Best way to evaluate a 4 plex??

Question

I am curious as to what everybody uses to evaluate a 4 plex to determine if it's a good deal or not. Should I be using the 1% rule like a SFR or should I evaluate it based off the NOI and Cap rate?

I have seen two ways of using the Cap rate. One by multiplying the purchase price by the Cap rate to determine what income you should be getting. And the other way is to figure out the NOI and then divide that number by the Cap rate. Are these correct?

I am currently looking at a 4 plex right now that I like but I need to figure out how much I could offer. The numbers are

Asking: $299,000

Annual gross rent: $29,820

Mort/tax/insur: $22,400/yr

Property management : $1920/yr

Any insight on the subject would be greatly appreciated! Thank you

David S. · Answer

The 1% rule is a guideline, not a rule. I'd suggest building a spreadsheet yourself to evaluate any deals. Include purchase price, financing, taxes, insurance, projected expenses(utilities, maintenance, capex, etc.).  That way you can get an estimated NOI and cap rate based on your assumptions. Note:unless the seller provides a pro forma, or you have lots of experience, you're going to be making some guesses.

1% is a starting point - if you look at twenty properties in an area, you can calculate the % for each. If everything is in the .5% and you find a 1%, great! But be careful of hidden costs. Are other LLs not paying utilities, and this one is?

Use your spreadsheet - it should be easy to calculate each new property. Based on your numbers, you're looking at $2485 rent minus $1870 for PITI. That leaves $615 for utilities, maintenance, and capex. Assuming everything is amazing and you only need $100/mth/door for those items leaves you $215 a month in cash flow. Assuming 25% down, that means for a $80k down payment you're making $2600 a year, or 3% on your money. And that's with very low assumed costs. You could easily have negative cash flow with this property. With a two month vacancy, half of that $2600 is gone.

Brent Coombs · Answer

4plexes are still classed as Residential rather than Commercial, so their market value is based on sold COMPS, not by cap rate or NOI/ROI. It's only after you determine ARV minus Rehab cost that you can work backwards to see at what price it would work for your investment goals. Cheers...

Daniel Zapata · Answer

Like Account Closed I'm big on the Cash On Cash Return number. I want to be making a decent return on the money I have deployed.

As others have mentioned, make sure you are accounting for all expenses including setting money aside for vacancy, small repairs and capex. It's easy to fudge those numbers to justify a bad deal.

Another thing to consider is the inherited tenants. It may take you a long time to get the rents to market, especially with the tenant-friendly laws in CA. Does the deal still make sense if it takes you 6 months+ to get the rents to market? Are you coming out of pocket until then? Do you have an emergency fund if water heaters break in the first few months of ownership?

Mano Chidambaram · Answer

I believe both are correct, but if you are trying to figure out the offer price, then as you mentioned, take the "actual" NOI & divide by the going cap rate to arrive at the price.

BTW, what market are you finding these 4-plex? Curious...

Account Closed · Answer

I backwards calculate a purchase price based on my desired COCR with all expenses baked in. Set a range of desired returns (e.g. 15%-20%) to identify your high-low price range and then offer and negotiate within that range.

I might offer the lower end of my COCR range (higher price) if it’s a nice area with lots of recent maintenance, but I’ll push for a higher return (lower offer) if the property presents more risk.

4-plexes are great! As a point of reference, I’ve found I can cover the mortgage with 2 units occupied, and break even with 3 units occupied.  This is more-less what you’ll find in my experience.

Brent Coombs · Answer

Pay no attention to what they're LISTED for! What matters is: what other comps already SOLD for!

(But if you end up paying market value, then your time here on BP has been largely wasted)...

Tyler Kirk · Answer

@Mano chidambaram this was in Redding market.

Thank you for the replies. Looks like this 4 plex went pending this morning but I still want to fully evaluate it so I am ready for the next one. I was interested in this 4 plex because it appeared to have some room for value add and increase on rents. I think they were slightly under market value as is but you could have easily added covered tenant parking and possibly washer and dryer units on the property.

In your opinions would it be a good strategy to continue to look for value add multifamily units in hope of picking them up at a decent price. Or search more for some that are already renovated and easier to care for?

There is another 4 plex on the market fully renovated listed for $379,000

Matt Lefebvre · Answer

To @Brent Coombs point, any property 4 units or under is considered a residential property and is typically valued based on sold comps.  Income/expenses should play an important factor in your decision to buy, and quite frankly, I see this losing you money every month.

Your expense numbers don't account for any utility bills (electric, heat, hot water, water, sewer) for common areas or for the tenants depending on the way the building is set up.  Accounting for yard maintenance, depending on the lot size, is important as well.  And budgeting for repairs and maintenance is something that should be taken into account as well.

In my opinion, to justify a good investment, the income needs to be more in the ballpark of $39K - $42K annually.  That would get you a modest to decent return (I'm assuming this is 25% down) on your investment if the expenses weren't too high.

Best way to evaluate a 4 plex??

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