What’s your investment worth? A simple question with not such a simple answer.
If you have any follow-on questions or need to know how this affects your taxes please speak with your tax planner, financial adviser or CPA. I cannot advise you.
Usually the question is along the lines of what is the property worth and what is my ownership percentage. Let me address these questions and provide some insight as I see it.
The ownership percentage – also known as Share Ratio in our deals – is by far the easiest question to answer. It is published in the company Schedule A. Generally this ownership percentage does not change over the lifetime of the investment. The exception to this is if there is a need for additional capital injection – a “cash call” – something that we have not had to do.
The Property Valuation
What is the property really worth? This really is a loaded question. The best answer is that it depends on why you’re asking! Yes, really. For property tax assessments you generally want the lowest possible value. When selling or refinancing you want the highest possible value. The “true value” (whatever that means) is likely somewhere in between.
As an owner myself there are only two values that I’m really interested in. One is what a potential buyer is willing and able to pay for it. The other is what value the bank/lender is willing to lend or refinance against.
However there are many times between purchase and subsequent sale of a property that we have to come up with an estimated value of the property. This is mostly when updating our PFS as a borrower or KP on another deal. For this I generally use a multi-pronged approach:
- Within the first 6 months after purchase, I just use the purchase price or the “as is” appraised value from the appraisal performed during loan application.
- Within months 6-12 months I may use the “after repairs” appraisal performed during loan application.
- After 13-14 months or more of ownership then you should be able to use the trailing 12 month NOI. Admittedly this is likely to be on the low side of your projections for the first 12 months after purchase, but it’s a starting point. Then apply a “reasonable” cap rate to that NOI to come up with a valuation. A few years ago I used to use an 8% cap rate, but the last couple of years or so I’ve moved more towards a 7% cap rate. [Remember: Value = NOI divided by Cap. Rate.]
So often I see people think that they can multiply their ownership percentage by the property value and come up with an estimate of the value of their investment. Close. But if you do this you probably will be disappointed with the resulting value because you’re missing so much more. Remember that if you are one several investors in a company then strictly speaking you are not buying a percentage of the MF property purchased. Rather you are purchasing a share of the owning entity which has multiple assets and liabilities.
I would argue that a better and much simpler estimate is to assume that it is worth exactly what you invested in it in the first place. You could optionally increase this 5-10% per year if you like provided the property performs as expected. [Hopefully you’ll be pleasantly surprised after the sale when you get back so much more.]
If you are interested in performing a deeper analysis of the value of your investment then you will need to look at all of the major assets and liabilities reported on the company Balance Sheet. In addition to the property (most likely the largest asset) then the company may also have a fairly significant amount of cash and current assets – in reserves, escrow (taxes, insurance, cap ex and immediate needs), operating capital and prepaid accounts. In contrast, the major liability is (obviously) the loan. Then there are current liabilities most of which are property taxes owed for this year but also any unpaid bills and vendor accounts.
The more detailed valuation would then take the property value plus all of the major current assets, less the loan and the major liabilities to come up with the remaining “value” of the company. Multiply that by your ownership percentage and you should come up with something close to your initial investment and then some depending on how long the company has owned the property and how the property has been performing.
Valuations for IRA Custodians
For the purpose of IRA valuations I would suggest reporting a valuation and your equity as the same as when we purchased the property. Anything else is very subjective and I’m not sure what difference it makes to the custodian. I’ve heard from other leads that they just simply ignore these requests from IRA Custodians and there don’t appear to be any repercussions for to doing this.
I think the IRA Custodians probably just want to make sure – or perhaps have some obligation to ensure – that the investment isn’t significantly diminishing in value. So as long as it is not, does it really matter to them if it’s gone up much, if any?