# Quad to 6-plex: repositioning valuation

7 Replies

I have a hypothetical question for the community about purchasing a 4-plex that has been zoned for 2 additional units.This is a hypothetical exercise to identify gaps and valuations not currently under consideration.Feedback is appreciated!

The existing quad is listed for sale at \$1.1M and a 5.3% CAP.Commercial multifamily in the area sells at a CAP rate of roughly 4.5%.The existing property is zoned to allow for 6 units and has available land to build an addition duplex for ~\$150 per sqft.Assume 1000 sqft duplex at \$150,000 and we'll build that into the loan.After expenses, the additional units will each increase the annual NOI by \$14,400 = (Gross rent – operating expenses = \$600x12x2).

Purchase Price  \$1.1MM

Construction:  \$150K

Loan amount: \$1MM

Total for project:  \$1.25MM

20% down: \$250K

Pre-construction NOI: \$58,300

Post construction NOI: \$72,700

What is the estimated property value after construction?

• A.\$1,615,555 = The post construction property value is \$72,700 (NOI) / .0045 (Comp CAP Rate 4.5%)
• B.\$1,371,698 = Post construction = NOI \$72,700 / purchased CAP rate of 5.3%
• C.None of the above, but please explain

@Mark Doty in theory the post construction valuation should be based on your NOI. Most lenders would probably want a year or two of tax returns and financial statements so that you could prove the NOI. You would probably want to check this with local commercial brokers and lenders though. I know in the Chicago market a lot of the 6 units sure seem to be priced on comps and not on cap rate. I know this is not "correct", but that is the reality on the ground.

I would also make sure you had a lender in place to help you cash out the value you are creating. Not all lenders are into this kind of play, and you would want to make sure you could get your cash back after completing the value add. In addition, you would want to make sure you could cash flow at 4.5% cap rate. I know that area is hot, but really drill down into the numbers to make sure you are actually getting a 4.5% and not a 2.5%...

@John Warren thanks for the reply! I used to live in your town before moving out west...do you know at what point lenders really look away from comps and at the NOI vs CAP? Since my example here is hypothetical, maybe it makes more sense to look at adding 4 more units or 6. And to make it work out here it would take a lot bigger down payment. Are 8 or 10 units looked at more on the numbers than comps? There are probably a number of variables that make sense to the right lender.

@Mark Doty Be mindful that if you intend to bundle the funds needed to add the additional units into a conventional mortgage loan lenders may require you to have building plans, detailed budgets and permits etc. It may be easier to close the property and then apply for a construction loan.

Good luck.

Good thing to consider. Thanks for the feedback!

4 units and less are supposed to have value primarily based on comps.

More than 4 units the value should be primary function of cap rate and NOI.

So in your hypothetical example current cap rate should not be used to establish the value on the quad. The value should be based on comps. After adding units the price should be established based on NOI and cap rate but it needs time to establish the NOI.

Good luck.

@Mark Doty I don't know if I have a definitive answer to your question, but if I were in your shoes I would start this journey by focusing on the lender relationship. Not every bank likes development deals, but once you find the right bank they will become your partner in the deal. The lender will literally walk you through what you need if you find the right one!

As to the NOI versus comparables, technically 5 units and above are supposed to be sold on cap rate. Like I mentioned, at least in my market this is not happening! People are buying these based on comps/speculation. From what I can tell, a lot of deals are negative cash flow if you account for property management and repairs.

@Dan Heuschele thanks for the post...very much in line with what I was thinking.

@John Warren I’ll start looking for the right lender!