Price Per Square Foot vs. Cap Rate/Return Metrics on 2-4 Unit Multi-Family

[Roig V.]

Hello All,

I wanted to float a scenario that I found myself in to get some perspective on people's opinions of where $/SF should rank in terms of priority when valuing a 3-4 unit MF property. I recently came across a 3-unit, 2600 SF property that was very attractively priced from a return metrics standpoint (i.e. gross monthly rents were 1.3% of purchase price (slightly above norm for my market), GRM 7, Cap Rate 8.5% (about 0.5% above typical cap rate for the market), Cash on Cash Return over 17%, passed the 50% rule, and cash flowed over $100/unit assuming 100% financing on a 30 year fixed, etc). It passed all of my return hurdles with flying colors and was above what I typically see in my market. All of these return tests used very conservative expenses including a 10% management fee and vacancy. The property was 100% occupied with 2 long term tenants and one new tenant. It was well maintained and recently updated with no deferred maintenance. The list price was $245k ($91/SF), however I think there was a high likelihood I could have tied it up for around $230k ($86/SF). Sounds like a great deal right? That was my thought as well, until I dug into the comps.

There were about 6 MF comparable sales within a few miles of the subject property and what stuck out to me was that all of them sold for around $65/SF. These properties were of similar age, quality, and the samerental market as the subject. I did not have rental figures for the sales so I could not determine sale cap rates for these properties however based on my knowledge of the market they probably penciled out to around 8% sale cap rates (consistent with the subject). There was nothing in the market that supported a subject sale price $86/SF, let alone the seller's ask priceof $91/SF. Basing an offer on the market norm of $65/SF resulted in a value of $174k, a price that would have sent the cap rate and Cash on Cash returns through the roof, and that was well below what the seller would have accepted.

So my long winded question is, in making purchase decisions as a buy and hold investor should primary emphasis be placed on return metrics (ROI, cap rates, CoC, etc), with $/SF a secondary measure, or should it be a prerequisite that the $/SF price be at or below market in order to protect yourself in the case that you need to sell? Obviously as a triplex, this is a residential property so its value is more heavily influenced by sale comparables ($/SF) than return metrics (cap rate, CoC returns). I ultimately passed on this deal as I couldn't get comfortable with the $/SF at the purchase price however I can't help but think about it in the middle of the night and wonder if I missed out on a great opportunity to pick up a very strong cash flowing property that would have required very little maintenance or management effort.

Sorry for the long post here, hopefully you made it through it. Curious to see if any other MF investors out there come across this type of discrepancy and how they address it. Thanks and happy holidays!