4 unit or add 5th unit?

Question

I am under contract for a 4 unit property with a lot of poorly allocated space from additions over the last century.

Utilities are separated per unit already.

One first floor unit has enough space for to be a 3bed/2bath or convert to 2 - 1 bedroom units

4 unit ARV is $240k, $2800 gross rents

5 unit would be $3400 gross rents

What other issues other than being forced to use commercial financing should I consider before making the conversion?

Zoning would permit it, large lot provides plenty of space for parking or additional unit construction

Thanks in advance

Russell Brazil · Answer

A 4 unit property in many instances is more valuable than a 5th unit property.  I have a family member who has twice now purchased 5 unit properties, combined 2 of the units to bring it down to a 4 and flipped it.  Hugely larger buyer pool for 4s than 5s makes them often more valuable.

Joseph Cacciapaglia · Answer

When you sell, you'll have a much smaller buyer pool. Your appreciation will be tied to your income growth and cap rate, versus straight market appreciation. Neither of those matter much, if you're planning to hold long term. In my market, there are often properties with 5 or 6 units that sell for less than a fourplex for these very reasons.

Salvatore Lentini · Answer

@Michael Cross - all valid and interesting points by @Russell Brazil and @Joseph Cacciapaglia.  I guess you really need to do the math on what the decreased value is for 5 units and compare that to what it will cost to add the 5th unit, how much extra rent you'll get and how long you plan to hold it.  The other thing to consider is, if a 4 unit in that area truly is worth more, in the future you can just do a cash out refi and use that money to buy more rental properties.  Money that possibly wouldn't be there if it was a 5 unit.

Michael Cross · Answer

@Alex Deacon Thanks for that advice - my plan right now is to rehab it as it stands with 4 units, obtain long-term 15 or 30 year fixed financing from some of my local lenders in south central Pennsylvania. The largest unit i will rehab such that i could split it as 2 units in the future but in the mean time it will remain a single unit.

Alex Deacon · Answer

@Michael Cross I would have to agree with @Salvatore Lentini. I dont agree that a five unit makes the property less marketable. That makes no sense. Does that mean that anything over a 4 unit is harder to sell? In fact the larger multi family investments right now are super hot and sell very quickly. At least in my market. I have sold hundreds of multi family properties. My main concern would be although its zoned for 5 units you still need to make sure of all the caveats that the local borough will have. They may make you jump through so many hoops and spend so much cash that it doesnt make sense to add the 5th unit. I would work your numbers based on the current four units. Then after the purchase if you can add another unit and it makes viable financial sense then thats the icing on the cake.

Michael Cross · Answer

@Salvatore Lentini Thank you for that insight, I am actually investing in south central PA, about 3 hours from Doylestown, PA. I am going to review all these recommendations with my property manager, real estate agent, and preferred lenders and lean on their expertise to make the best decision.

Thanks again for all of the different perspectives - really helped me to think through the ramifications of my decisions!

Joseph Cacciapaglia · Answer

I can't think of any other downside, other than the initial investment, the difficulty in financing, and the diminished value. I understand that latter two issues may be a long way off, so it might make sense for you.

Michael Cross · Answer

@Joseph CacciapagliaWhat if you are holding it for the long term? Once you have long term financing in place are there any downsides in spitting the unit into 2 for cash flow? Or am i better off just reinvesting those same kitchen rehab funds into other properties and stabilizing a nice solid 4 unit for the long term?@Russell BrazilThanks again for all of the insights. I reached out to my realtor and he told me my ARV is under value for the market for a 4 unit. Your comments are making me look at a huge 2 unit i have with 3 bedroom 2 bath over under which could gain substantial equity as a 4 unit. Zoning will allow thankfully.

Joseph Cacciapaglia · Answer

It's really just a matter of your priorities. You're essentially trading higher cash flow for lower value and worse financing (which could hurt your cash flow). It's a math problem that is dependent on your holding period and the appreciation rate in your market. You can't really say that one strategy is better than the other in all cases.

Michael Cross · Answer

@Joseph Cacciapaglia other that the reduced buyer pool do you have experience whether it's a good long term strategy?

4 unit or add 5th unit?

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