The Valuation of Apartment Properties

by Arlen Mills, MAI
Published by the Appraisal Institute, 1999

Review by Stephen Traub, ASA

Copyright © 1999 Property Valuation Advisors, Newburyport, MA


WHAT IS AN apartment property and what distinguishes one from another? These are some of the questions to which the author provides answers in this broad but not deep primer on apartment valuation.

The author tells us that the Dictionary of Real Estate defines Apartment Building as "a structure containing four or more dwelling units". The Institute of Real Estate Management (IREM) in its annual survey narrows this scope, however, to properties that 1) contain a minimum of 12 units, 2) contain 80% residential rentable area, and 3) have been in operation for at least 12 months.

Moreover, the term apartment has long been interchangeable with the term multifamily housing. Technically, the term multifamily implies any building with more than one residential unit. FHA-insured, multifamily mortgages, however, typically are earmarked for properties of only eight units or more. Another authoritative definition recognizes two categories: 1) buildings of two to four residential units, and 2) buildings of five or more residential units.

Apartment types are also based on height and density. For example, high rise apartments have six or more stories, elevators, and dense lot usage. Mid-rise apartments consist of four to seven stories with limited elevator service. Low-rise apartments have three stories or less, while garden apartments refer to two- to three-story walkups, typically on sizable landscaped lots.


Finally, another classification is qualitative and considers building condition, age, quality, and location. The author provides a table showing the criteria associated with each class. Classifications range from "AA" through "D".

The author distinguishes among tenant type as well. He states that tenants fall into two categories: tenants by circumstance and tenants by choice. Those who seek rental accommodations because their lives are in flux or they cannot afford to purchase are considered tenants by circumstance. Empty nesters or career-oriented individuals who choose to occupy their unit for an extended period are considered tenants by choice. They usually have more commitment to keeping up their apartments, have lower turnover, and generally create fewer problems.

The author next discusses market analysis. For a proposed development, it should be thorough using the following six-step process:

  1. Property Productivity Analysis
  2. Identifying the Most Probable Users
  3. Demand Analysis and Forecast
  4. Competitive Supply Analysis and Forecast
  5. Supply and Demand Study or Equilibrium Analysis
  6. Capture Analysis

Ultimately, the ranking of a property in the market should reveal its advantages and disadvantages. Ranking helps in forecasting the most probable market share for a property. For existing properties with stable operating records, however, often the market analysis can be simpler because a forecast can draw upon actual operating history.

Income Approach

Direct Capitalization is the preferred income method. The income period analyzed generally is 12 months. It may be the 12 months preceding the valuation date, the 12 months after, or even 12 times the monthly income of the month in which the valuation date falls. No matter which period is used, the result is the Potential Gross Income (PGI).

The PGI minus anticipated vacancy and collection loss results in the Effective Gross Income (EGI). Next, expenses are deducted to attain the Net Operating Income (NOI).

Expenses tied to the property are fixed, whereas expenses tied to the operation, which rise or fall with occupancy, are variable. Actual expenses can be benchmarked against industry averages through a sample of comparables or through publications such as the Dollars and Cents of Multifamily Housing. To facilitate analysis, the appraiser should reconstruct the operating statement to ensure that only appropriate expenses are included.

  1. Nonrecurring past items should not be repeated.
  2. Deductions taken for non-operating expenses (i.e., personal expenses) should be eliminated
  3. Ambiguous, non-allowable, and/or atypical expense items should be removed or recategorized
  4. All items should be appropriately grouped

The author also reminds us that reserves for replacement of short-lived items or for likely future liabilities also should be deducted from EGI before estimating the NOI. In the end, the NOI will be converted to value by application of a cap rate.

If buyers generally rely on the Gross Income Multiplier (GIM) method in your market, it may be used to appraise smaller apartment buildings. The GIM (Sale Price/Gross Income) must be developed using truly comparable sales, however, with a similar rental and expense structure as the subject. The developed GIM is then multiplied by the subject's gross income to provide a value indication for the subject. Alternatively, Effective Gross Income Multipliers (EGIM) can be developed and applied. Derived multipliers rarely if ever should be adjusted.

Units of Comparison

Of all property types, apartments have the most units of comparison. To show the possibilities, the author presents a typical sales reporting sheet. Units of comparison on the sale property include Sale Price per GBA, per NRA, per Apartment Unit, and per Room. Additionally, it includes GIM, EGIM, Cap Rate, expenses per SF, and an overall expense ratio (OER).

For highly similar properties (unit mix, etc.), the price paid per apartment is the most common unit of comparison. Nevertheless, the price paid per SF is also useful when the average number of SF per apartment varies significantly. Still, the difference in apartment size does not necessarily translate into a difference in rent or sale price. A larger SF area could be the result of an awkward configuration or an oversized entrance or hallway.

The difference in apartment size does not necessarily translate into a difference in rent or sale price.

One method to compare sold properties and the subject is to rank each qualitatively, then array them from worst to best showing their respective sale prices per unit and/or sale prices per SF. In doing so, a per unit or per SF bracket of value for the subject should emerge.

Site and Building Cost Estimates

Even if a complete cost approach is not performed, performing a site valuation can be important to check the land value to ensure it does not exceed the value of the entire property. When sufficient sales of vacant sites are not available, one can employ less direct methods such as allocation, extraction, income land residual, or ground rent capitalization. The author provides details on the use of these approaches. Typically, however, value of apartment land is based on the sale price per permitted or planned apartment unit or the price per SF of allowable building area.

The primary structure also should be investigated and dated features, inefficient floor plans and undesirable apartment sizes should be considered. Other deficiencies may include non-existent or inadequate elevator service, inadequate parking, or inefficient heat or air conditioning systems. Moreover, external forces could diminish the value if traffic or inharmonious uses nearby create noise, odors, or unattractive views.

Next, the author discusses value reconciliation. He states: "For a typical property, the appraiser may have to reconcile as many as nine preliminary value indications". In an extreme case, the results of three income capitalization approach procedures (cash flow discounting, net income capitalization, gross income multiplier), four sales approach procedures (per apt., per room, per GBA, and per NRA), and two cost approach indications (land as vacant and a summation method including the depreciated improvement value) could be considered. A more common method, however, is to reconcile each approach within that section of the report. Final reconciliation, therefore, will be restricted to no more than three potential value indicators that typically are reconciled to a single point value.

In conclusion, although long stretches of the book are elementary and obvious, when you least expect it, the surface becomes scratched and a novel point or useful insight emerges.

The book above, The Valuation of Apartment Properties, is available on-line at Amazon Books.

Stephen Traub, ASA, the reviewer, is chief commercial appraiser for Property Valuation Advisors, 63 Hill St., Newburyport, MA 01950. He is a certified general appraiser in NH, ME, and MA.

To contact the author of this review, e-mail to: [Mailbox] or contact him at the address above, or call 978-462-4347.

| PVM Summer 1999 story menu | PVM archive menu | PVM's intro page | PVA's Free RE Publication menu | Property Valuation Advisors front page |

HTML 4.0 Transitional Checked. Copyright © 1999 Property Valuation Advisors, Newburyport, MA. All rights reserved. Disclaimer