Twelve Units, One Stale Lease, and an Optimistic Asking Price
You are asked to review a 12-unit apartment building in a market where well-located, stabilized multifamily trades at capitalization rates of 5.75% to 6.25%. Eight one-bedroom units rent for $1,650; four two-bedroom units rent for $2,100. Market rent for the one-bedrooms is $1,650 and for the two-bedrooms $2,100. The owner reports vacancy and credit loss of 6% of scheduled income and operating expenses of 38% of effective gross income, both of which match comparable properties. One one-bedroom unit, however, is on a three-year lease signed 10 months ago at $1,250 per month. The seller is asking $2,725,000 and describes the property as 'fully stabilized at market rents.'
1. Build the net operating income and derive a value by direct capitalization at a 6.00% rate.
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Gross scheduled income (annual)
| Unit type | Count | Monthly | Monthly total | Annual |
|---|---|---|---|---|
| 1BR @ $1,650 | 8 | $1,650 | $13,200 | $158,400 |
| 2BR @ $2,100 | 4 | $2,100 | $8,400 | $100,800 |
| Total | 12 | $21,600 | $259,200 |
- Less vacancy and credit loss, 6%: $15,552
- Effective gross income: $243,648
- Less operating expenses, 38% of EGI: $92,586
- Net operating income: $151,062
Value at 6.00%: $151,062 ÷ 0.06 = $2,517,700
At the edges of the market range: 5.75% → $2,627,165; 6.25% → $2,416,992. So the supported range is roughly $2.42M to $2.63M, before any lease adjustment. Note that the 6% vacancy figure already reflects the market; do not add a second vacancy deduction.
2. How should the below-market lease be handled, and what is the common analytical error here?
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The error is to treat the $400 monthly shortfall as permanent - capitalize $4,800 a year at 6.00% and deduct $80,000. That assumes the unit never reaches market rent. It does: the lease expires in 26 months.
The correct adjustment is the present value of the rent loss over the remaining lease term only:
- Monthly shortfall: $1,650 − $1,250 = $400
- Remaining term: 36 − 10 = 26 months
- Discount at 6.00% annual (0.5% per month): annuity factor = (1 − 1.005⁻²⁶) ÷ 0.005 ≈ 24.33
- Present value of the loss ≈ 24.33 × $400 ≈ $9,700 (an undiscounted $10,400 is an acceptable shortcut)
A market buyer might also price in a modest turnover cost (repainting, a month of vacancy) at expiration, but the magnitude stays in the low five figures, not the high five figures.
Adjusted value: $2,517,700 − $9,700 ≈ $2,508,000, and the indicated range becomes roughly $2.41M to $2.62M. The lease is a real but small defect; it is not what is wrong with this deal.
3. The seller is asking $2,725,000. Test that price against the income evidence and recommend a position.
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Implied cap rate at the asking price: $151,062 ÷ $2,725,000 = 5.54%. That is 21 to 71 basis points below the market range of 5.75%–6.25%, and the number is computed on already-adjusted income. The price is not supported by the income approach.
Cross-check with a gross rent multiplier. Price ÷ gross scheduled income at $2,725,000 = 10.51. Market GRMs for comparable sales in this range are typically about 9.5 to 10.0. At 10.0 × $259,200 = $2,592,000; at 9.5 × $259,200 = $2,462,400. The GRM check brackets the same range as the cap rate analysis.
Reconciliation and advice. Weight the direct capitalization approach most heavily - buyers of this asset class price on NOI, and both vacancy and expense ratios are confirmed by comparables. The lease adjustment is small and should not be used as a bargaining chip in either direction.
- Supported value: $2.45M–$2.60M, point estimate about $2.51M.
- The $2,725,000 ask is roughly 8%–9% above the top of the range.
- Recommend $2,500,000 with a ceiling near $2,600,000, and state the cap rate and dollar-per-unit math in the offer so the seller's broker must argue with numbers rather than with the word 'stabilized.'