Price per Unit – Techniques to Speed Up Your Decision Making, Part I
If you’re evaluating many apartment investment deals, oftentimes you need a quick way to determine ones that warrant more detailed analysis. After all, your time is valuable and any time spent analyzing deals that don’t make sense from the very beginning may result in other lost opportunities. What you need are techniques to act as filter mechanisms and help you quickly decide if the investment deal will really work.
Three general metrics are used for this purpose:
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Each has its own way of illustrating to the investor if the apartment requires more detailed analysis based on the asking price.
The purpose of this tutorial series is to provide investors a better understanding of each measure and how to apply them when evaluating apartment deals.
Exploring Price per Unit
The most popular of the three metrics is Price per Unit. It’s often used because it’s simple and quick to calculate.
Price per Unit = Price ÷ Number of Rental Units.
What makes it popular is that it’s easy to gather the necessary information to run the calculation. All that’s needed is the asking price and the total number of units.
Example: A 10-unit apartment building is offered for sale at $1 million. The property has a total of 20 bedrooms and 20 baths. What is the Price per Unit?
$1,000,000 ÷ 10 units = $100,000 per Unit.
If the general price per unit rate is $50k per unit, and the property is offered at $100k per unit, then red flags should be raised immediately. If evaluating multiple deals, this might be one you choose to set aside.
Precaution #1 – Neglecting to Factor in Property Features
What if the general rate in the area was $75,000 per unit? Will you still be quick to discount the property? One precaution to take with Price per Unit is that it doesn’t take into account property features such as amenities, location, or floor plans. Each of these can add or subtract to the Price per Unit value. Let’s say the 10-unit subject property’s 2bd/2ba units are generous in size at 1400 sq ft each. Other surrounding properties have outdated floor plans with only 2bd/1ba models and average 800sq ft each going at the general rate of $75k per unit. The higher price per unit of the 10-unit apartment would then be warranted because of its more modern features and larger floor plans. If you were strictly comparing price per unit rates, then you may have dismissed this opportunity by thinking the property was overpriced.
Precaution #2 – Ignoring the Investment Feasibility
Since Price per Unit is based on the physical feature of the property, it’s really a physical measure, not a true financial measure. Because the income is never reflected in the formula, price per unit provides little insight towards financial feasibility of the investment property. You can’t derive from it whether the investment property will provide a suitable return or not. A property could be offered at a low price per unit but still turn out to be a horrible investment because of negative factors such as bad location or problems due to deferred maintenance. Alternatively, a high price per unit doesn’t necessarily mean it’s a bad deal as illustrated in the section above.
Price per Unit is easy to calculate so it’s often a good initial measure to use. However, keep in mind that Price per Unit only looks at the number of units; it completely ignores everything else about the property including its features, location, and income and is limited in its usefulness. Therefore, if the deal passes the Price per Unit test, then move on to the GRM test, which we’ll cover in Part 2 of this series.
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