Determining property value is one of the great difficulties faced by multi-resident housing investors. Many investors have previous experience with other types of real estate, typically residential homes or duplexes. However, the methods used to value those properties are different and often much simpler than the methods needed to value multifamily. For example, it is generally quite easy to find the fair market value of a single family residence by using a comparative sales approach. However, investors and appraisers use a variety of techniques to determine the fair value of a multi-resident property. Among these methods, The Rule of 150 is one of the most common.
What is The Rule of 150?
The Rule of 150 applies to the operational profitability of a multifamily property. It suggests that for each additional $1 in monthly NOI (net operating income), the value of the property is increased by approximately $150. This rise in NOI can come in one of two ways: increasing income or decreasing expenses.
How does it work?
Unlike the comparative sales approach mentioned above, multifamily property valuations are primarily a function of the CAP (capitalization) rate. This method maintains that by improving the financial operation of a building, this will in turn improve its overall value and equity. The following terms and formulas will help to explain further:
- NOI = income minus operating expenses
- Capitalization Rate = a measure of the income produced by an apartment building divided by the cost of the building
- Simple CAP Rate Formula: Capitalization Rate = NOI/Building Value
So as an example, if a property generates an annual NOI of $100,000 and is purchased for the price of $1,250,000 (Building Value), the CAP rate of the property is 8%. The Rule of 150 assumes a capitalization rate of 8%, but it may be higher or lower in your area.
If we rearrange the Simple CAP Rate Formula named above, so Building Value = NOI / Capitalization Rate…by increasing our NOI by $1 per month, this will equal an increase of $12 per year. This $12 annual increase in NOI, divided by our 8% assumed CAP rate, leads to a $150 increase in building value. Simply put, $1 per month x 12 months per year / 8% cap rate = $150 increase in building value.
What does this mean for you?
As a property owner, the one variable in this formula that you can influence is the NOI. And as mentioned above, NOI can be improved by either increasing income or decreasing expenses. So, you may opt to increase income by raising rents to market rate, adding to your property offerings, or enhancing on-notice units. Or you may choose a low-expense approach by moving to energy-efficient lighting, sourcing other vendors, screening prospects more effectively, or investing in a property management software to free up valuable time. Regardless of your approach, it’s important to realize that a $1 per month increase in NOI, multiplied across hundreds of units, could make a major difference to your property’s value and appeal to potential investors.