The four-plex whose taxes will double
Your client, a first-time investor, is considering a four-unit building listed at $480,000. The rent roll shows three units leased at $1,200 a month; the fourth is vacant but rents at market, also $1,200. Other income is zero. The owner's operating statement shows property taxes of $6,200, insurance $2,400, water and sewer $2,600, repairs and maintenance $4,200, and management at 8% of effective gross income. Your client wants to underwrite with a 5% vacancy and credit-loss allowance. The county auditor currently values the property at $455,000; Ohio assesses property at 35% of market value, and the effective combined millage is 68 mills. Comparable four-plexes trade at a 7.5% cap rate. The lender will lend 75% of the purchase price at 6.75% interest on a 25-year amortization and requires a minimum 1.20 DSCR.
1. Compute effective gross income and net operating income using realistic property taxes, then value the property at a 7.5% cap rate.
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Effective gross income. Gross potential rent = 4 × $1,200 × 12 = $57,600. Vacancy and credit loss at 5% = $2,880. EGI = $57,600 − $2,880 = $54,720.
Do not use the owner's tax figure. The auditor's value of $455,000 × 35% assessment ratio = $159,250 of taxable value; × 0.068 = about $10,829 - already far above the $6,200 reported, which suggests an owner-occupant homestead exemption or a stale valuation. On a sale at $480,000 the new taxable value is $480,000 × 0.35 = $168,000; × 0.068 = $11,424.
Operating expenses. Taxes $11,424 + insurance $2,400 + water/sewer $2,600 + repairs $4,200 + management (8% × $54,720 = $4,378) = $25,002.
NOI = $54,720 − $25,002 = $29,718.
Value at a 7.5% cap rate = $29,718 ÷ 0.075 = about $396,000. The $480,000 asking price implies a 6.2% cap on corrected numbers.
2. Compute annual debt service and the DSCR at the asking price, and advise the client.
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Loan. 75% × $480,000 = $360,000. At 6.75% with 25-year amortization the monthly payment factor is about $6.91 per $1,000, so the payment is roughly $2,487 a month, or $29,848 a year.
DSCR = $29,718 ÷ $29,848 = about 1.00. The property generates just enough income to pay the mortgage and nothing more.
Advice. The lender requires 1.20, so this application fails as written. At a 1.20 DSCR the property supports annual debt service of $29,718 ÷ 1.20 = $24,765, which is about $2,064 a month. Backing that into the same loan terms gives a loan of roughly $299,000, which at 75% LTV implies a price near $398,000 - almost exactly the cap-rate value. The client has three realistic moves: negotiate the price toward $395,000–$400,000, bring more equity so the loan shrinks, or walk.
Flag two more items: NOI above does not include a reserve for replacement (roof, HVAC, paving), which is real cash outflow, and the 5% vacancy allowance is optimistic with one unit already empty. Both push the deal further from working.
3. The client says, 'You're the expert - just tell me what it's worth.' What may you provide, and how must you characterize it?
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You may prepare a broker price opinion or comparative market analysis: rent comparables, sales comparables, a cap-rate-derived value range, and your analysis of the income approach as shown above. That is legitimate brokerage services and often more useful to an investor than a form appraisal.
What you may not do is call it an appraisal or hold yourself out as an appraiser. An appraisal for a federally related transaction - which this purchase-money loan almost certainly is - must be performed by a state-certified or state-licensed appraiser. Deliver your analysis in writing, label it a broker price opinion or CMA, state that it is not an appraisal, state that it was not prepared to appraisal standards, and note the assumptions (market rents, corrected taxes, no reserves).
Be equally clear about the limits of your role: you are advising a principal in a purchase, not providing an independent valuation for a lender. If the client's lender needs a number, the lender orders its own appraisal.