5 units with space for a 6th? or reno down to 4 units?

[Rachel Payton]

I recently closed on a 5 unit apartment building in Urbandale, IA.  It has 1-3 bedroom apparent and 4-1 bedroom apartments, with a gutted space that is large enough to add a 5th 1 bedroom for a total of 6 units.  I'm trying to think about what would increase my profit margin the most and wanted a sounding board.

Market rent in the area for my 1bdrms is probably somewhere between $550-600.

My 3 bedroom is currently rented at $1300, but I think it's under market, and should probably be between $1350-1500.

The options I'm toying with are converting the gutted space into a 5th 1 bdrm apartment to add ~$600 a month to income, OR, I can demo the apartment next to the gutted space, and turn both areas into a 3bdrm apartment for $1350+ a month.  I could also eventually do the same with 2 more 1bdrm apartments on the lowest level.  

The option to convert to 6 units is obviously the easiest, and cheapest option to get more cash flow quickly.  BUT, if I do convert the property to have 3- 3bdrms and 1-1 bdrm, then I'm now at 4 units.  I think I would be able to re-finance the property as a single family residence, get a lower rate and a longer mortgage.  So I would be increasing my income AND lowering my monthly payments.

What do you think?