This is in response to the owner of a 10-unit apartment building who asked "What is the best way to determine a fair price?" (The Small Investor, July 22).
The advice you gave, to consult with real estate agents who specialize in apartments is excellent. There are numerous real estate companies that specialize in apartment properties in Southern California that are professional and knowledgeable.
However, your advice to use the capitalization method of valuation is not the accepted practice in valuing small apartment buildings. The capitalization method is utilized in valuing smaller apartment buildings, but only as a check to the market approach or gross income multiplier method.
Your explanation of the capitalization method left out one very important step; how to get from the gross annual income to the net operating income. Determining reasonable operation expenses would be extremely difficult for the novice investor. Rules of thumb or typical expenses are often misleading. To rely on the owner's expense statement can be very dangerous. Determining the appropriate capitalization rate is as difficult as determining an appropriate gross income multiplier. When choosing the appropriate capitalization rate or gross income multiplier, many factors must be considered. These include vacancy/collection loss, age, condition, locational features, nuisances, amenities, unit type and sizes, number of units, rent control, existing rent levels, size of units, utilities paid by owners as well as a number of other factors.