Analyzing a Duplex Vs 40 unit Apartment Complex?

Have you ever wondered if analyzing a 20 unit or 40 unit is similar to analyzing a duplex? Do the same rules apply? As far as the 1% rule or 2% rule? Well the answer is no, analyzing a 40 unit is very different from analyzing a duplex, it’s actually a lot easier to analyze the 40 unit apartment complex than the duplex. You might be wondering, well how can that be? With a duplex, its only two units I have to worry about, that is a lot less moving parts then with a 40 units.

Truth be told, I was under the same impression too. I currently own a duplex and before I bought it, I analyzed a lot of duplexes and what I realized is that once you account for vacancy, CapEx, repairs and maintenance and we can’t forget property management, you realize there is usually not enough spread there to have a good amount of cash flow unless you remove the property management aspect and self-manage which i currently do, but how much is your time worth? You see with a 40 unit complex all of the expenses mentioned above are accounted for upfront because a 40-unit is going to be bringing in a lot more income to cover those expenses than a duplex thus allowing you to cash flow adequately per your particular investing criteria.

Another aspect of Commercial properties that is easier to analyze is that unlike residential units where you have to rely on comps for the value of a property, with commercial properties the performance of the building dictates the value. The higher the income of the property, the higher the value rises, the lower the expenses of the property, the higher the value rises. There are only three levers you need to worry about when it comes to analyzing a commercial property; Cap rate, Price and the NOI.

Cap Rate

What is Cap rate? Well the Cap rate is the ratio of the net operating income and the purchase price of the property if you were to buy it cash. What does that really mean for you an investor? Well it’s a measure of risk, a higher Cap rate is seen as more risk, a less stable property and potential upside meaning higher returns whereas a lower CAP rate means a more stable asset, less risk and less returns. As an investor you cannot control cap rates, what controls it is the macro and micro level market influences and the type of property you are purchasing. Put it simply the cap rate tells you what other investors are willing to trade at for a specific type of property in a given market.

Price

This one is relatively easy, most folks when analyzing a property start by looking at the asking price but price is relative. There are three different prices you have to worry about, the seller’s price which is usually way out of the box because of their belief that their particular asset is worth a lot more than its current production and the illusion that expenses are always low. The second price to worry about is the true value of the property which is usually way under what the seller is asking for because you as a potential buyer has actually looked at the real expenses and the vacancy of the property. The third price to worry about is your price, which is the amount you are willing to pay to acquire the property; you want your price between the asking price and a price that allows you to meet your investing criteria. The different prices points tell a different story with different facts and you want your version of the story to be told and ultimately accepted as the factual story.

NOI

The Net operating income is one of the three levers that you can move to affect the value of an asset. Put it simply the net operating income is the gross income less expenses not including the debt service. With that definition, there are only two ways to increase the Net Operating Income, you can increase the rental income or you can decrease the operating expenses. In a small 2-4 unit situation, you can increase the rents as high as possible or decrease your expenses to where they are almost non-existent and unfortunately you will still have to rely on the residential market and the comparable analysis of your particular area to get a value of your property. This is why it is easier to analyze a 40-unit and it gives you more control of the direction of the asset.

As you can see, analyzing a 40-unit is easier than a duplex for the simple fact that there is more income to account for all the expenses and the asset can run itself assuming you have an appropriate property manager in place because they can make or break the success of a project. With Commercial properties you only have three items to worry about, the Cap rate which you cannot control, the price which is relative based on who you are asking and the NOI which allows you to directly affect the value of the asset. The only challenge here is that, unlike a duplex where you can save enough funds to use as a down payment or partner up with a buddy, with bigger commercial properties, you would need to raise the funds from investors to acquire the asset and ensure that after the investors return, you as the deal finder and manager receives an acceptable return for putting it all together.