[youtube]http://www.youtube.com/watch?v=_0jyKabLHVc[/youtube]Real estate isn’t like a Rolling Stones tune.
A seller can’t always get what he wants, or needs, out of the Minneapolis duplex or multi-family property he’s selling.
The market determines the value of investment property; not the amount of capital gains tax a seller may have to pay when he sells, nor the amount of money he’s put into the property.
What contributes to value?
First, duplexes can be difficult to price because there are two distinctly different markets for them: owner-occupants and investors.
For today, I would like to discuss an investor’s perspective.
Unlike single family homes, duplexes are not valued by the amount of finished square feet, nor the numbers of bedrooms or bathrooms.
The biggest single contributor to value is the amount of revenue the property generates every year after expenses.
Most investors want a property that gives them some return for the time and effort they put in to managing it. The minimum returns my investment buyers expect are as diverse as their personalities.
While there are exceptions to every rule, a property should, at the very least, cover all of its expenses, including the mortgage.
Most investors, however, are looking for the most favorable return they can find on their money. A good barometer of this is in smaller properties is something called the “cash on cash” return.
The easiest way to think of this valuation is to compare it to the amount of interest your money would earn in a savings account. If, for example, you had $1000 in a savings account that paid you 3 percent annual interest, at year’s end you would have earned $30. That $30 would be your cash return for the $1000 in cash you invested.
Now, if you heard of a money market account that was paying 6 percent interest, would you be interested in moving your investment? Probably. Provided the risks associated with the two were comparable.
An investor is doing the same thing. Where can she put her money, in the form of a down payment, in order to get the highest and best return?
To illustrate, let’s say there are two four-plexes on the market, in the same neighborhood, with the same number and type of units. They have identical rental income, both were built in the 1960’s, and they are listed at the same price. In fact, the two properties could be twins. However, there is one distinctive difference between the two.
In one building the tenants pay their own heating bills. In the other, the landlord pays the heat. Which property is likely to give the investor a better cash return?
The one with lower expenses; meaning the one where the tenants pay for their heat.
It doesn’t mean the one boiler building is a bad investment. It simply needs to be purchased at a price which allows the buyer to obtain the same return. In other words, for less.
Of course, a high return isn’t the sole criteria investors use. Some buildings have terrific returns, but may involve a higher degree of hands-on management than an investor is willing to take on.
Others may have a low return, but are in a highly desirable neighborhood, where the risk of vacancy and intangible promise of appreciation is greater.
No matter what, a buyer isn’t going to pay a seller more simply because that’s what he owes on the property, or because he had to buy a new boiler last year and now wants that expenditure reimbursed. (After all, a property in Minnesota likely won’t be able to appraise without a working heating system.)