Multi Unit Investment Question?

[La Jolla Renter]

What is a fair value for a four plex that is producing $6,500 per month in rent?

The building is zoned multi use and is in A+ condition. Looking for some input from a professional investor that can valuate based on cash flow.

I would put my office in the bottom unit so could I qualify for an owner occupied loan? Assuming a 780+ fico, what type loan rate could I get?

[Daniel]

About 1.2-1.3M, I guess. But I ain’t no “professional investor”, so take this with a grain of salt.

[surveyor]

Assuming your four-plex is here in the San Diego area, i’ve been seeing four-plexes for around $700k to $900k. There are quite a few variables so I would suggest going to loopnet.com and take a look at properties similar to that four plex and see what their values are.

780 is a very good fico score, similar to mine. I’ve been getting around 6.875% to 7%. With that kind of score, you can probably get any kind of loan you want, from negative amortization to interest only to fixed rate.

If you were able to get an owner occupied loan, the rate would go down to around maybe 6.5%. As for the difference between owner occupying an office and owner occupying a home, I can’t help you there.

Hope that helps somewhat.

[Daniel]

6.875% to 7% sounds about right (if you pay no points). If you are willing to pay a lot of points, you can get it much lower, of course. E*Trade (www.etrade.com) has instant mortgage rates for multi-unit rentals, among others, so you can get an idea for what to expect.

[4plexowner]

I always looked at prices based on gross rent multiplier.

So, I take $6500/mo income for 12 months => $78,000/year.

The last 4 plex I sold (2004) went for 18x rents which would give us $78,000 x 18 = $1.4 mil. Let’s say that the market has softened and the 4 plex were talking about doesn’t have the amenities or whatever, so it only warrants a GRM of 15. That’s $1.17 mil.

Let’s say we can buy it for $1.2 so we can do some back-of-the-envelope cashflow analysis.

You’re going to live in one of the units so income becomes 75% of $6500/mo or $4875. Let’s pay property taxes next – 1.1% yearly on $1.2 mil is $13,200/yr or $1100/mo so we have $3775 left.

Let’s say we put 5% down ($60K) and get owner-occ financing on the rest. 80% first mtg (30 yr fixed) for $912K at %6 means a monthly payment of about $4500. We will need a second to cover the other 15% – depending on your credit rating this 2nd mortgage is likely to be at 10% or more – let’s say the gods are smiling on us and we can get a 15 yr, interest only loan of $228K at 8% – that gives us a 2nd mortgage payment of $1520/mo.

We have now taken $2,245 out of our pockets for the right to ‘own’ this property for one month and we haven’t paid for any insurance, utilities or maintenance yet. We also haven’t accounted for vacancies or turnover costs.

Let’s be conservative and say it will cost $2750/mo to own this property and cover expenses. This assumes you will manage the property and do all the minor maintenance work yourself. When someone moves out it will be you doing the cleaning, painting, etc.

Can you afford that monthly nut? Will you have any reserves if something goes wrong?

Do you really want to have $1.1 mil in debt secured against rental income property? Real estate is very non-liquid in a soft market so this could be dead money for a long time.

Buying this 4plex might make sense for your personal situation but it doesn’t make sense to me as an investment.

As an owner-occupant you get better loans and you’ll have lots of write-offs for your taxes. Just don’t kid yourself about what it will cost to ‘own’ a property like this.

[Steve Beebo]

“What is a fair value for a four plex that is producing $6,500 per month in rent?”

Nobody can give you an intelligent answer without knowing where the property is located.

A gross rent multiplier may not be the best way to value a 4-plex, but if you do use it, you’ll have to know what the GRM is for similar properties listed and sold in that particular neighborhood. A fair GRM in La Jolla may be double a fair GRM in North Park.

[Anonymous]

Well here goes. asssuming gross annual operating income is $78,000. Subtract 20% for expenses… normally I would take out 30% to be on the safe side but, since you will be your own property manager we will keep it at 20%($15,600 in expenses. This leaves you with $62,400 of annual rents, so based on a 30 yr loan @ 7% on a loan of $780,000 your annual debt service would be $62,272. So I would not want to take out a loan greater than $780,000 and this is not including the loss of rents for you taking up residence in one of the units. I hope this helps.

I am also looking to buy a multi family for some positive cash flow, they are just real hard to find…..

[surveyor]

You won’t find any positive cash flow multi-family properties in California, Nevada, Florida, New Jersey, and New York.

The positive cash flow properties can be found in North Carolina, South Carolina, Georgia, Tennessee, Missouri, Colorado, and Idaho.

Go to loopnet.com to find them (no i do not work for loopnet). Stick to major cities.

[Anonymous]

Does anyone know how multi-family and commercial RE performs during the type of housing downturn we all expect to see in the next few years? Do rents go higher on the multi’s? Do the buildings prices go down?

Thank you for all future responses

[surveyor]

downturn values

Multi-families tend to follow the overall residential market. During a downturn, they will tend to lose about 20% of their value (and most residential properties tend to lose that much peak to trough). There are many on this board though who say that this peak to trough will be more this time, so take all this with a grain of salt.

Commercial property (pure commercial properties, those that rely on business rent) will go down about 30% peak to trough.

Rents can increase or decrease in a downturn (they tend to increase in a downturn). If rents do go down, they usually go down 10% (absent some major catastrophe).

All this information I learned from my real estate class. Other investors may have other perspectives.

[Anonymous]

Thanks surveyor, for the insight. I am looking to find some multi-families with positive cash flow thinking along those lines that if rents go up maybe the value of the property would hold and even maybe appreciate. Was wondering if there any historical charts or data to show what has happened in previous cycles.

[surveyor]

historical data

Rich actually put up a pretty good graph a few weeks ago.

Historical Home Prices, Payments, Rents, and Rates

It’s inflation indexed, so take it as you will, but you will notice that rents went down 10% in 1997, considered a market low for San Diego. So there is a cycle for rents. I don’t really consider it a big deal to lower rents myself because it is better to lose $50 to $100 than to lose $100 to $1800. As long as the property cash flows, you’re in good shape.

[Anonymous]

I learned a lot from looking at Rich’s charts, but I am also wanting to figure out how the multi-family building values fluctuated during up/down RE cycles. Basically, wanting to know if it is a good or bad time to purchase this type of investment right now.

[4plexowner]

I bought my first 4plex in 1998 – paid about 11 GRM which was high at the time but made sense due to property and location (not to mention that everything else I had looked at over the previous 4 months was absolute TRASH).

Bought the next one in 1999 – 11.5 GRM for 4plex in Mission Beach. Never again – beach people (I call them beach scum) are horrible tenants – all they want to do is drink their beer, smoke their weed and figure out how to get over on the landlord.

Bought several more in the next two years – GRM kept increasing but rents were rising sharply too.

Around 2002 GRMs were consistently 14-15 for anything that wasn’t obviously trash – it was very common to see properties listed AND SELLING at 16-20 GRM – I stopped buying. It was no longer possible to pretend that I was INVESTING in real estate – it finally dawned on me that I was just another speculator playing the game so I started selling. (I had also read Robert Prechter’s books and was convinced that a major deflation was about to occur.)

The last 4plex I sold was in 2004 and it went for 18 GRM.

I haven’t been watching the multi-unit market since I sold all of my investment real estate but IMO, if GRMs are still above 12, there is no way in hell that you will get positive cashflow out of property. If you think you can get some type of suicide loan (interest only, ARM, neg am, etc) and make the cashflow work, I hope you will ask yourself this question: “Am I investing or speculating?”

I will be a buyer of multi-unit property again – probably in the 2009-2012 timeframe depending on how things unfold in our local market.

As far as buying income property somewhere other than where you live, my opinion is “DON’T DO IT”. All of the real estate books I have read say that being an out-of-town owner is a mistake. My experience: one of my properties was in Imperial Beach – I could drive to the property in about 45 minutes unless traffic was bad – and I decided that even IB was too far away to own property!

As far as value fluctuating: IMO multi-unit properties are priced strictly based on rental income (that is why I only talk about GRM) – if you can accept this premise, ask yourself “Are rents going up or down?” If you think rents are going up I’d like to hear how you think 3000 additional condos downtown in the next two years are NOT going to provide a glut of rentals which will depress rents throughout San Diego.

The multi-unit game in San Diego is over for several years, IMO. I believe you will be fooling yourself if you come to any other decision.

[Bugs]

Commercial RE does march to a different beat, but that difference is generally about timing, not direction. Commercial RE in this region didn’t enter bubble territory until a couple years after the residential markets were in full swing. So far, most of the commercial markets haven’t entered into decline.

But they will go into decline, sooner or later, because they’re still subejct to the same economic forces that residential properties adhere to.

During the last downturn the different commercial market segments took a beating, some being hit worse than others. I expect the same thing to happen this time, and to at least the same degree as what happens to the residential markets.

The biggest difference between the two markets is that a home really does provide shelter and a given populace does require a certain amoung of housing. Businesses can die off or go dormant, and nobody is going to subsidize their continued existence by way of social entitlements.

BTW, the reason a 4-plex can qualify for residential financing is because it’s classified as a residence. Unless that 4-plex is your domicile, you will not qualify for a residential loan at the optimum rates; at least, not without committing some mortgage fraud. You’ll be an offsite investor and will be subject to those underwriting criteria.

[Author]

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