4 Units Or Less, 5 Units Or More? Which way would you go?

Question

I have a piece of property with that has already been divided, utilities in place, and ready to build.  I hope to start construction by mid May.  The property is zoned R-3  which in my area allows for up to 6 units per lot.  I am leaning toward building 4 6 unit buildings on the property.  I know by building over 4 units it takes away future FHA buyers and moves me from residential to commercial in the eyes of the lender.  What advantages/ disadvantages are there to building 4 or 6 units other than the obvious additional number of units, land cost per unit.  I have not owned any rentals bigger than a duplex.  Are there tax advantages to 4 vs 6, insurance costs 4 vs 6, and anything else you can think of.  The buildings will be built ranch style, basically a duplex doubled or tripled/ mirrored to increase the number of units.  Any suggestions are appreciated.

Chris Soignier · Answer

Biggest difference IMO is that your value for 4 and under units will be largely dictated by area comps (and duplexes - quadplexes can be difficult to comp depending on recent sales in area), vs. you have a lot more influence in driving value in 5+ since it's based on a multiple of NOI.    The more control over the outcome of an investment, the better IMO, so 5+ would be my choice.

David Krulac · Answer

@Michael Hicks

FHA is only a consideration if the buyer is an owner occupant.  There is a chance of that but a smaller chance than selling to a mom and pop investor looking for a property that qualifies for a residential mortgage, where the limit is 4 units.

So in the consideration of whether to go 4 unit buildings or 6 unit building besides how long you want to own, there is the consideration of your exit strategy.  Since you are possibly building four 6 unit buildings sounds like you have possible 24 units together.  Having the flexibility of selling 25% pieces is an added feature.

But there is another possibility, and that would be to condo the units from the get go, so that you would have the added flexibility of selling each unit separately.  You would have 24 condos which you could sell individually or in groups to investors.

Michael Hicks · Answer

@Chris S., great input.  I'm leaning to building 6 unit buildings.  I would like to move all of my SFR's and have my rentals in one spot.  We will see what happens.  Thanks for the reply

Michael Hicks · Answer

@Keith Baird, The demand for affordable units in my area is great.  I usually have units filled in a week or less.  Thanks for the reply

Michael Hicks · Answer

@Steve Vaughan, Definitely a buy and hold.

Keith Baird · Answer

Another crucial consideration should be end user demand. What price point is hottest in that area, what does inventory look like? If the area is in need of luxury units, then fewer, nicer units may be optimal. Alternatively, like where I do business, the market for "affordable" units is so hot that days on market is under a week. Just my 2 cents... good luck on your project.

Jeff G. · Answer

I agree with @Virginia C. Huddleston I'm on the hunt for quads and triplexes myself.

As a rule of thumb the more units a non-commercial property has the less likely it is to be in a good area of town. It's not a hard-and-fast rule, more like a sliding-scale of sorts. So, you'll want to balance your desire for number of doors against the quality of the neighborhood and the amount of pain required in extracting rent from your tenants.

Bill Gulley · Answer

The market should determine the highest and best use, a letter of opinon by a qualified appraiser might be a better way to determine what the market demand, cost benefit might be, expected CAP rates and your return on the investment should be.

Since financing is tougher for 5+ commercial, that limits financing opportnties for you as well as any uture buyer, that effects the marketability of the property.

If you are selling, I'd find the buyer and build to suit rather than speculate.

If you are holding long term, check with your lender as to financing options down the road, 2-4 units can go as single family refinanced properties, commercial will have less desirable terms.

Taxes, depreciation will be greater simply due to cost, no real difference to the owner....but RE taxes may be much higher on multi than SFDs.

Commercial insurance will be higher than landlord policies on a SFD.

Before you "decide" I suggest you nail down the costs to build, finance, hold and manage in your market and select the best opportunity based on research......and an appraiser's opinion. Good luck :)

Virginia C. Huddleston · Answer

speaking only for myself- as a newbie investor I am looking at 4 plexs because I can get residential financing. If you choose to sale in the future that may limit buyers if you divide it up.

Steve Vaughan · Answer

For re-sale, yes I believe a quad will be easier to sell and will have a broader audience.  For long-term hold, I would max my units per lot as long as there is ample space for parking and a yard of some sort.  I bet you will find the cost to build a 6 vs 4 isn't much more, relatively speaking.  Economies of scale.  As a long-term buy and hold guy I would do 6.  If you just want to sell quickly, I would do 4.  What's your long-term goal @Michael Hicks ?

4 Units Or Less, 5 Units Or More? Which way would you go?

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