Valuing a 4-plex im considering purchasing

19 Replies

Hello all,

I've been heavily focused on SFR buy and hold analysis and I'm thinking about looking at a 4-plex in my area. When looking at the ARV, etc...how exactly is the ARV determined on a 4-plex. Before you say comps, let's say comps are scarce in this area for this type of property. What then? You can find SFR comps all day, but it seems MF comps aren't as plentiful.

Comps for small multi's are challenging. Yes, you want to look at any comps you can find. If you have to look at duplexes, triplexes or 6plexes, that's fine, just make the appropriate adjustments. Even look at single families, not as a direct comparison, but to get an idea of the quality of the neighborhood.

Also, fourplex is about the time when you want to start looking at cap rates. Do you know about what cap rates in that area are going for normally? You can look at comps or ask agents to get a feel for it. (This is not an exact science). Then if you have an operating statement on the 4plex, that can give you an idea of what you're looking at. You can also use a pro forma, but use your own, not the seller's, and use conservative numbers. It is not at all uncommon for sellers to give grossly exaggerated pro formas to puff up the supposed value of the property they are trying to sell.

Hi Miles,

The CAP rate is the most accurate way to calculate your ARV since the majority of buyers will be investors and CAP rate is what they look at to evaluate a purchase.

Take your total annual gross revenue and subtract out management fees (approximately 10-15% of gross revenue), vacancy (approximately 8% of gross revenue), annual property taxes and insurance.  You also need to subtract out maintenance (plumber bills, lawn care etc.) and capital expenditures (big ticket items that are to be budgeted for over the long term like a new furnace or roof in 10 years).  Then divide that number by the purchase price and multiply by 100.

If the property is in a ‘D' neighborhood, its considered more risky and investors would want to see a higher cap rate such as 15 to 20%. If the property is in an ‘A' neighborhood, attracts better tenants at a higher rent, and has more consistent appreciation, a lower CAP rate can be seen as acceptable.

CAP rate calculations are not very complex, but determining accurate vacancy, maintenance, and capital expenditure costs can get tricky so make sure you read up on them beforehand. What one investor sees as a 8% CAP rate can been seen as a 5% CAP rate by an experienced investor who has more knowledge on estimating long term maintenance costs and capital expenditures.

Good luck!

@Miles Stanley

In this forum, you will find that the experienced investors prescribe the use of sales comparables in valuing SFR, 2 to 4 plexes. Anything above 4 plexes are normally valued using cap rate comparables. Absent sales and cap rates comparables, I would suggest GRM (i.e. Gross Rent Multiples) comparables. The challenge to using GRM comparables are obviously the type of propertyies you're comparing. You would want to compare the GRM of a fourplex with other fourplexes. You could compare the GRM of a fourplex with a duplex or an SFR but I would think you would want to adjust for it.

@Tony R. Yagiela

- NOI (Net Operating Income) does not include capital expenditures (i.e. big ticket items).

- Dividing NOI by the Value/Purchase Price gives you cap rate, it's not necessary to multiply by 100.

- The cap rate is determined by the market, it varies by localities. Investors would need to find the cap rate by talking to brokers, local experienced investors, and other sources, as opposed to calculating their own cap rates.

Immanuel

@Immanuel Sibero, i thought NOI basically included everything except financing costs?? i will look into the GRM method some more.

@Tony R. Yagiela , @Andrew Syrios , thanks for the feedback...but i thought cap rate was really for 5-plex's on up?

@Immanuel Sibero , @Andrew Syrios , @Tony R. Yagiela - thanks, but unless I'm seriously mistaken, even the BP calculators include CapEx as an operating expense to determine the NOI. Are the calculators wrong then? i know there are a useful tool, but i strive to understand the underlying concepts, not just plug and chug into a spreadsheet/calculator.

I could have sworn also that several real estate books i have include cap ex as operating expenses too.  i don't have any nearby (they're at home)...

Thanks,

@Miles Stanley

Miles,

I agree completely about striving to understand the underlying concepts... that's the way I am... probably why I never use BP calculators in the first place... lol. Needless to say, I don't know what all BP calculators do so I can't comment on them. I may take a look at them when I have time. But check out the following BP post:

https://www.biggerpockets.com/forums/48/topics/877...

Speaking of underlying concepts, the reasoning for excluding CapEx from NOI is because CapEx items are generally infrequent in nature, not in the ordinary "operation" of the properties. I guess we can roughly say that NOI (Net "Operating" Income) is just that; a group of items necessary for the day to day "operation" of the properties. Roof replacement is not an "operating" item in a sense that it can be deferred for sometime.

Immanuel

@Immanuel Sibero

Great! so moral of the story, don't neglect CapEx (since it affects cash flow), just don't consider it an operating expense...that way it doesn't skew the Cap Rate calcuation.

The reason i bring up the BP calculators is that they are promoted so heavily on the site/podcasts/webinars, etc. I would hate to know that they are incorrectly calculating some of these metrics (which sounds like it MAY be the case here with NOI). Just putting this out there...

Thanks again,

MS

@Miles Stanley

I can add to this that, as you pointed out earlier, it's important to understand the underlying concepts behind these metrics, because then you would be able to tell when others have misused/abused them. You should do a search on "cap rate" right here on Biggerpockets, you would see the gross misconceptions many investors have surrounding it.

Best of luck to you,

Immanuel

Originally posted by @Miles Stanley :

@Immanuel Sibero

Great! so moral of the story, don't neglect CapEx (since it affects cash flow), just don't consider it an operating expense...that way it doesn't skew the Cap Rate calcuation.

The reason i bring up the BP calculators is that they are promoted so heavily on the site/podcasts/webinars, etc. I would hate to know that they are incorrectly calculating some of these metrics (which sounds like it MAY be the case here with NOI). Just putting this out there...

Thanks again,

MS

 Immanuel is giving you good advice IMO, and i would follow it, ignore the BP calculators, and understand how to do your own analysis from scratch, what all the variables are, how they interact, and why they are important.

Another serious deficiency in the BP calculators are that they completely ignore appreciation. The standard line on BP is that this is speculation and immediate cash flow is the only thing that matters. I strongly disagree. Following this advice will tend to lead you into the heart of the ghetto. 

Market appreciation may be impossible to predict in the short term (<10 years), though forced appreciation can be predicted short term, but market appreciation is fairly consistent over the long term in a stable market with a long track record of it. I therefore screen for neighborhoods with a long historic track record of increasing prices and rents ... I pay a premium in the short run and they don't cash flow on paper as well day 1, but they increase your purchasing power over time and I also buy distressed under market in these neighborhoods to force some appreciation to market value in the short term; quality over quantity.

If I buy a property and the price and rents don't go up over the long term, as the standard advice seems to go, then I've made a serious error in my analysis; inflation and CapEx will erode my profits away and I will lose purchasing power over time ... some food for thought from a slightly different POV.

Thanks @David Faulkner and @Immanuel Sibero , this is all great stuff!

i am actually developing my own spreadsheet specifically because i have trust issues when it comes to packaged calculators, etc.  

i have met with a local investor/agent here and he didn't seem to care much about if some of his properties are in a bad part of town because, and i quote, "what do i care, i don't live there!".  i was taken back by this because i was hoping to buy in better parts of town where i wouldn't be worried about my wife having to go there at night for some reason.  After all, why would i expect a good tenant to live in a house I wouldn't be caught dead in??

i just don't think these rougher areas would see the appreciation of a nicer part...so i like the reinforcement of appreciation as another tool to build wealth...not just cash flow.

Thanks!

@Immanuel Sibero thanks for pointing that out. I once listened to a podcast with one investor outlining the traditional way to determine CAP rate (the one you just mentioned), and another investor arguing that it isn't the best way to determine a properties performance since it doesn't account for the true cost to maintain the building. I was in the same boat as @Miles Stanley .  And Miles, yes, CAP rate is typically used for larger multi-families, but I dont see how using it on a 4 unit can skew the value much compared to 5 unit.  Its always served me well.  My CAP rates on all my properties look fantastic when I exclude CAP Ex!!!  

The way I see it is just because an item is infrequent in nature doesn't mean its free.  If i need a new roof in 10 years and it will cost $12,000, then that is still $100 per month that needs to be accounted for.  I've learned to take the same approach to everything else that needs replaced on a building, over their respective costs and timelines.  I feel that gives a more accurate evaluation of the properties performance in the long run and to determine true cash flow.

But to be clear - Immanuel is correct to exclude capex in NOI the traditional way, however, the real question is which method best serves the investor.

@David Faulkner  - I like your approach to investing.  I buy in areas that see good appreciation.  Its the best way to accumulate net worth.  Ive heard many investors say it like this: 'their 'D' Class properties pay their monthly bills, but their 'A' Class properties is where their wealth is accumulated.' 

Best Regards,

Tony

Originally posted by @Miles Stanley :

Hello all,

I've been heavily focused on SFR buy and hold analysis and I'm thinking about looking at a 4-plex in my area. When looking at the ARV, etc...how exactly is the ARV determined on a 4-plex. Before you say comps, let's say comps are scarce in this area for this type of property. What then? You can find SFR comps all day, but it seems MF comps aren't as plentiful.

 HI Miles,

I've refinanced many client's loans on fourplexes (owner and non owner transactions) and my own as well and I'll say the simple answer is that while appraisers will take note of all this income that everyone else talks about (GRM, NOI, etc, etc) they will most often not go above comparable sales value of other triplexes and fourplexes.

Note I mentioned triplexes and fourplexes. The reason I mention this is because they will only sometimes use duplexes but often times duplexes have a higher sales price per sqft or has a higher sales price per unit than triplex & fourplexes for the simple fact that most duplexes are larger unit wise than units of tri's and quads. So there is a grey area where if the appraiser doesnt adjust his comparables correctly for rent potential, size, beds, baths, condition, etc it could be to your detriment or your advantage (if the error favors a higher value).

I would only use duplexes as comps if there are no other multi-units. The advantage of having only duplexes as comps is that you can try to make light that each unit "sells higher," and try to rebut the appraiser on the grounds that each unit sells for X and we should be valued at X times 4.

The appraisers in my past experience have never used 5+ unit MF properties (on conventional loans).

So I thought well... perhaps if I use a commercial portfolio loan from a local bank that they'd try using an income approach? I was sadly mistaken they still assigned the appraisal to a residential appraiser and comps nearby were the limit of their valuation.

The values  as an example were:

Comparable sales approach - 390k

Income approach - 485,000 - starkly higher when capitalizing the income

Cost Approach - 413,000

Then at the end of the report there is language that says " with the most weight of value going towards the sales comparable approach with value at $390,000 ." This becomes the value we use from a conventional lending point of view and so far the value that is being used in my limited experience in financing residential 1-4 unit properties with local portfolio paper too.

Hope that helped, let me know if you have any questions.

Originally posted by @Tony R. Yagiela :

@Immanuel Sibero

@David Faulkner - I like your approach to investing.  I buy in areas that see good appreciation.  Its the best way to accumulate net worth.  Ive heard many investors say it like this: 'their 'D' Class properties pay their monthly bills, but their 'A' Class properties is where their wealth is accumulated.' 

Best Regards,

Tony

Thanks ... agree with half your statement. If you rely on D class properties to pay your bills you may have a problem. At best that is a fulltime job with a highly unsteady paycheck. B class I can maybe see ... Price appreciation and rent increases go hand and hand, but most expenses do not scale as such, and class A rentals are a good, solid paychecks with no hassles, so my appreciation properties build wealth AND pay my bills, but that does not happen overnight, you have to play the long game and make sure you can make it to the longterm :)

Originally posted by @Miles Stanley :

@Immanuel Sibero , @Andrew Syrios, @Tony R. Yagiela - thanks, but unless I'm seriously mistaken, even the BP calculators include CapEx as an operating expense to determine the NOI. Are the calculators wrong then? i know there are a useful tool, but i strive to understand the underlying concepts, not just plug and chug into a spreadsheet/calculator.

I could have sworn also that several real estate books i have include cap ex as operating expenses too.  i don't have any nearby (they're at home)...

Thanks,

Up front CAPEX should not be included, but it's important to include recurring CAPEX in the operating expenses (at least in my opinion). Banks often call this item Replacement Reserves. HVAC, roofs, etc. will go out and those expenses will need to be paid out of cash flow, so it should be accounted for up front.

Originally posted by @Miles Stanley :

@Immanuel Sibero , i thought NOI basically included everything except financing costs?? i will look into the GRM method some more.

@Tony R. Yagiela , @Andrew Syrios, thanks for the feedback...but i thought cap rate was really for 5-plex's on up?

 Sort of, but there's no hard and fast rule. There is no exact rule for valuing properties and you have to use the tools that are available in any given circumstance. 

I always look at cap rate of 14% or better. The Residential properties are very easy and quick to fund with flexible terms and requirements. NIV, low rates, good credit scores are part of the play here. I can discuss options available on there type of deals - expecially for out-of-state investors.

Originally posted by @Andrew Syrios :
Originally posted by @Miles Stanley:

@Immanuel Sibero , i thought NOI basically included everything except financing costs?? i will look into the GRM method some more.

@Tony R. Yagiela , @Andrew Syrios, thanks for the feedback...but i thought cap rate was really for 5-plex's on up?

 Sort of, but there's no hard and fast rule. There is no exact rule for valuing properties and you have to use the tools that are available in any given circumstance. 

No, not sort of ... there is a right way to apply cap rate and a rule for valuing properties, the one used by professional real estate appraisers and banks. For under 4 units valuation is based on comparable sales. For greater than 4 units it is cap rate. Tony is correct ... please stop giving newbies incorrect information.

Originally posted by @Miles Stanley :

Hello all,

When looking at the ARV, etc...how exactly is the ARV determined on a 4-plex. Before you say comps, let's say comps are scarce in this area for this type of property. What then? You can find SFR comps all day, but it seems MF comps aren't as plentiful.

In the majority of markets the method used to determine value (ARV) for a 4-plex is the same as single family. Doesn't matter if comps are scarce, the same method is used. Most appraiser will look for comparable 4 plexes, then use 3 or 2 plexes if they can't find 4 plexes. They,ll make adjustments in value, up or down based on bedroom counts, garages, ....... They will not include SFR in the analysis. If forced to they may go beyond one mile to find comparables.

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