What Drives Value of Your 2-4 Unit Properties? (Part I)

You will hear many things about how to value an apartment or a home. But engineer training and working on high profile projects such as Star Wars (President Reagan’s ground based prototype laser MIRACL) and the corrective optics for the Hubble Space Telescope, I learned to look at the underlying fundamentals for what makes a difference. It can be as simple as what Richard Feynman discovered about the challenger Space Shuttle O-Ring failure – a simple test can be quite illuminating.

I have examined many aspects of what drives value and there are many small factors that add up to ultimate price/value of a rental property. The key lies in rental price per Square Foot – $/SF.

Many people look at the number of units (also referred to as “doors”), number of bedrooms, lot size, etc. But profits drive investment properties forward.

I tend to use Gross Rent Multiplier (GRM) for an initial evaluation of the property.

Gross Rent Multiplier = Market Value / Annual Gross Income.

Often, one of the only things a lender will look at is an investment properties’ profitability.

I also look at the rent per SF and size of the property to identify potentially undervalued properties. This is only the first look and needs to be verified with the layout and all the rest of your due diligence.

It is difficult to concisely explain all that goes into due diligence because I am always looking for what clues exist to indicate better or worse value. You can’t take my years of experience and put it into a brief article for someone to reference. The details and conditions triggering further inspection get too complicated. It is really the experience and team approach to valuing a property.

It also depends on the goals of the buyer as to what emphasis is placed on each aspect. In a 1031 exchange approaching deadlines, many smaller items might be overlooked. A new investor with limited cash may place more emphasis on no repairs for the next 5-10 years. An experienced investor wants to buy something at the lowest price possible and will fix it up over time to create more value.

When selling your property, you have all the physical aspects which drive value, but  also you have to understand the focus of each buyer to make sure the key benefits they are looking for are pointed out. This is where the listing and buying agent have discussions about what the buyer is looking to accomplish so they can get the appropriate information to the buyer to make the right decision for them. While I, as the listing agent, have a fiduciary obligation to you, the seller, if I can find out what the buyer wants and demonstrate there is clear value there for them based on their requirements, I have met their needs and can get the higher price or the quicker sale or the easier sale for you.

My favorite type of property is 3-4 units. Though duplexes and 5 unit properties have some intriguing features we can take advantage of to create value. Sometimes an Accessory Dwelling Unit (ADU can be added to create more income for a duplex and sometimes it makes sense to convert a 5 or 6 unit property to a Fourplex. It is all in the evaluation and knowing the market.

In general, I find the general valuation of units follows this pattern:

  1. 2 unit is more like a Single Family Residence and can have emotional value which drives up price.
  2. 3-4 units are typically Mom and Pop landlords and in Orange County a first glance valuation will be 16 GRM and may be a personal residence – about 16% of 2-4 units are owner occupied.
  3. 5+ it is a commercial loan and there is no way to get around 20% – 30% down so you end up with more sophisticated buyers with more money (however, if you get a 203k loan and downconvert to a 4plex, you can get higher leverage – see my blog post on 203K loans)

Regardless of what you are looking for, we will sit down together and be very clear on your goals as a buyer or seller to ensure we get you exactly what you are looking for.

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