Pros & Cons of adding a studio to an existing 4-plex building

[Spencer Perron]

Hi all - I have a 4 unit building in St. Paul, Minnesota. I'm considering renovating part of the basement to add another unit, effectively converting it to a 5 unit building. Wondering if anyone has ever weighed the pros & cons of adding an additional unit to a 4-plex?

While this would improve the cashflow and cap rate for resale, I'm wondering if it would shrink my market of buyers, since they could no longer use conventional financing as it would no longer conform to a 2-4 unit building. On that note, I'm also wondering if I'd be violating anything in my current loan (30 yr, fixed rate conventional financing on 2-4 unit investment property). Appreciate any thoughts folks have on this. Thanks!   

[Randall Alan]

Quote from @Spencer Perron:

Hi all - I have a 4 unit building in St. Paul, Minnesota. I'm considering renovating part of the basement to add another unit, effectively converting it to a 5 unit building. Wondering if anyone has ever weighed the pros & cons of adding an additional unit to a 4-plex?

While this would improve the cashflow and cap rate for resale, I'm wondering if it would shrink my market of buyers, since they could no longer use conventional financing as it would no longer conform to a 2-4 unit building. On that note, I'm also wondering if I'd be violating anything in my current loan (30 yr, fixed rate conventional financing on 2-4 unit investment property). Appreciate any thoughts folks have on this. Thanks!   

@Spencer Perron

Yes, I would definitely have concerns about future financing as you mention.  Also realize your insurance is based on the number of units as well.  It’s entirely likely you would have to switch insurance products  - going to a commercial policy - but check with your carrier. 

I doubt your current loan would care too much because usually it’s only looked at when underwriting…. But being that they may see the insurance change it might pique their interest in that change … you can always ask them - most banks will gladly advise you of their policies regarding such items 

4 plexes are attractive acquisitions… I’m not sure I would bump it to five if it were me.

All the best!

Randy

[Tim Swierczek]

@Spencer Perron check the data. Determine what it would sell for on a comp-based approach as a 4 unit (they don't sell based on cap rates) and determine what it would sell for as a Cap rate 5 unit. Try hard to find 5-7 unit property cap rates. Buyers of 5-unit properties are different from 10+ unit buyers. This data should give you a better answer than we can give. Randy is correct on the insurance, check out those rates. and then make your decision.

[Sam Applegate]

@Spencer Perron

I agree with the previous comments. I believe tenant laws in Saint Paul can be quite strict. I’d make sure your business plan lines up with these rules to avoid any problems. It might be a good idea to talk to a local expert to make sure you’re on the right track.

[Matthew Crivelli]

If you ever wanted to refinance the property the loan would look totally different if you make it a legal 5 unit. Lower leverage, higher rates, you will be required to pay for a commercial narrative report instead of a standard 1025 investment property appraisal. The CNR (appraisal) typically runs 2k-4k. If you want to sell it down the road, the buyer pool for 5+ is smaller. To me, it wouldn't be worth it for a single unit.  

[David Bohn]

Many of the above comments are very spot-on.

Not sure if this comment will help, but maybe there's a way to get the best of both worlds if you can build this studio separate from the building and split the lot?  Just a thought.

[Gino Barbaro]

@Spencer Perron

Great question. I think it comes down to your exit strategy. If you're looking to hold long term, and want to add value and cash flow, then I would consider adding the unit.

It will take away some buyers, and you would need to work with your lender.