Fourplex For Sale... I don't get it.

I'm totally serious.  Maybe I'm showing my inexperience here, but I don't get why someone would buy this.

For sale is a four unit building in a desireable part of Los Angeles.  Check out the listing on Realtor.com.  Looks to be in good condition.  All four units are currently rented.  I called the realtor and found out that three of the four units are within their one year leases.  The fourth is currently month to month.  They have tennants sign one year leases, then let them go month to month after that.  So, this means that the tennants are paying current market rate.  In other words, the rents are not artificially low due to a two decade tennant in a rent controlled area.

The total monthly rents are $5150.  Not a bad investment property.

The problem, of course, is the asking price.  They want $1,249,000.  Plain ol' gross rent multiplier calculations tell us to look out.  GRM=price/annual rents.  As I understand it, you are looking for a GRM of around ten or less.  In this case $1,249,000/$61,800 = 20.2.  Yikes, red flags already.

But that's just an estimate.  How you finance it matters, but let's keep it simple and say that you put down 20% (~$250k) and finance the rest at around 6.5% in a 30 year fixed.  Your monthly mortgage payment would be $6,320.  Now I understand that there are tax savings and depreciation and such.  But after you pay for insurance, property taxes and maintenance, that's still a pretty huge negative cash flow.  Not to mention the opportunity cost of the $250k downpayment.  Stick that in a CD and you'll make about a grand a month.

Is it for appreciation?  Let's say you finance with an interest only for five years.  If you put the same $250k down and got a 6% interest only rate, your monthly payment would be $5k even.  After taxes, insurance and opportunity cost, you are cash flow negative.  But what if you could float by on that for the next five years.  Could you sell it for $1.5 mil and make a nice quarter million in a few years?  Or more?  But I guess I would have to ask why the next guy would pay that much.  Unless the rents increased significantly.

I don't know.  Is there someone out there with experience with this type of property?  Could you explain why you would buy it, and how you would make a profit?  Thanks.

Comments

[Lazy Man and Money]

It seems to me that in California (and Boston where I'm originally from) that the purchase prices are way over the rents. This isn't just for four-plexes, but pretty much any property you could buy.

In San Mateo county, I rent a 2 bd/1.5 bath for $1900 (I know it's an expensive place to live, but the salary makes up for it for me), while buying the place would cost around $650K - or about a $3750 mortgage. I've realized it's better to take that $2000 and invest in other areas. The place I left in Boston to move is cash-flow negative, but it's better than selling at a loss.

Some places are just cheaper to rent than it is to buy. If you want to buy an investment property, I would not look at those places.

[Lau]

I'm also just learning about rental properties myself, and I have to agree that buying such a properties would make no sense at all.

[mapgirl]

I agree with Lazy Man and Money. There are days where I ask myself why I bought an apartment in DC, because I could rent my apartment for 30% less than my mortgage and HOA fee.

But my price v. rent differential is less than $500. I get the tax break and ownership, so it kind of works out for me. When the savings is in the thousands, it doesn't make sense to buy. There's a lot of that going on in DC and the surrounding area.

[Carol]

As a Realtor of 14 years I would strongly advise against buying such an inflated property. California has been through unbelievable boom and bust cycles and the busts are truly frightening. There are a few realtors (tm) who will take overpriced listings to make the phone ring - any buyers that call will be converted to buyers for other properties. Potential sellers or comparable properties will be intrigued and inquire about the property as well. But over all professional realtors cannot be bothered with stroking the egos of unrealistic sellers.
While potential appreciation and tax savings are important aspects to consider, look for listings where the seller and realtor advertise the GRM as a
positive feature of the property, not as an apology. Grossly under-rented properties should be avoided as tenants don't look too kindly at suddenly paying double their current rent.

[hustlermoneyblog]

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[Robert Cote]

As an investment against regular income you can take about $3000/mo in depreciation and as a property you can roll a lot of expenses into "management" and upkeep. 240x rent (monthly, same as your 20x annual) is still too high. California 120-140 is saner. Most other places 100-120 is the metric. The higher multiple in CA involves stable property taxes, lower mantainence costs, etc. Oh and the multiple has been legitimately creeping up as interest rates have stayed low. Still I not only wouldn't touch this, I sold all my similar for similar multiples as did most everyone I know old enough to remember the last time.

[Bill Perry]

One approach I've looked at concerning plexes is a VA loan. I've looked into the possibility before of using my VA home loan benefit to buy a plex, for one major reason.
VA home loans have a residency requirement. Meaning, the loan applicant must live in the property in question.

One can, legally, use a VA loan to buy a 4-plex and live in one of the units. This satisfies the VA's residency requirement.

If the numbers work right in a particular deal, the rents of the other 3 units might help pay the mortgage for the entire unit. I'm sure this idea isn't an original one on my part. It struck me, however, that it might be a a valid method of entry for a vey into real estate investing, while providing him or her a "free" place to live.

That would be MY main reason to buy such a place, if I ever did.

If a 14-year realtor tells us it might not be a good deal, that may be a good indicator to stay away from that particular property deal.

[Kaye]

I am a REALTOR® in the South Bay area of Southern CA. We have always had high GRM's for income property because of the land value. The structure is never worth as much as the land unless it is new and rents while high rarely cover debt service until after 5 years. It's the land that goes up in value. A 50x150 multiple dwelling zoned lot can easily be worth $1,000,000 or more just for the land.. it's about what you can build later. If you bought a 4 plex in Redondo Beach 5 years ago for $450,000 the underlying land value could easily be $1,000,000 or more depending on location and if it is zoned for more then 2 units. Builders will snap up the property and sell new units at $750,000.. which results in a tidy profit.

[SCapitalist]

This is why I enjoy reading your blog. You provide good real estate analysis of both the good and the bad. I very interested in real estate investments, and I like how you up that into personal finance. Sadly, I am not at the point in my life where investing in real estate makes sense... Until that time, I will continue following you blog. =)

As for this property, I would stay away. The money you use to finance this deal can be better spend in another location. I once read somewhere that out of 100 "deals", less than 5 would be worth pursuing. This one would not be one of those 5.

[saneman]

I one should respect rations like GRM . An investment propoerty like 4plex must be evluated purely on return on invesment basis .

[Jonathan]

JW from Canada
Toronto can be as expensive as California
Facts for me are simple
can I buy a property where the rent covers 100% financing on the property ( not that you can finance 100% in Canada - but you need the same return on your down payment as the bank wants on their loan or why do it? )

Best way I've found to do this is to buy properties that are structurally sound but have major defects cosmetically.

Reason some people overpay so much is that they sell their single family residence and take the "sexy" unit in the building because they love it - not true investors as they have emotion tied to the unit in which they live ( location - square footage - layout whatever )

because they are using the equity gained in their past primary residence - they see it as free money rather than investment dollars.

Due to the size of their deposit they either cash flow for the balance of the loan or they may receive some positive cash flow making the deal attractive to them and less than acceptable to those of us who invest.

Keep looking you will find the property you want in the area you want - patience is rewarded

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