Valuing (and value adding) small multi in overpriced areas (San Diego)

San Diego, California
Multi-Family and Apartment Investing
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Valuing (and value adding) small multi in overpriced areas (San Diego)

Jeff Thompson
San Diego, CA · Member since 2011 · 86 posts · 9 votes

Hi all,

I'm early in the "figure out where we are going" phase and will do a ton more research before doing anything, so my question isn't if this is a good idea for a newbie, the question is: How do I value a small multi-family deal in a "overpriced" area like San Diego and determine the ARV if I'm going to try to make money by forced appreciation? (cuz haha cashflow around here unless you have a huge pile of cash).

Just to have something specific to talk about here's a property: https://redf.in/DxEDC2 - 4-plex of 3/1.5 units listed at $2m and actual NOI of $74k which puts it at a 3.7% cap rate. Projections (rents are under-market and the owner is living in one unit) list a NOI of $126.6k which is a 6.33% cap rate at the list price. The projected numbers listed actually seem rather fair at $2,950 rents where market rates are more like $4,000 if the place was updated.

How should I determine a fair valuation of this place?

Then lets say we rehab the building and get it stabilized at $4,000 rents which is let's say a $170k NOI. What is the value of the place now?

Now lets say run the units as MTR and average $5,000 per month for something like $200k NOI. Did I further increase the value on the property?

Thanks,

Jeff

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Dan H.Pro Member
Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
2y
Quote from @Jeff Thompson:

@Dan H. You're close, but I believe you selected the Kelly St. property, I was looking at the Tait St. one around the corner which is 3/1.5 and has more reasonable projected numbers. (The Kelly St one could be more appealing as there is plenty of room to add 2 ADU's however). Thanks for the headsup on SD rent control, that's more of an issue than I was thinking.

But you guys confirmed what I was seeing and thinking: it's the comps that determine value on these rather than the financials. The numbers approach appeals to me vs the "black art" of valuation, but I guess I need to become best buddies with an agent with extensive multi-unit experience anyways if this is the course I want to pursue. Is there a certain unit count that financials become dominant or is it area specific? 

I was thinking maybe it's something like land value + financials where if we're talking someplace like Ohio the land is somewhat negligible even on a small multi, but obviously in SD is highly valuable so much more of a factor. 

Going in lowish down and house hacking a local 4plex has a lot of appeal as our "getting started" first multi, but traveling a bit to buy something that doesn't bleed cash (Victorville area maybe?) would probably be a better place to start.

Thanks, 

Jeff


One more thing, you add an ADU to a quad and it now is commercial MF (more than 4 units) and should be valued based on NOI.

You may know this but commercial MF families have been more impacted by the rate increase than non-commercial MF nationally. It means that 5 units are getting valuations close to 4 units in many markets (but I have seen 4 units impacted more than 3 units, and 3 units more impacted than duplexes, and duplexes more impacted than SFH in the local market). If the rates do not increase further, the commercial MF (and their shorter term loans) can be a better value than non-commercial MF (assuming the commercial MF value does not fall further).

Good luck
 

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  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y

    First thing to note is MF in CA is rent controlled.  In addition, the city of San Diego has rent control more extreme than the statewide rent control.  This implies you cannot simply raise the rents on the 3 rented units to market rate. 

    The link did not work for me but I believe that is the Linda vista property (except market rent I saw was $3.6k which seems slightly aggressive to me - I show median to be $3.5k and I would use $3.4k because lack of any amenities).  Maybe not Linda via as those are 3/1 units, not 3/1.5.    If it is Linda vista property it is city of San Diego and it would fall under the city of San Diego rent control.  The two most common legal ways to get tenant out at lease end is to 1) move close family into the units 2) rehab extensive enough that tenant cannot reasonably reside in the property.  In both cases you must pay the tenant at least 2 months rent.  If they are senior or disabled, you must pay them 3 months rent.  In instance #1, tenant has option of first occupancy when family moves out I believe for 5 years. For instance #2, you must have permit in hand prior to tenant termination.  This does not make sense as you can add new flooring, replace cabinets, etc in city of San Diego without a permit.  So it is an absurd criteria, but San Diego city counsel is absurd.  

    So 2 or 3 months rent, city permits (I just paid $2300 to city for permits related to a rehab), and cost of rehab (I would use $40k unit for someone with minimal experience).  $3.7k * 2 = $7.4k.  $120k in rehab.  I would expect permits to be between $5k and $10k.  Architect, which is easiest way to get the permits, ~$10k.  Approach $150k to get the 3 units to market rate via rehab. 

    ARV is easy. There are dozen of comp tools or an RE agent or mortgage broker can typically provide you comps for future business. If you use the re agent or mortgage broker for comps, you show provide them business. No one wants to work for free.

    4 unit properties are not valued on NOI. Higher NOI will not increase the value; the value is from comps.

    Good luck


    1Reply
  • Evan Polaski
    Cincinnati, OH · Member since 2020 · 4k+ posts · 3k+ votes
    2y

    @Jeff Thompson, I am going to echo the last part of Dan's post, since I don't know the intricacies of SD rental market.

    To find ARV on the property, look at other renovated 4 family sales. It is like finding comps on single families, so you will look properties that are getting about the same rent in a similar condition to what you plan to do, ideally with same size units, amenities, area, etc. Since this might not exist, you have to start making tweaks to the comps: renovated 4 family in same area but all 2/1s. Renovated 3/1.5s but next neighborhood over. If the neighborhood over is nicer, subtract from their price, if your neighborhood is nicer, add to comps price.

    0Reply
  • Jeff Thompson
    OP
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    2y

    @Dan H. You're close, but I believe you selected the Kelly St. property, I was looking at the Tait St. one around the corner which is 3/1.5 and has more reasonable projected numbers. (The Kelly St one could be more appealing as there is plenty of room to add 2 ADU's however). Thanks for the headsup on SD rent control, that's more of an issue than I was thinking.

    But you guys confirmed what I was seeing and thinking: it's the comps that determine value on these rather than the financials. The numbers approach appeals to me vs the "black art" of valuation, but I guess I need to become best buddies with an agent with extensive multi-unit experience anyways if this is the course I want to pursue. Is there a certain unit count that financials become dominant or is it area specific? 

    I was thinking maybe it's something like land value + financials where if we're talking someplace like Ohio the land is somewhat negligible even on a small multi, but obviously in SD is highly valuable so much more of a factor. 

    Going in lowish down and house hacking a local 4plex has a lot of appeal as our "getting started" first multi, but traveling a bit to buy something that doesn't bleed cash (Victorville area maybe?) would probably be a better place to start.

    Thanks, 

    Jeff

    1Reply
  • Dan H.Pro Member
    Investor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
    2y
    Quote from @Jeff Thompson:

    @Dan H. You're close, but I believe you selected the Kelly St. property, I was looking at the Tait St. one around the corner which is 3/1.5 and has more reasonable projected numbers. (The Kelly St one could be more appealing as there is plenty of room to add 2 ADU's however). Thanks for the headsup on SD rent control, that's more of an issue than I was thinking.

    But you guys confirmed what I was seeing and thinking: it's the comps that determine value on these rather than the financials. The numbers approach appeals to me vs the "black art" of valuation, but I guess I need to become best buddies with an agent with extensive multi-unit experience anyways if this is the course I want to pursue. Is there a certain unit count that financials become dominant or is it area specific? 

    I was thinking maybe it's something like land value + financials where if we're talking someplace like Ohio the land is somewhat negligible even on a small multi, but obviously in SD is highly valuable so much more of a factor. 

    Going in lowish down and house hacking a local 4plex has a lot of appeal as our "getting started" first multi, but traveling a bit to buy something that doesn't bleed cash (Victorville area maybe?) would probably be a better place to start.

    Thanks, 

    Jeff


    One more thing, you add an ADU to a quad and it now is commercial MF (more than 4 units) and should be valued based on NOI.

    You may know this but commercial MF families have been more impacted by the rate increase than non-commercial MF nationally. It means that 5 units are getting valuations close to 4 units in many markets (but I have seen 4 units impacted more than 3 units, and 3 units more impacted than duplexes, and duplexes more impacted than SFH in the local market). If the rates do not increase further, the commercial MF (and their shorter term loans) can be a better value than non-commercial MF (assuming the commercial MF value does not fall further).

    Good luck
     

    1Reply
  • Jeff Thompson
    OP
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    2y

    Thank you for the insights, I really appreciate it.

    I have noticed 5 or 6 unit properties list for similar prices to 4-plexes, and higher unit counts certainly get cheaper per unit. Commercial loans are harder to get so to a certain extent that dip from 4 to 5 makes sense. I for example can househack into a ~2m 4-plex no problem but a 5 unit I'd have to come up with 25% down which limits me to something like 1.4m without doing some cash raising. And that's only if I'm ok dumping in ALL the cash we'll get in selling our house (leaving just enough for reserves).

    In general I think there has been a "compacting" of prices where the less expensive properties have been outpacing the higher priced ones as people end up shopping down market from where they would have with lower rates - Hell the house we are selling in Del Sur I wouldn't buy today, monthly payments would be like 2x what we pay and we only bought it 2.5 years ago!

    0Reply
  • Twana RasoulBusiness Member
    Real Estate Agent · San Diego, CA · Member since 2017 · 1k+ posts · 1k+ votes
    2y

    @Jeff Thompson You are correct even with a similar priced 5 unit to a 4 unit next door, most buyers are better off with the 4 unit as it has fixed financing and more often than not needs quite a bit less in down payment.  With higher rates its not uncommon to see 5+ unit properties needing well over 25% down and many even in the 45%+ with well below market rental rates.  

    A lot of times adding an ADU to a 4 unit property is not very attractive as you lower your buyer pool without necessarily adding much overall value since a 5 unit property is not value on comps and a 4 unit can sometimes demand a premium over 5 units. I have investors in San Diego buying duplexes in areas and adding 2 full size ADUs to get valuations of 2X to 3X but leaving out possibility of adding a 5th unit as the likely hood is the valuation for the 5 unit may end up being less with a lot less qualified buyers. the 4 unit could be purchased with 25% down and the 5th unit would end up needing likely 40% or more down.

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  • Steven S.
    Specialist · LA & Ventura · Member since 2023 · 119 posts · 60 votes
    2y
    Quote from @Jeff Thompson:

    Hi all,

    I'm early in the "figure out where we are going" phase and will do a ton more research before doing anything, so my question isn't if this is a good idea for a newbie, the question is: How do I value a small multi-family deal in a "overpriced" area like San Diego and determine the ARV if I'm going to try to make money by forced appreciation? (cuz haha cashflow around here unless you have a huge pile of cash).

    Just to have something specific to talk about here's a property: https://redf.in/DxEDC2 - 4-plex of 3/1.5 units listed at $2m and actual NOI of $74k which puts it at a 3.7% cap rate. Projections (rents are under-market and the owner is living in one unit) list a NOI of $126.6k which is a 6.33% cap rate at the list price. The projected numbers listed actually seem rather fair at $2,950 rents where market rates are more like $4,000 if the place was updated.

    How should I determine a fair valuation of this place?

    Then lets say we rehab the building and get it stabilized at $4,000 rents which is let's say a $170k NOI. What is the value of the place now?

    Now lets say run the units as MTR and average $5,000 per month for something like $200k NOI. Did I further increase the value on the property?

    Thanks,

    Jeff

    @Dan Heuschele is right, 2-4 unit is valued off comps not income-approach of value, BUT it is still nice to draw up the terminal-end financials of your project to ensure you are in-line with the sold comps and get used to underwriting deals.

    If you just run rent & sales comps for your terminal product (what you'll turn it into/already renovated properties), you can use them to fill in a chart like this. It will help you determine & validate the value on a Avg Sale Price, Avg Cap Rate, and Avg $/sf basis. Take the lesser of the 3 and you should have a solid estimate to be confident in:

    0Reply
  • Alex U.
    Investor · San Diego, CA · Member since 2013 · 94 posts · 32 votes
    2y

    Good conversation, I would personally avoid anything on Kelly and Tait.  Lot's of people shot at Kelly park over the years. LV had a big gang problem in the 70s-10s.  It's gotten better, but anyone who knows LV well, would avoid certain streets.  Real estate is certainly more than spreadsheets and cap rates.

    0Reply
  • Steven S.
    Specialist · LA & Ventura · Member since 2023 · 119 posts · 60 votes
    2y
    Quote from @Alex U.:

    ...Real estate is certainly more than spreadsheets and cap rates.

    Would the market not reflect that based on price? See below, Hancock Park area of Los Angeles:

    Not to advocate for a high-crime area, but it should baked into the value already (with good comp selections), something a spreadsheet would accurately reflect?

    0Reply
  • Alex U.
    Investor · San Diego, CA · Member since 2013 · 94 posts · 32 votes
    2y

    Here are the streets in question Tait and Kelly. Real estate is not an efficient market.

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    2y

    Just don't buy 5 or 6 unit, currently SF MF with 5/6 unit is crashing while 4 is doing fine. 3BR w/ $3k seems accurate rent price.

    0Reply
  • Alex U.
    Investor · San Diego, CA · Member since 2013 · 94 posts · 32 votes
    2y

    IF $/sqft on a 5-6 is better than a 4 plex, that should offset the financing hit on commercial, I would imagine?

    0Reply
  • Jeff Thompson
    OP
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    2y
    Quote from @Alex U.:

    IF $/sqft on a 5-6 is better than a 4 plex, that should offset the financing hit on commercial, I would imagine?

    I think the required down payment to clear DSCR requirements make 5/6 units hard to justify. Could be a good time to hunt for "creative financing" deals though?

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    2y
    Quote from @Alex U.:

    IF $/sqft on a 5-6 is better than a 4 plex, that should offset the financing hit on commercial, I would imagine?


     nope as valuation is calculated based on cap rate and short term financing.

    For me it's SF, duplex or 50/150 units. Rest in between doesn't quite scale.

    0Reply
  • Alex U.
    Investor · San Diego, CA · Member since 2013 · 94 posts · 32 votes
    2y
    Quote from @Carlos Ptriawan:
    Quote from @Alex U.:

    IF $/sqft on a 5-6 is better than a 4 plex, that should offset the financing hit on commercial, I would imagine?


     nope as valuation is calculated based on cap rate and short term financing.

    For me it's SF, duplex or 50/150 units. Rest in between doesn't quite scale.


    NOI will determine valuation. My point is 4 plex in LV is at $2M...Im seeing 6 units in the same area for 2.2M....producing more income.

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    2y
    Quote from @Alex U.:
    Quote from @Carlos Ptriawan:
    Quote from @Alex U.:

    IF $/sqft on a 5-6 is better than a 4 plex, that should offset the financing hit on commercial, I would imagine?


     nope as valuation is calculated based on cap rate and short term financing.

    For me it's SF, duplex or 50/150 units. Rest in between doesn't quite scale.


    NOI will determine valuation. My point is 4 plex in LV is at $2M...Im seeing 6 units in the same area for 2.2M....producing more income.


    be careful of short term financing vs long term financing.

    If you could get at least 10 years financing at least then you would be okay. I would run away from anything shorter than 7 years.

    I care more on DSCR and baloon payment rather than NOI. You could increase NOI also in 4 unit.
    The longer the financing and the more conventional loan it is , it would have  lesser risk. 
    0Reply
  • Jeff Thompson
    OP
    San Diego, CA · Member since 2011 · 86 posts · 9 votes
    2y

    Why not 3-4 units? (my guess is quality of the units thus quality of renters?) Price per unit wise generally the more units the better from what I see. I assume 50+ as staffing requirement makes more sense when you hit that scale?

    0Reply
  • Carlos Ptriawan
    Member since 2019 · 7k+ posts · 4k+ votes
    2y
    Quote from @Jeff Thompson:

    Why not 3-4 units? (my guess is quality of the units thus quality of renters?) Price per unit wise generally the more units the better from what I see. I assume 50+ as staffing requirement makes more sense when you hit that scale?


     thing is when we move to MF 3-4 ; then it's located usually in class C. While it's common although rare to see duplex in Class A.

    but these are 'generalization'; if you could find MF 4 unit in good class A/B neighborhood then you may be in sweet spot.

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