4-Plex vs. 12-Plex: shouldn`t CAP Rate be Significantly Different?

[Nir]

Hi All,

I find it interesting that the CAP Rate of a triplex or 4-plex in certain areas is very similar to the CAP Rate of apartment buildings like a 12-plex in the same neighborhood. (around 8%)

Shouldn`t the CAP Rate of a 12-plex be significantly higher due to the higher risk - more expensive, more money down, AND its advantage to size - less roof per unit, less furnaces per unit, etc.?

Do CAP Rates tend to increase with the number of units or does the finding above reflect reality, meaning not necessarily?

The answer can help decide, for example, whether purchasing two 6-plexes is better than one 12-plex in the same city(?) (as always there are other factors to consider)

Also, what do you think is more risky – purchasing two 6-plexes or one 12-plex in the same city?

Thanks & Regards,
Neil

 

[Thomas Beyer]

CAP is a function of: interest rates, expected yields, expected rental upside, demand, in-migration, land cost, state of the asset, # of units, economies of scale, construction cost of a similar new asset, condo conversion potential, supply & demand, location, location potential, unit size ..

all things being equal (and they usually are not) a 6-plex should have a lower CAP than a 12 plex since it has more land per unit, or more cost per unit (doorbells, boilers, hallways ..) i.e. more $s per door assuming the rent is the same, thus: a 120 suiter is better than 10 12 plexes ! or a 12 plex is better than 2 6-plexes (assuming same rent per unit) .. as your operating cost per door are lower in a bigger asset and it is usually "denser" i.e. more doors per boiler/roof/land !

However given the many variables listed in the 1st sentence, it could be that your 6-plex per door is cheaper than the 12-plex !

 

[DrewBetts]

CAP rates are driven by buyers` expectations of future returns and risk. If you take a building that is in an area that is poised for growth, or has an opportunity to condo convert or reno and generate quick value, the CAP rate should be lower because a buyer is willing to pay more for the same amount of NOI. Larger buildings are typically lower risk, from the perspective of tenant risk, because if you have a 4 plex and 1 unit is vacant, you`re at 25% vacancy, whereas if you have 100 suites and 1 is vacant, you have 1% vacancy.

CAP rates in A class areas will be lower than secondary markets, because a buyer is willing to pay more for a building in that area. For example, in Edmonton right now, wood frame walkup buildings in primary areas are trading at about a 5.75% CAP, but the same building in a secondary area would be 7%.

Hope that helps. Cheers!

 

[Nir]

Hi Drew and Thomas,

Assuming CAPs were the SAME what would you buy: one 12-plex or two 6-plexes? (assuming everything else is the same including potential future CAP, again same neighborhood)

Re: CAP itself - I think the rule is the higher the risk the higher the CAP.
In the same neighborhood do you see purchasing two 6-plexes as higher, lower or the same risk as one 12-plex?

It is not an easy question! For example vacancy is no longer an advantage as you have 12 units in total in both cases. risk also works both ways. with 12-plex if something severe happens to the building 12 units are gone, if a 6-plex is gone you have another one. However, with two 6-plexes there is higher failures rate due to more roof per unit, more furnaces per unit, etc.

As Thomas mentioned "All things being equal (and they usually are not)..." - that`s my point, they are NOT. Yes, the CAP is a function of many things, let`s not forget, including the purchase PRICE. I`m trying to look at it from a macro economic level not micro. micro explains the CAP calculation. however the question is regarding market supply and demand defining a certain PRICE that generates certain (similar?) CAP.

I think (hope) this is a VERY important discussion for many investors because it can help decide what property type to purchase: 4-plexes, 20-plexes? Big difference.

Regards,
Neil

 

[Thomas Beyer]

QUOTE (investmart @ Nov 1 2008, 11:58 AM) Hi Drew and Thomas,

Assuming CAPs were the SAME what would you buy: one 12-plex or two 6-plexes? ...

I think (hope) this is a VERY important discussion for many investors because it can help decide what property type to purchase: 4-plexes, 20-plexes? Big difference.

Regards,
Neil
hard to say .. usually bigger is better ! i.e. a 12 plex is better than 2 6-plexes .. BUT: if they are the same price/door .. you might get a better deal with 2 6-plexes as they should have been more expensive but are not.

You can sell one, but keep the 2nd (assuming 2 mortgages, not one) .. so it depends on your goals and the many issues I mention in my opening sentence !

 

[Nir]

THANKS Thomas. I like it as a general rule "if they are the same price/door .. you might get a better deal with 2 6-plexes as they should have been more expensive but are not."

I know we are used to thinking about it this way - the more units, the lower the price/door is. HOWEVER:

1. Is it really the case? As mentioned, in different cities I found duplexes and triplexes where price/door is around $55K where 6 plexes are sold for around $420K
or $70K/door.

2. Why should we expect a lower price/door with more units? if we agree there is more risk, at least from certain points of view, to buying two 6-plexes compared to one 12-plex then perhaps they shouldn`t be more expensive AND are not more expensive in reality as suggested in #1. Also, as you too suggested, 12-plex (more units) is less headaches, less roof per unit etc.. THEREFORE, isn`t the market price (demand and supply) actually "compensating" those buying more properties and less units per property?

What I`m trying to say is because of it working both ways (the risk, amount of work, headaches..), I am no longer sure the price per door is or should be lower when buying more units per property. Hope I`m not confusing everyone

Regards,
Neil

 

[Thomas Beyer]

QUOTE (investmart @ Nov 1 2008, 03:34 PM) THANKS Thomas. I like it as a general rule "if they are the same price/door .. you might get a better deal with 2 6-plexes as they should have been more expensive but are not."

I know we are used to thinking about it this way - the more units, the lower the price/door is. HOWEVER:

1. Is it really the case? As mentioned, in different cities I found duplexes and triplexes where price/door is around $55K where 6 plexes are sold for around $420K
or $70K/door.

2. Why should we expect a lower price/door with more units? if we agree there is more risk, at least from certain points of view, to buying two 6-plexes compared to one 12-plex then perhaps they shouldn`t be more expensive AND are not more expensive in reality as suggested in #1. Also, as you too suggested, 12-plex (more units) is less headaches, less roof per unit etc.. THEREFORE, isn`t the market price (demand and supply) actually "compensating" those buying more properties and less units per property?

What I`m trying to say is because of it working both ways (the risk, amount of work, headaches..), I am no longer sure the price per door is or should be lower when buying more units per property. Hope I`m not confusing everyone

Regards,
Neil

too many variables: is the size the same ? the land ? the location ? the condo conversion potential ? the view ? the rental upside ? the location ? !! to many "what ifs" and too many "could be this .. or could be that" .. the market is the market .. and the price is always what someone is willing to pay ..

 

[housingrental]

Hi Neil

1) This is rare when equal quality - ie is the lower cost per door a function of deferred maintenance? below grade suite? small size?

2) You should (often but not always) expect a lower price per door with more units because of generally less demand and greater barriers to entry. Ie a) less owner occupied and b) harder to finance - few people can afford the deposit, get a loan, have to pay higher interest on that loan, etc..

So often in markets the cost might look like:
Condo - $150k - 150k suite
Duplex - 250k - 125k suite
Triplex - 330k - 110k suite
Sixtyplex - 3.6mil - 60k suite

 

[Nir]

Thank You Adam for the input and example!

You are correct, I guess those duplexes/triplexes/4-plexes I mentioned are in fact in a worse condition than the multiplexes in the same area so it is not a good apples to apples comparison.

Your explanation of price/door differences, supply and demand, and the difficulty in obtaining financing for a property with more units (i.e. 12-plex) being a significant factor affecting actual demand, makes sense and is what I was looking for.

Regards,
Neil