Convert two Triplexs on Separate Tax Parcels to Commercial Prop

[Ryan Judah]

Hey BP Members -

I am looking at tax parcel 1 and tax parcel 2 which are on the same acre of land. It’s two triplexes, each consisting of (3) 2x1’s. They are listed for $480k and $485k. I'm wondering if I can increase the value of the property by making two changes: 

1. Remove the "boundary line" and ask the city to consider the acre one tax parcel with 6 units; i.e. commercial

2. Increase rents to market, thereby increasing the NOI, and driving the value of the property much higher due to the difference in how residential 2-4 unit properties are valued versus commercial 5+

Proforma markt rent is $1250 per unit x 6 = $7500/mo or 90k annually minus expenses of $25,550 annually = $64,450 in NOI. Assuming the listed CAP rate of 4.4, the property is now valued at $1,464,772. Even if I paid full price, the appreciate is incredible and I have 30 year conventional loans in place...

Where is the flaw in my thinking? Current NOI is only $43,390.

Thank you for your input.

[Paul Smythe]

I think this is a fun exercise, and it sounds like the conversion could be worth it. That said, I think you're operating under a few big assumptions here. None of them are necessarily wrong, but they are important to consider:

• The big one for me is you are assuming that the market cap rate is 4.4% for this property. I would double check that just in case because it's on the lower end. It's clearly a nice property in a nice area if you can get $1,250/month for each unit, but 4.4 is low.
• I would double check the $1,250/month rental rate, as well. Most markets probably won't support that type of rent to live in one unit of a triplex, but it sounds like yours might. Still, I'd do some more research on that.
• The expenses are pretty low, especially if you're converting to a commercial property. Most commercial buyers aren't going to trust your 28% expense ratio and will run their own numbers at closer to 50%. I would run the numbers at a 40% expense ratio and see how they shake out, because that is a little more realistic and would be something a typical buyer would accept.

I don't think it's a bad idea, especially at the numbers you gave. It can be a great way to pull some extra value out of a property, but I'd be cautious. Make sure your cap rate, rents, and expenses are all actually correct/make sense.