How to Value Unit Blocks

Unit blocks are one of the best risk-adjusted investment vehicles in Australia.

There are about 20,000 of them across our states and territories. They rarely go down in value and have consistently doubled every 10 years since as far back as the records go.

But just because they are generally good investments, doesn’t make them all good investments.

Each one is unique and valuing them involves creating a financial model to assess their investments' potential, considering key variables and associated risks.

In this article, we'll walk you through the core elements of underwriting unit blocks.

Net Operating Income (NOI)

One of the biggest differences between residential and commercial real estate is the way it is valued.

The value of single-family homes often hinges on emotional factors and comparable sales in the neighbourhood.  

The valuation of unit blocks (like commercial real estate) is based on numbers, specifically on the property's Net Operating Income (NOI).

NOI is pivotal in determining a property's value, with two seemingly identical buildings potentially having drastically different valuations based on their NOI.

The Net Operating Income (NOI) is a critical figure in underwriting, representing the property's income after operating expenses but before financing and taxes. 

It should be noted that interest and financing costs are not included. That’s because underwriting should be done independently of the financing structure. 

An unbiased assessment of the property's intrinsic value and income-generating potential is necessary before considering the impacts of debt or equity financing.

Cap Rates

A cap rate is the most common evaluation metric in commercial real estate and is likely a familiar term to many.

It measures the rate of return based on the Net Operating Income (NOI) divided by the property value. 

Cap rates provide a snapshot of a property's yield in a specific year, without factoring in future income increases or financing costs. 

Two seemingly identical buildings built at the same time by the same developer can have different cap rates and valuations. 

While their locations may be almost the same, their tenant profiles, rent performance, and expense management could lead to wide variances in value. 

This can make it difficult to do side-by-side comparisons of properties, but it is always necessary to account for these differences.

Cap rates and property values have an inverse relationship. 

Higher cap rates equal lower values and vice versa. This is really important to understand as even a slight cap rate movement—say, from 3% to 4%—is more impactful than it appears, equating to a 33% change in property price. 

When leveraged with debt, such as a 50% loan-to-value ratio, fluctuations in the value of the asset can significantly affect the equity value when the debt is fixed.

Comparable Valuation

If the net operating income and the property values of recent sales are available, this data can be benchmarked to determine the comparable cap rates.

This is referred to as comparable market analysis and below is an example from the Yura Capital Market Report for Q1 2024.

A Good Deal?

Understanding a ‘good deal’ requires an understanding of the context in which it is being asked.

A good deal should be viewed as - will this property generate attractive, risk-adjusted returns compared to other investment opportunities?

By understanding key concepts like Net Operating Income, cap rates, and comparable valuations, you can better assess potential investments and ensure they align with your financial objectives.

Yura Capital considers 100s of quantitative factors (like the above) and qualitative factors to assess whether deals meet the criteria required for its investor club. 

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