The "Quality" Duplex Trap

14 Replies

When I first got interested in RE, I could never understand buying a "quality" duplex. By quality I mean, a nice neighborhood of mostly owner occupied singles, and then there's this one duplex, first class, beautiful...but who does it appeal to? Investors? Forget it, the numbers don't make sense...for a little more there's probably a 4plex nearby...

I bring this up because I've been approached by a relative to buy her parent's duplex. Just a beautiful building, all brick, nice part of town...it's their only building. They're in their late 70's, snowbirds and tired of it all. They've often lamented to me about tenant issues. Like I always say, being a landlord isn't for everyone. Now they've got it with a name realtor, big price...and it sits...and sits, and sits... It's currently at 184k, and the rents are around 8 per. They offered it to me at 170...but that's not close to investor numbers.

The kids aren't interested, and have approached me. Wanting to keep good relations with the family, I've politely asked for "the numbers", knowing it wouldn't make financial sense even with a dramatic price reduction. I feel kinda sorry for them.

My point is that these "quality" duplexes appeal to a VERY narrow market, first time buyers..."Oh honey, let's buy a duplex and the other rent will make our payment!"... but when it's time to sell, they have to hope for someone with the same mentality.

It's a trap.

The problem is that duplexes and anything up to 4-plexes are appraised based on the sales of "similar" single family properties in the area. In the market, we all know that rent does not correlate 1:1 with home values. This creates markets where owning a duplex does not make sense, because the rent on a duplex would not justify buying that duplex for cost of single family homes. If they were appraised differently, that might solve the issue. 

I think these types of duplexes are the least liquid of all residential income real estate.

I completely agree, and I feel bad for the people that own these types of properties. I'm just a beginner, but my strategy going forward for finding small multi-families will be to compare the market rents to the home values and search for properties in hot spots. 

I steer clear of duplexes, triplexes, and quadplexes. Vs. SFR, you lack ease of resale, take on tenant vs. tenant issues, and generally get a lower class of tenant. Vs. true MF (>4), you lose out on economies of scale, valuation based on NOI vs. comps, and better financing terms.

I am currently buying a fourplex in a fantastic area and the previous owner has never had a vacancy in 25 years. I feel it depends on your specific niche. Buying a multi family property in a solid area could potentially be way more profitable than a single family home. You gain equity, and of cash flow to support future investments. Your short term gains with a single family property may be higher for resale, but  by buying multi family properties, your supporting your financial stability; by providing solid cash flow for years to come that will allow you to make more aggressive deals to see larger short term gains. 

Just to be clear, I prefer MF, but 5+ unit ones.

Chris S. Can I ask why you would like a 5 family over a 4plex. I'm looking at another investment purchase sometime next year and have been thinking about going with maybe a 5-7 unit property instead of a 4plex.

What's the difference in the terms in your experience? And any other pros to doing it?

I have a duplex that I live in now. And also a 4plex and 3plex I rent out in another area.

5+ unit MF's are valued based on a multiple of NOI - given an 8% cap rate (about avg. here for Class C), for every $1 improvement you generate in monthly NOI, that will increase the property's value by ~$144. For a quadplex, it won't matter, as it's value will be dictated by neighborhood comps.

Depending on the property, you may also qualify for nonrecourse financing on a 5+ unit MF property.    Disclaimer:   I don't have any actual experience at that end of the market, it's just what I've learned from the Lifestyles' founder's mistakes.   ;)     I have an interest in an 84 unit complex, and am actively looking for 2-3 large MF investment opps in the DFW area.

We will buy duplexes and quads all day long if the numbers work but we then convert them to shared housing effectively turning my duplex into a quad or more.  Our net rents are are 2 to 4 times what you'd see otherwise and we always have income stream on the property...if one person moves out we still have several paying.  Our approach is the same with single family homes - we have a now 5-unit that net cashflows at $2,000 a month versus the $500 it would have netted as a single family rental.  The shared housing approach is a more difficult one to operate but it works and the returns make it worth the effort!

Hi Arnie,

I wanted to give you a vote just based on the title of this thread!   As a new investor, a quality neighborhood and property is VERY appealing -- but you have said it -- these properties sitting for $250 with $800 or $900 rents don't make sense.  I have also wondered if the owners of these properties have just never raised the rents over their many years of ownership.  Of course, there is a ceiling for how many raises you can do…

This leads into @Ben Leybovich  's blog discussion of ability to raise rents (he is talking about under $30k single family homes) -- it seems that the nice neighborhoods WOULD appreciate and have rent increases -- but still I see the nice neighborhoods (sometimes older duplexes) sitting with rents that feel way too low.

Karen

P.S.  If they want to lower the price and seller finance, maybe we should talk!  ;-)  

Who would it appeal to? House hackers!

Lack of liquidity is certainly something to be aware of. That's why my personal strategy is to start with SFRs and move straight up to 10+ MF in a few years. Can cash out of the SFRs relatively easily in X years whenever the cycle makes sense, and trade up.

For your relative's specific situation - does a single-family conversion look possible? Given the amount of sqftage from a duplex, you could end up with quite a nice SFH after unloading a dumpster load of cash into it. Just a thought

-D

Originally posted by @Dmitri L. :

For your relative's specific situation - does a single-family conversion look possible? Given the amount of sqftage from a duplex, you could end up with quite a nice SFH after unloading a dumpster load of cash into it. Just a thought

-D

Hey, that's a great idea! Thanks so much...no, really, thanks a lot...I really mean it...honest...

Jesus...

I wouldn't go so far as to call it a "trap," but my local market is similar. I purchased a duplex to "live in one side and rent out the other-yay!" in June of 2013. It has upsides and downsides, no doubt. The upside was primarily a kick in the behind to get me into the rental business in the first place. It was a fairly low cost way to own my own house as well. Also, when I moved out, it allowed me to begin with 2 units and therefore hedge some risk prior to building a SFH porfolio. The downside, and you already said it, is that there is much less liquidity in that the market you're selling to is limited.


It's crazy how similar a situation I have on my end though:
The property behind my duplex is a matching duplex and was put up for sale with a residential realtor at $180k and pulling $775/side.  Top notch neighborhood. It is being marketed as "LIVE IN ONE SIDE, RENT OUT THE OTHER!" No sale and they've since dropped it to $170k. (This is also an estate liquidation situation.)  I mean I'd love to have this property, but I'll take it for $125k, probably. It's just a tough sell to try to get that premium price when the rents don't really make sense. 

So here it is, throughout writing this post I am definitely more inclined to agree that if a buyer isn't expecting to hold onto the property for the LONG HAUL, then this very well could be a trap. Let's hope that all realtors are very clear in describing the expectations to potential buyers.

For me, I was pretty clear on what I was getting into, and long term is my goal. Could I have done better? Yes
Am I still glad I did it in the first place? Yes

Folks with different goals and a different realtor/mentor may end up with a much different experience though. I hope that all duplex buyers are aware of their overall picture.

Great topic and I look forward to hearing from others.

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