison approach.

I could see how a local bank might possibly consider financing and equity building rates, but this direction would venture away from a standard and brings in much more subjective factors such as the local bank’s finance tastes. Some banks like mobile home parks better than others. This, in itself, suggests that a standard approach would need to be taken to produce an objective determination.

I would however be very much interested in looking at a specific scenario of numbers to make sure I understand it correctly BJY. I love to play with numbers!

Andy pretty hit a few items right on the nose! Valuation doesn’t have to be all that complicated. True appraisal valuation can become quite complicated when you consider all the factors that go into a commercial appraisal. Aside from the obvious subject property information, there are surrounding factors such as local employment, population, services available, etc. considered. Though these other factors tend to have little impact, in most cases, on the valuation weights.

To get a good idea of value the simplest way is the capitalization approach. Net Operating Income / Capitalization Rate = Value. In determining net operating income do not consider expenditures such as debt service, capital improvement, depreciation, anything considered non-recurring or abnormal.

One correction I would like to make… Typically a lender is not looking for cushion in value in case values go down. A lender is typically looking at value in terms of the investor participation. Lenders NEVER want to foreclose on a property! Lenders do not make money by foreclosing, no matter what previous misconceptions have been construed about the industry. A hard money or private money lender might conceivably be able to work out a “for profit” scheme, but it takes a lot of time, and a lot of money to foreclose. Plus, if a commercial property were foreclosed upon, it is usually because the property is under performing or couldn’t pay for itself. And who wants a property that went into foreclosure when it couldn’t even support itself let alone a profit?

A lender needs to see that an investor has a good reason not to walk away from the property. 20% into the property is a very big reason and motivation to ensure the success of the property. A lender doesn’t care if you have a property that appraises at $2 million when the sales price is $1 million. They care that at a sales price of $1 million and with a supposed equity of $1 million, that the investor has put some of their money into the deal. This is why lenders usually consider value to be the lower of sales price or appraised value. You could get a property for a real good price, but if you have nothing to lose in the deal what’s to keep you from walking away when business gets too tough or stressful?

One more thing… Don’t get me wrong about hard or private money. I just posed that they could possibly stand to make money simply because they have the lowest LTV limits of any other type of lender. When you call into a hard money lender with a scenario though… One of the first things they’ll want to know is… “How much does the borrower have into the project?” In this way hard money lenders “share” the risk of a project with an investor.

So… debt service coverage ratios are used in the qualification of loan dollars by lenders. It is a direct reflection of the net income a property produces against its proposed debt load.

There are 3 standard approaches to commercial valuation for income producing properties.

I will take one more look to make sure I have covered everything. I will do a follow up post in a few days. Please make any questions about these posts as specific as possible. I would very much like to run through some numbers or any other cases/questions people have.

P.S. I am in the midst of updating some past articles I have written regarding valuation, park-owned mobiles, true net operating income, etc. Any constructive feedback on my posts would be greatly appreciated. Hopefully I can get some of them posted on MobileHomeUniversity.com).


#7

Great post, Colby. Sure, I would love to post some articles about evaluation. Just send them to me for review.

One of the toughest areas to learn in this business has to do with value. Just how much is a half empty 100 space park worth? The truth of the matter is that it’s worth more to some and less to others. Corey and I spend several hours at the Mobile Home Bootcamp going over evaluation. We even spend the evenings looking at actual deals brought by the students or going over case studies.

You are absolutely correct, there are three methods that a commercial appraiser uses to determine value. Once he has computed a value based on each, it’s up to him/her to put weight on each approach and come up with a final number.

In the case of a mature, 80 percent or more occupied property, the final value is heavily weighted by the capitalization rate. If the property is struggling and there is very little NOI, most of the time the appraiser is going to try and get some good comps to justify value through sales comparisons.

What I’ve seen develop within the industry in the past two years is that many buyers are giving very little value to empty lots. I agree with this if you have a mature park that can be valued using a cap rate. However, when you buy a 75 space park that has only 30 occupied lots, like I did this past year with a couple of great investors, you have to put some sort of value on the empty spaces.

I still use the methods Ernest Tew taught me several years ago and many posts have been made about it. It’s the 60/30 rule. It has worked for me in the past and continues to work for me and others that use it. It’s conservative enough to make sure that you don’t pay too much as long as the infrastructure is sound.

On a different note, I can’t wait to meet everyone in a few weeks at the MOM meeting. Greg has undoubtedly outdone himself this time.

Steve


#8

Hey Steve, you are absolutely right! Its always difficult to paint the perfect background when discussing all the intricacies of the business. Thanks for clarifying the issue.

Most of my posts have been with the assumption we are talking about a performing property. This brings up a really good point that I would like to touch on in another post…

Different types of money for different types of projects!

But first relating to value… I am by no means, an expert when it comes to valuation of distressed properties, under performing properties, etc. I have a very firm background in normal properties that are available for permanent finance options. I think that once you go into the under performing types you begin to have to weigh out speculative price with real current price. This becomes a really subjective issue at that point.

I would be interested to hear what you have to say about how you might value a property that has a low occupancy. Also, I have not heard of the 60/30 rule.

I will try to direct my posts with more specifics in the future. Thanks again Steve! Your input is invaluable.

P.S. Let me know if you’d be interested in teaming up for an article in the Scottsman Guide. I would like to address some issues relating to value and hopefully make a very clear and concise guide to commercial valuation, from a bird’s eye view, in as brief an article as is possible. It would be directed towards mortgage brokers. Typically residential brokers moving into commercial.


#9

Steve,

Thanks for the info. Assuming the park is a mature park, how do you determine the cap rate to make sure it is a good deal? What range are you looking for in regards to cap rate? I’ve read the article by Michael McCune regarding cap rate and thought I had a clear understanding of it but then I received conflicting information from a broker.

Thanks for the help,

Lee Cobb


#10

How about a story on a MHP valuation that needs a turnaround? You know, one with 50% or so vacancy, and a bunch of older homes with a high ratio of park owned homes (over 40%) but maybe decent infrastructure. Could even be something that’s losing money. Something where traditional valuation methods are more difficult to use.


#11

Colby,

I would love to help you with the article, but it’s going to be a few months before I will have time to write anything. I’ve got several properties now. The operations and accounting is burying me these days. Plus, I’m working with Corey on the upcoming MHM V event in California.

Maybe we can readdress this Summer.

Steve


#12

Lee,

I’ve read several articles from McCune and they are very helpful. As I teach at the bootcamps, only use cap rate only mature properties and make SURE you are using a correct NOI. This NOI must be calculated on how you plan on operating the property, not necessarily how it is being operated by the seller. In other words, the seller may be managing the property themselves and paying nothing for this. You would definitely want a manager or at least pay yourself something for managing the property. This must be included in the expenses.

What cap rate should you pay for a mature property? Well, this varies for every investor. My criteria is a maximum of a 10 cap on a park that is mature (90%+) occupied with no park rentals or park owned homes. I get excited when I can get it at a 12 cap or better, but that hasn’t happened yet. But, one must realize that most of my deals have been parks that were 50% or less occupied…turnaround situations. I did run across a deal locally on a small 42 pad park that had 30 lots occupied, but it involved a very motivated seller who was about to lose the park to the bank. The park came with 25 homes. The seller tried selling the whole thing for several months at $800K and ended up selling to me for $342K because I was the only one who could pay all cash for it…quickly.

Lee, in most cases the larger (100 space plus) parks that are full are being bought by many of the bigger companies in the business for too much money. I don’t even get involved in their game until it’s time to sell. I’d much rather get a larger park that is half full, spend a few years building it up and then sell to the big boys for a nice profit.

Steve


#13

To the posters in this thread,

I’m a commercial real estate appraiser in So. California. I’ve appraised a few parks & individual units over the years. I mostly specialize in apartment projects & industrial buildings. I found my way to this site because I was talked into appraising a single unit in a Stanton, CA park & I needed to bone up on valuation procedures for a single unit appraisal.

I could not profess current competency in appraising MHP’s because it has been several years since I valued one. I do have the experience to be able to get “back up to speed quickly” however. I have extensive experience in apartment, industrial, office, retail, and high balance residential valuation.

First, the posts to date are generally correct in the way that valuations are made. Appraisers value an income producing property thru the three standard valuation methods, the Cost Approach, the Direct Comparison approach & the Income Approach.

Most of the posts above have pertained to the Income Approach so I’ll continue with that methodology. Simplistically, we value an Income Stream from an investment property using the following methodology:

  1. Estimate Gross Income from all sources

  2. Subtract vacancy and collection loss

  3. Result is called the Effictive Gross Income (EGI)

  4. From EGI subtract expenses & estimated reserves

  5. Result is the Net Operating Income (NOI)

With respect to MHP’s, when sales of comparable MHPs are located for the Direct Comparison Approach, analysis is also made of gross income, expenses & vacancies in the comparable parks. In general, the actual income, vacancy & expenses are analyzed as indicated above. In the case of the comparable parks, a sales price is known. Therefore a Cap Rate can be abstracted from each of the comparable sales by the equasion: NOI/Sales Price = Indicated Cap rate for that sale.

After analysis of several MHP park sales, a range of Cap rates is abstracted. For the Income Approach, the NOI of the Subject property is divided by the abstracted Cap Rate from the comparable sales to yield a value for the Subject Property by the Income approach. This is the basic Income Approach methodology for any property with a cash flow.

These are not “assumed” numbers as the poster “BJY” indicated. Appraisers are supposed to used objective market derived numbers for their primary analysis. Other subjective mathematical “models” can also be used as a “check” but again, the primary numbers are obtained from comparable sales in a market area.

With regard to the Debt Coverage Ratio discussion, my experience has been that this is a “lender specific” number. Each lender has a different DCR that they apply depending upon their percieved risk by the property type, borrower credit profile, & loan rate and terms (LTV, etc.) In general, the more conservative the lender, the higher the DCR.

BJY asked about the Mortgage Constant. This number can be calculated using any standard financial calculator. In general, appraisers do not get down into the flyspecks with regard to Equity Dividend Rate as this is more investor specific based upon investor tax considerations, etc.

That in a nutshell, covers the Income Approach. Its much more involved than this actually, but you will be able to get the gist of what we do.

I will come back from time to time. I’d also like to invest some day. Anyone who has any appraisal related questions, please feel free to e-mail me. I made my e-mail address visible when I signed in. If I don’t have the answer, I’ll try to get one for you. For anyone who is buying or selling a park in So. CA & needs a valuation, I’d like to get back “up to speed” so to speak with this property type.

Sincerely,

John C. Carlson

Certified General Real Estate Appraiser