Portfolio of duplexes - Commercial or Residential Valuation?

Question

Hello all,

This past year I purchased a duplex to house hack using a VA loan. My plan was to stay in it a year and then buy another duplex using a second VA loan or FHA and rent the first one out completely. Then continue buying a new property once a year as long as I could save for a down payment and qualify for more loans.

Recently, I've been drawn to commercial multifamily real estate (many reasons) in lieu of small residential multifamily. So, I'm looking for a solid exit strategy and was wondering if the following would work:

Continue purchasing duplexes until I have at least three (6 units total) and then market the three (or more) properties as one commercial package. The reason for doing this would be to value the properties as one commercial package using NOI and cap rate versus valuing each individual property based on comps. From running the numbers on my current property I believe the value of my duplex would be worth a whole lot more if it was valued using NOI instead of comps.

Has anyone ever used this strategy and has it worked? I still have yet to purchase my second property but I wanted to go into it with a solid exit strategy. Any other thoughts or advice?

Thanks in advance!

Steve Babiak · Answer

Let's say you found a buyer willing to agree with your proposition, to pay more for a package than to pay less by buying individually (wouldn't have to be yours they buy one at a time). Now the buyer goes to the bank and is looking to get financing for this package so he can buy it from you. How do you think the bank is going to evaluate this package? My reply to that is most likely, the bank would use the most conservative approach, and when an appraisal is performed each duplex will be considered separately for valuation - because if they foreclose, they might just have to sell one by one.

Maybe somebody would pay all cash, maybe you seller finance - but the bank financing would expose to the buyer that they could do better. Some of the turnkey sellers have your approach working for them, so there could be buyers ...

Mike Dymski · Answer

The market is not willing to pay for NOI in a duplex the same way it is willing to pay for NOI with larger properties.  Size matters.  Whether it is real estate or any business, markets become more efficient with size and vice versa.

James Wise · Answer

I sell about 400 duplexes per year. So pretty well versed in them. It'll never happen that way.

1. The appraisal is a residential appraisal. At the end of the day the appraisal is the key to getting the deal done.

2. These properties are not solely used as rentals. Sometimes owners occupy a unit. Sometimes they are used for extended family etc.

3. If you only have 2 tenants what happens when one moves out during escrow. Is your building now worth half of what it was before? Of course not.

Yousif Abudra · Answer

@Nathan Angles  Can't agree more with @Steve Babiak, @Immanuel Sibero, and @James Wise

Your thoughts are in the right place, but in this case, you are thinking of it backwards.  Duplexes will be valued based on comps.  Yes, investors should (and do) look at NOI when valuing acquisitions, but anything under 4 units and you are in the comps business.  Think about Costco - you don't pay more because you are buying more.  You pay less.  The same is true for what you are proposing.  You should be looking to buy a portfolio of duplexes and then selling them off one at a time to maximize value.

James Wise · Answer

@Nathan Angles buyers aren't going to pay more than what they are worth just because you have a couple of them. The value will be derived from comps.

Brian Garrett · Answer

I personally would expect to get a nice discount if I'm buying a portfolio of properties.

Immanuel Sibero · Answer

Agree with @Steve Babiak

Residential properties (1 to 4 units) are valued using sold comparables, not NOI. Steve brought up a good point about the valuation issue on the lending side. Also, if you are selling a package of rental houses then you're more than likely targeting investors. As an investor why would I pay higher than comps? If anything I'm looking to pay LOWER than comps - isn't this the holy grail of residential rental investing?

I'm a relative newbie so someone can chime in here and correct me, but in general, when it comes to residential properties the comps values are usually higher than NOI/Cap values especially in a hot market. I have looked at a couple of these packages of SFR's for sale. The SFR's are actually priced slightly below comps. The motivation to sell as a package is more about saving on transaction costs (i.e. commissions, etc) than about getting a higher price.

Cheers... Immanuel

Matt K. · Answer

There's people that sell portfolios (even of single family homes scattered about) as partial/whole. Not sure how the lending side works but there's some loopnet and every once and while redfin (KCMO and surround areas for example).These were under separate MLS numbers... but if you dig about 30 of them were up for sell

https://www.redfin.com/KS/Olathe/1508-E-Leona-St-66061/home/83312494

John Minock · Answer

@Nathan Angles why sell the duplex?

Does it cashflow?

That is my first thought.

What questions aren't you thinking of to ask yourself? Is there a way to keep the duplex and buy Multifamily and or Commercial.

Albert Vallejos · Answer

Know this is an old post but figure I'd share my situation. If the duplexes are adjacent to one another and the total amount of units is over 5 than the lender would most likely have a commercial appraisal done weighted mostly towards the income approach value. This was the case with my three duplexes which I secured financing for from Fannie Mae SBL at competitive rates. The value was definitely higher than if appraised by comparable sales due to the lack of duplex comps on the area.

Portfolio of duplexes - Commercial or Residential Valuation?

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