Upside of a multiplex is limited by the upside of rent?

Question

I am in negotiations to purchase a triplex in an A neighborhood.

It is unique in that everything around it are SFRs.  There is literally no similar property nearby to comp.

I didn't use the SFR properties for comp.

I did an income expense analysis and the cap rate is barely over 6%(on my offer price, not the sellers asking price), hardly a good deal but with the current market and high insurance high property taxes good deals are few and far between especially in the better neighborhoods.

Even though nearby SFR homes have increased their values by a good bit last 2 years, the rent hasn't.

With the rent sort of stagnant, the triplex value is also limited accordingly, right?

I told the owner it has to cash flow and the numbers are the numbers and another investor would calculate this the same way, and 6% is already very marginal.  It doesn't matter if the SFR next door increased value by 30%, his triplex rent money didn't go up by 30%.

I also told him he can probably get more out of an owner occupant who will live in one unit and rent out the other two.  Immediately the property tax is lowered with homestead, financing rate is better with OCs, and vacancy rate drops 30%, so they may be more inclined to pay more.

Makes sense?  Or should the triplex be evaluated based on nearby SFR comps?

Roy N. · Answer

@Louis Leone

Absolutely!  None of these ratios or rules of thumb are rigorous enough that one should base investment decisions upon them.

For those investing for a long term hold, a thorough discounted cash flow analysis over at least the first five years of the hold period should be the minimum.  We use a home grown simulation package to model potential acquisition under varying future market conditions (most of them pessimistic) to see of the property will hold its own and provide acceptable returns in all likely scenarios.

Roy N. · Answer

@Louis Leone

I find CAP rates one of the most misused ratios out there in investorland.    Looking deceiving simple - NOI / price pad - they are only really useful if comparing apples to apples in the same bushel ... and it helps if the same person is doing the calculations on them all (using the same methodology obviously).

Even then it is just a ratio which allows you to quickly compare the cost of the similar cashflows ... it doesn't confirm any of them as a good investment.

Jeff Stephens · Answer

@Sam Leon I have a triplex as well, and have often wondered what I could get for it if I sold it. In trying to figure that out, I've personally come to the opinion that a 3-4 unit building is sort of unique because it's right on the border between a SFR and a small apartment building. Like you, I would prefer to value the property using cap rates and NOI like apartments would be valued (which I perceive to be a more sophisticated analysis), but I think in reality a triplex is a very "retail" product. One broker pointed this out to me by asking me, "Jeff, who do you think buys triplexes?" My answer: Beginning or other small individual investors. So with that in mind, they are often not familiar with NOI and cap rates, but are very familiar with the simple notion of "sales comps." For that reason, I believe that when I go to sell my triplex, I will simply be paid the going rate for triplexes, whether that correlates with current cap rates or not.

All that is to say that in my own opinion, the rents going up or down a little in this triplex may not affect the triplex value as much as it would it it were a 5+ unit building. That's just my take.

Ben Leybovich · Answer

@Sam Leon The fact that you are having trouble placing valuation is one thing.  This is simple - the question is not "what's the thing worth"; the question is "what's the marketplace think it's worth.  What's an appraiser going to think it's worth...?

A tri will be valuated via a CMA - period.  To you, as an investor, the value may be relative to some variant of CF analysis, but not so to the marketplace, bank, appraiser, etc...

With this in mind, an appraiser will weight the analysis 90% CMA, and 10% GRM.  On a small multi CAP Rate valuation is unlikely to have any weight at all.  As such, call an appraiser, give him $350, and find out how he adjusts the value.  This is what your lender will do...

Account Closed · Answer

@Sam Leon Is there a similar NBHD within 10 miles where rents are similar to the subject?  Then these are your GRM comps.  Maybe slightly higher if the demand is higher for apts in SFR NBHD.

@Brandon Turner. this is a good read on cap rates.

Sam Leon · Answer

The problem I face is there aren't any duplex, triplex, fourplex near by for comparison, it's a single multiplex within a sea of SFRs.

I happen to own the SFR right next to it.  I also own another SFR about six blocks from it, both rental properties.  I also know the tenants currently occupying the triplex and are aware of potential repairs needed etc...so the good thing is I believe I have a good handle on the projected expenses and cap ex.

Yes property value has been rising here, rent is a bit flat.  My gut does not think the rent will rise soon (or later) with the same magnitude as the rent.

Account Closed · Answer

As @Roy N. explained cap rates and GRM's ONLY help you with maket value, NOT profitability.  But if you don't know the market you can overpay and lose profit.  If you have 4 duplexes in a row you'd expect rents and expenses to be similar.  If gross rents of $24, 000 are being bought at ten times that but the one you're looking at needs a $10, 000 roof it would be appropriate to deduct that much from the $240, 000 market value.  That's just one example of making GRM more useful.

Account Closed · Answer

NO NO NO NO NO!  You are using GRM comps against your gross rents!!  A GRM on a comparable property that CLOSED had all the NOI analyzed by an investor.  So if you have a range of 8-9 GRM'S on 5 sales AND A Doofus one at 13 you are going with the 8-9 range TIMES your properties gross rents.

Louis Leone · Answer

@Bob Bowling @Roy N.

I don't disagree with the points you're making.  You would want to buy for what people are paying for that NOI (or lower).  My only point is GRM isn't much better and definitely isn't the holy grail.  All it tells you is how you compare based on a multiple of rent (it completely ignores all the variables I mentioned above), so different investors all buying at similar GRM can have vastly different profits even in similar areas.

Account Closed · Answer

@Louis Leone 
Red this thread.

http://www.biggerpockets.com/forums/88-real-estate-deal-analysis-and-advice

If you buy at a cap rate you calculated on the subject and the market is paying a LOT less for the same NOI then you are overpaying and are a doofus.

You get the cap rate COMPS and use them against your NOI to get an idea of how much the MARKET is paying.  Just like my example of $ per sf!  It means NOTHING unless you know the marker $ per sf.

Upside of a multiplex is limited by the upside of rent?

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