Why 2-4's have not fallen with rate increases and why they won't!

Question

Lately, many 2-4 unit clients understandably ask me why prices are still going up with rate increases. I have sold 40 million seen a lot of 2-4's in Chicago and the answer is simple, supply has more impact in this niche on prices then interest rates. Chicago does not allow you to build new 2-4 unit rentals on the north side (not easily or profitibly atleast) and each year more and more 2-4 units are torn down/gutted into single families making that supply lower and lower by the year. The 5+ market cooled off almost immediatly as rates started increasing but have seen 0 impact on 2-4's. The 5+ multifamily space is a lot more sensitive to rates.

What you can do about it? As always but even more important now you need to make the deal. I always recomend doing a cosmetic rehab (white quartz, white cabinets, bathroom vanity, add in unit laundry, paint) these can be done very affordably and often see a 50%+ increase in rents in the trendier house hack areas like avondale, logan square, albany park, etc. I did this on my house hack 4 unit in Edgewater. The kicker is you also create equity doing this strategy and can use that equity to get a HELOC to fund the next project which @Kristopher Toribio just did for his second house hack a 4 unit in Irving Park after finishing cosmetic rehab on a 2 unit house hack in Albany Park last year. Being able to run numbers using 10% down if owner occupant also helps boost returns vs 25% down traditional financing.

Paul De Luca · Answer

@Henry Lazerow you are exactly right. Not sure if you've seen this already but here is a great study on the topic called "Patterns of Lost 2-4 Unit Buildings in Chicago" published about a year ago. One stat from the study: " Since 2013, Chicago has lost more than 4,800 2 to 4 unit buildings representing 11,775 rental and owner-occupied housing units or 4.2 percent of its stock of parcels and housing units."

Tom Shallcross · Answer

It's a combo of lack of supply (inability to rebuild similar units in a cost effective manner, deconversions, family-owned units that get passed down...etc), superior financing options compared to 5+ space, and just the simple monthly math compared to buying a SFH or renting. We recently listed a 2-unit that went under contract 40k over ask because there is not a lot of alternatives if that's the area the buyer wants to live in. Let's say the buyer pays 465k and has a 5% interest rate. That's a 2,2500/m pmnt assuming 10% down. If tenant below is paying 1,500/m he's living in area he wants for roughly 750/m P/I payment. You obviously won't find anything ifor 750/m P/I payment in the area and you won't even find rent for double that amount if you want to keep renting. And that's just a 2 unit, obviously the numbers creep closer to actual investor-numbers with a 3 or 4 unit pumping in more rent. I'm not saying "wow, what a deal" or to copy this I'm just saying when compared to SFH or continuing to rent, the 2-4 unit househack is very appealing and thus demand is strong.

Eudith Vacio · Answer

Really great information, thanks for sharing @Henry Lazerow and another great read, thanks @Paul De Luca - I didn't realize how prominent de-conversions to SFH was in the north side.

John Hu · Answer

while there is some truth to the supply issue... I think the 2-4 units down fall because while the interest is higher, its still affordable with an FHA loan for owner occupied and there are enough people looking to house hack still that it'll prop up the market. Fannie has effectively killed the non-owner occupied multiunit loan so that means investor's aren't looking for 2-4 as hard (unless they're willing to get portfolio financing). As an investor looking to make decisions purely on numbers, I can tell you I'm out bid by FHA owner occupied offers by as much as 80k... my last one was I went in at list with 25% down conventional and a 3% FHA owner occupied outbid me close to 60k. that right there means us investors just don't impact pricing.I do think the top end of the 2-4 where you don't see has many house hackers are going to come down with the lack of funding availability... meaning buildings that spec'd on investors abilities to purchase... buildings that can't pass FHA, or the price is higher than the max loan limit with a 3% down etc... those guys are going to come down... if you can get private funding... I would look into the higher price buildings that command decent rent or buildings that can't pass an FHA inspection and just plan on spending $ to renovate afterwards

Forrest Williams · Answer

Good points. I've noticed that local governments aren't interested in upgrading basements to garden units for extra value as well. Seems like that would be a good way to add more supply and more value, provided the units are up to code of course.

Zachary Inman · Answer

Turning a 2-4 to a SFH is tragic. They usually have awkward floor plans (and sketchy renos) and so much wasted rental potential.

Henry Lazerow · Answer

Theres some BS political jargon about it in certain areas but reality you can turn multi units into single families in most of the city neighborhoods pretty easily. I had a client kill it doing roscoe village 2 units to single family conversions few years ago, rinse and repeat projects.

John Clark · Answer

--------------------------------------------------------I though Chicago was discouraging converting 2-4 unit buildings into single-family houses. No?