What determines ARV for Multifamily Properties?

Question

Is ARV on a multifamily home based solely on its ability to produce rental income? If not, what other factors exist? I am asking because I am looking at a small multi family deal. It is a quad with plenty of deferred maintenance and good potential for rent raises.

200k Purchase Price, $2100 Current Rental Income, $40k in repairs/reno, $2800 to $3000 post-rehab monthly rental income. Sounds pretty good and looks pretty good on paper to me. But what if my resale value can't get up to 240k? I am thinking a large raise in rent roll should justify the price increase but if I am wrong this deal could be a bad deal.

Jerry Hollifield · Answer

@Nathan Hui  In my experience, anything classified as commercial, value is determined by NOI. Typically that is 5+ units. With the 4-plex, the ARV should be similar to SFR.

Jerry Hollifield · Answer

@Ryan Proffit. You can check county records using PIN

Jerry Hollifield · Answer

@Nathan Hui any residential rental property with 4 or fewer units is considered “residential” and qualifies for a residential mortgage. Any residential rental property of 5 units or more is considered “commercial”, thus you must obtain a commercial mortgage.

Tiffany Stevens · Answer

I think I saw that same Quad LOL.  Anyway, yes it comes down to how lenders determine the value of the property, as was stated above.

Josh Obregon · Answer

@Jerry Hollifield is correct. It all boils down to the definitions of "residential" and "commercial" which lenders have defined for us investors. That being said, there are always exceptions. I have colleagues with close relationships to lenders that were able to treat a 4-plex as a "commercial" property. Properties 1-4 units are deemed "residential" and are valued based on comparables. Properties with 5+ units are deemed "commercial" and values are based on NOI. Why? No clue and really don't care. I'm sure a savvy BP member knows the justification behind this distinction.

Understanding those definitions, the ARV of your 4-plex would be valued based on comps in your market (other 4-unit properties in your market) since it is treated as residential property. Best advice I can give is present your business plan to 2-3 lenders and get their feedback on ARV. Depending on your strategy with this property it could still be a good deal. All in for $240K. Lets assume best case scenario rents bump to $3000/month, that's a $900/month increase or $10,800/year increase giving you a 25% ROI on your reno costs. You're above the 1% rule, get to take advantage of bonus depreciation (I recommend conducting a cost seg analysis), and you're positive cash flow. If you wanted to flip it sell the story - turnkey 4-plex, recently renovated cash flowing X amount per month.

Hope this answers your questions and gives you some exit strategies. BTW... if you find more 4 unit properties like this let me know! Where are you located?

Jerry Hollifield · Answer

@Nathan Hui. In my experience, when I have increased income on a property classified as residential, the lender’s value of the property has not been driven by NOI. They may use the income to assist on debt to income ratios though. Maybe one of the residential lenders on BP can weigh in. And perhaps as a residential lender, they may have parameters that allow them to increase LTV based on NOI.

Nathan Hui · Answer

Im asking how to determine ARV on a quad. Your answer before was "ARV on a quad will be similar to SFR". In other words, the value of a quad will be based on comps in that market. If it is as simple as that then I already have my answer.

I ask this question because I have an opportunity to significantly raise the rent roll in a quad I am looking at but I do not want to put more cash into a property than it is worth. I really do not care why lenders differentiate between (1-4) and (5+).

It seems logical that the value of a small multifamily property is proportional to its ability to produce rental income. I am new to this so I am trying to confirm whether or not this is the reality. If lender's rules are the key to this, then yes, please share.

Jerry Hollifield · Answer

@Nathan Hui. Are you asking why lenders treat 1-4 units as residential and 5+ units as commercial?

Nathan Hui · Answer

So the way the property is acquired makes the difference? I understand that commercial rentals exist for the sole purpose of investment but quads are not like single family, to me. For example, the quad I am interested in is 4800sq ft, 8BR, 6BA. If that was compared to other SF it would be worth at least 500k in my area but its not. I am under contract for 200k. And I think that is a competitive price since the gross rental income is $2100. No investor would pay 300k for a quad that produces $2100, also nobody who has the money to buy a 300k home is going to buy a quad for their primary residence, unless they are house hacking but still.. that's a bad deal.

I really do not see the logic on how the means of acquisition make the valuation different. My argument is quads should be valued the same way any other exclusive investment property is. Can you explain why not?

What determines ARV for Multifamily Properties?

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