Wednesday, February 21, 2024 | The Latest Buzz for the Appraisal Industry

The Challenges of Appraising Multifamily Properties

When you calculate a house’s worth, you think about how numerous factors position the property in the current market. This process has appraisers review location, condition, and other variables so they can assess whether buyers will be interested. However, things aren’t always as straightforward as they seem.

Challenges often arise in how professionals figure out the overall value of multifamily homes. Because appraisals are contingencies in 43% of contracts, you must find ways to accurately evaluate these properties. Here’s how to overcome any obstacles that may arise.

How Are Single-Family and Multifamily Buildings Different?

Mainly, single-family and multifamily buildings differ in how residents use them. If you purchase a single-family property, you don’t often rent out the space to others. It’s not uncommon for people to have tenants or roommates, but you’ll typically find that isn’t the case with single-family houses.

That’s why multifamily homes exist. If you want to be a real estate investor, you wouldn’t necessarily purchase multiple single-family properties when you could fit more tenants into one building. Rather, you’d buy a multifamily building, which allows you to earn an income from a few separate units. These properties are not for owner occupancy.

Because multifamily homes serve a different purpose than single-family properties, appraisers have yet another factor to consider before presenting a number to the bank. That’s where possible hurdles can arise. These issues lie in how to assess the loan accurately.

Three Common Methods Appraisers Can Use

There are three methods appraisers can use to calculate a multifamily property’s value. Each one can play a role in the eventual number they determine. That said, you may find that a particular tactic works better in different situations.

1. The Cost Approach

Those who use the cost approach typically do so to appraise a newer multifamily building. It’s meant to calculate value through the amount you’d pay to build that structure. There’s usually a 10-year cutoff rule, which means you can only use the cost approach for buildings that are newer than that.

This tactic uses the land’s price, plus the construction fees and minus depreciation. Basically, buyers don’t want to spend more than the original building costs for new properties since they could just as easily go through the process themselves. There are two ways to calculate the cost approach.

  • Reproduction refers to how much a replica would cost to build.
  • Replacement considers how much a similar structure would cost to build but with updated materials.

Because multifamily properties often include upgrades that aren’t typically featured in single-family homes, appraisers may want to use the cost approach. These additions come with specific benefits for renters in multi-unit buildings, like increased mobility. It’s the best way to keep particular home features in mind regarding value. Additionally, multifamily residences are considered to be commercial, which makes the cost approach perfect for them.

2. The Sales Comparison Approach

Anyone who’s appraised a single-family home before has usually done so with the sales comparison approach. This trick examines comparable properties in a one-mile radius that have sold in the last 12 months. It lets appraisers know how much buyers would pay for a similar home in the current market.

It tends to be the most reliable trick in the book, even for multifamily homes. However, you must consider how many similar properties are present in a given area. Not all neighborhoods have several multifamily homes, so appraisals with the sales comparison approach are tricky in many cases.

Additionally, you need to have the correct comparables to make an accurate assessment. It won’t be effective to compare a five-unit building with a duplex. There should also be at least a few similar features, although that’s not necessarily a must. Most appraisers can figure out how much the subtle differences are worth.

3. The Income Approach

If you can’t find comparable buildings in the designated area, you should use the income approach to assess the property’s value. Essentially, you calculate each unit’s fair market rent based on other rentals located in the neighborhood. Then, you multiply your numbers by the Gross Rent Multiplier to arrive at the property’s fair market value.

For some multifamily properties, you’ll find that the income approach works the best. It’s generally the most accurate approach to determining how much the landlord can charge for rent after purchasing the property. While sales comparisons still matter, you’ll achieve a more thorough assessment with the income approach.

This strategy can also be adjusted to consider concessions that are present in the market, which makes the income approach more adjustable than other methods.

Theses Hurdles Arise on a Case-by-Case Basis

These three methods are all accurate ways to determine a multifamily home’s worth. However, you can see that each approach has a time and a place. As an appraiser, you have to determine what the best path forward looks like.

It helps to consider whether the buyer wants to live in one unit while they rent out the others or lease out the entire property while they live elsewhere. This point matters since the purchaser will cover their rent with how much they earn from the other units. Therefore, they need to take out the loan for the property based on that fact.

Basically, appraisers need to think about which approach will be best case-by-case. There is no one-size-fits-all framework.

Appraisers Have Options to Overcome Issues with Multifamily Property Value

If you consider the differences between single-family homes and multifamily properties, you can quickly see that how you appraise them won’t be the same. They are classified as commercial properties, but you also have to consider how they look on the market. There are a few specific variables that determine a multifamily building’s value.

Between the cost, sales comparison and income approaches, appraisers can use three different options to calculate how much banks should lend to buyers. Each one will depend on the situation, so you should take each listing on a case-by-case basis. This way, you can use the proper method for that specific property.

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