4 Plex Analysis - 3 Questions

[Lee G.]

I just finished episode 61 with Ben Leybovich about how to succeed in multifamily properties (I highly recommend this podcast as well as episode 60 as the two best I've listened to so far). I was interested in what he had to say about valuation 4-plex, tri-plex and duplex properties. According to Ben, NOI is not correlated with purchase price as much as larger investments such as apartments. Instead, value of property is more about comparable 4-plexes or duplexes within that market.

QUESTION 1:  Can anyone explain on why a 4-plex is valued  on Comps than larger properties?

I have been running numbers on a 4-plex for weeks using NOI, CAP Rate, and Total ROI. I have been trying to nail down what I am willing to offer based on all of these measures with a CAP rate target of 8%. I am an analytical person and want the numbers to be "right" before I purchase my first multi-family (I currently own a single family).

QUESTION 2:  Concerning the 50% rule, if I plan to self manage the 4-plex is 40% a reasonable number to use?  My own estimates are at 36% currently.  These numbers can really swing these metrics dramatically!!

I really value TOTAL ROI as a metric, which includes cash flow, equity, taxes, and appreciation. I'm assuming it doesn't get discussed as much because 1) it is very subjective in nature (such as appreciation), and 2) the calculation is more involved and dependent on financing. However, this calculation to me, is a big picture approach and could be more valuable than even CAP rate and cash on cash. I have been a landlord for a single family for going on 5 years and to ignore equity accrual and income tax benefits doesn't begin to tell the story.

QUESTION 3:   Any thoughts on TOTAL ROI as a measure?

[Ben Leybovich]

@Lee G.:

1. Properties up to 4-plex can be financed with a sellable Fannie/Freddie residential note. With that being the case, lenders (and therefore appraisers) valuate these as any other owner-occupied residential structure.

That said, for our purposes as investors, we should definitely evaluate all of the metrics relative to investment returns. However, if your plan includes either a refi or a sale, understand that the value will be driven by the comps - no exceptions.

2. I can't think in terms of "Rules". I can't comment on 50% rule, because just like the 2% rule it is nonsense...Underwrite the NOI and get comfortable - done!

3. If you want a very true picture of the investment return, underwrite to IRR. IRR takes into account all of the in and out flows of capital, including refi and disposition. You can further discount the cash flows to NPV and base your IRR on that for an extremely true picture, but one that's extremely sophisticated and nobody does :)

Hope this helps.