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Multi-Family Homes
Two and three family
homes are often popular as early-stage investments, especially with
homeowners looking for help paying the mortgage. Unfortunately this can
sometimes make them difficult to value.
As an investor, the key
to putting a value on a multi-family home is to take a realistic look at
the potential (or actual) net income (after deducting operating costs,
taxes and associated expenses) vs. the expected investment. If you were
to invest $100,000 in a property and you could generate a 10% to 20%
return on your investment from NET rentals (i.e. $10,000 to $20,000 in
income) each year, you might be happy, but if the same property resulted
in a net income of only $2,000 each year, or even worse, a loss of
$1,000 a year, this investment doesn’t look as appealing.
With small multi-family
homes, you are competing in the market with buyers that may want to live
in one of the units. These buyers simply look at any rental income as
reducing their living expenses; they are not looking for a specific
return on investment. Because of this, they may become more emotionally
involved in the purchase of a property than you would as a property
investor and consequently may be willing to pay more than the property
could justify based upon its rental history. (If you are considering
moving into a multi-family and renting out the other units, look at it
as a business and consider yourself paying rent on the unit you will be
living in. This will help to correctly assess the value of the property
as a business investment).
When considering the net
income, take into account ALL operating expenses in running the
property. Factor in the cost of your time to provide management services
to the property. Be sure to add in estimated maintenance on the property
over the year; also factor in replacing appliances and carpets every two
or three years (don’t worry if they last longer, that will only add to
your profits, but remember tenants take less care than you would).
One final aspect of
multi-family homes worth considering is their value as a single family
home; in some areas, the value of single-family homes has risen so much
recently that investors can convert multi family units, especially
two-family units, into single family units offering ease of access to
downtown locations.
Apartment Complexes
Once you get over four
rental units, as with apartment complexes, the economics of the
investment tend to be the same for all potential buyers. The only real
differences between buyers is the level of profit expected from the
investment (or Return on Investment/ROI) and the degree of risk each
buyer is willing to take in estimating income and expenses.
The same rules regarding
valuing multi-family homes apply to apartment complexes; i.e. consider
your bottom-line income each year after deducting all of your operating
and marketing expenses. This will give you your percentage return on
your investment.
Apartment complexes
should have a history of rental income as well as vacancy rates
available for you to review. If possible, obtain copies of maintenance
records too. Larger complexes may be managed by a property management
company. Timing is important on buying apartment complexes since you
could receive one or two month’s rent upon closing as well as any
security deposits held by the previous landlord, and you may not have to
pay your first loan payment for several weeks.
Consider immediately
raising the rent on all the units by at least $10. Very few tenants
would even consider moving for a small $10 increase and the increase
will generate added revenue for your bottom-line and increase the resale
value of your investment.
Although demand for
apartment rentals tends to be low at times of low interest rates; demand
will rise as interest rates increase. In addition, apartments can be
offered for sale instead of for rent.
Commercial Real Estate
This category includes
office space, retail space (including strip malls), industrial space,
hotels, marinas, campgrounds, ski parks, amusement parks, sporting
facilities and a variety of more obscure investments.
The complexities of
commercial property investment typically require the investor to work
with a commercial property specialist.
Land
The simplest way to put
a value on a piece of land is to consider what you intend to build on
it. If you know how to value the land with the structure you intend to
build on it, you can readily calculate the value of the land in its
present state (depending upon what has been done to the land to prepare
it for development approval). Your local Home Investor Specialist can
help you with determining the value of land.
Be wary of possible
contaminated land such as may result from oil leakage. The cost of the
resulting environmental cleanup can far outweigh the value of the land.
Be sure to check with the local board of health regarding any suspected
contamination as well as the Environmental Protection Agency. If
necessary, have the land surveyed for possible contamination before
entering into an agreement to purchase.
Other Investment Properties
Some areas have seen a
trend of investing in older motels and converting them to condominiums
or timeshare units. The motel investor can substantially increase the
total value of the property by sub-dividing it in this way, even though
the initial redevelopment cost can be substantial. (Note: some towns are
now making it very difficult to obtain permission to undertake this type
of conversion so be sure you understand local policy before making a
purchase).
Bed and Breakfast
properties can be difficult to value because many buyers consider them
to be a home with some income generating potential. For example, many of
the Bed and Breakfast homes for sale on Cape Cod each year are
significantly overpriced when valued simply on the basis of their income
generation.
As a business
investment, overpriced B&B’s don’t make sense; but as a home
with the allure of “never having to work again” they become magnets
for less experienced investors. Many of these B&B’s appear are
sold on two or three year cycles after the unfortunate owners discover
that running a B&B is extremely hard work, particularly if the cost
of staff wasn’t factored into the economics of running the business.
Before buying a B&B,
ask to review detailed copies of the accounts and be sure the owner’s
salary is included as an expense even if they are only working in the
business part-time. Also check to see all the utilities and taxes are
included in the expenses. Depending upon the business structure (e.g.
Sole Proprietor vs Corporation), you should ask to see the owner’s tax
return for the previous year to verify any income generation claimed
from the property. (If you are thinking of buying into a B&B, we
will be publishing a B&B buying guide in a future issue). |
