Valuation Question for Ray - Posted by Bob

import · October 31, 2006, 6:12pm

Posted by Bob on November 01, 2006 at 09:44:13:

This was in northern NJ. It was 27 units at 1.3MM. The total of the two increases was approx 3,000. The only reason I knew about the increases was that I own property in the same city. To compound the problem, the seller was either intentionally or not, very unorganized. If you can believe it, he gave me financials that were hand written. I’m a blood hound when it comes to due diligence, sometimes to my detriment as it is such a seller’s market. I go to the building to check systems, he tells me that they run hot water off the boiler system on a stand alone gas powered hot water heater. I looked at the financials to see no gas figures. Call the local utilities to dig around the accounts. Find out his house meter is under a totally different name. Another 7K in expenses. Asked for 100K off the price. Told me i was nuts and the broker shouldn’t waste his time with a buyer who isn’t serious. How funny is that? He gets caught with his hand in the cookie jar and gets insulted. Real Estate can be a funny game.

import · October 31, 2006, 6:12pm

Posted by Bob on October 31, 2006 at 19:12:20:

I’ve read Dealmaker’s numerous times. I have what I think is an interesting question. You say in the book that the correct way to value is to use the trailing 12 month financials and then capitalize. What about a situation where the property taxes have been increased for the coming year, or any other hard expense. Do you use the new figure in your recontructed statement or the existing? I could see a seller saying that if you are using the going forward tax rate, then you should use the existing rent roll annualized. Any thoughts?

import · October 31, 2006, 7:13pm

Re: Valuation Question for Ray - Posted by ray@lcorn

Posted by ray@lcorn on October 31, 2006 at 20:13:57:

Hi Bob,

Good question, and one which highlights how tough it is to develop methodologies that anticipate every variable. Sad to say, there are always specific conditions that fall between the cracks of any methodology no matter how well thought out.

In the case of a known property tax increase I would have to run the numbers on both the trailing 12 basis and the projected first year income/expense, not forgetting to adjust the expenses upward at least in the amount of expected inflation, 2.5%-3% or so.

Then I’d have to make a gut judgment as to whether the valuation should be adjusted between the two. I can foresee a case in which scheduled rent increases (by scheduled I mean bumps in an existing lease, not a hypothetical rent increase) may offset the higher tax rate, and the NOI be the same or even better.

I use the projection to calculate my first year “going-in” return anyway, so there is no extra work, but the difference will come between the existing income stream for valuation puposes and a projected income stream for return purposes. The latter is my higher priority and usually controls my decision.

That’s a long way of giving you the most common answer in real estate, “it depends”. I could also make a case for treating the known tax increase like deferred maintenance, and simply deduct it from the valuation price derived from the trailing 12.

I actually dealt with a simliar situation last year in an office building acquisition. During due diligence we found that there was a significant natural gas price increase coming in the first month after our scheduled closing date. I ran the first year projection as explained above. In that case every tenant in the building has annual rent bumps and it was about a wash, so we closed with no further adjustments.

So, I may not have answered your question, but now you’re confused on a higher level, eh?

ray

import · November 1, 2006, 7:39am

Re: Valuation Question for Ray - Posted by Bob

Posted by Bob on November 01, 2006 at 08:39:31:

Tricky situation. Last deal I worked on, during due diligence, the city raised the tax rate and the sewer charges. I went to the seller to renegotiate the price, which he refused to do, stating that I stated that I was valuing the building based on the trailing numbers and it shouldn’t be re-adjusted. The deal didn’t close.

import · November 1, 2006, 8:32am

Re: Valuation Question for Ray - Posted by ray@lcorn

Posted by ray@lcorn on November 01, 2006 at 09:32:33:

Bob,

Just curious… what was the sale price and the proposed adjustment?

ray