I was surprised over the weekend when an experienced investor wanted to make an offer on a Minneapolis duplex based on the average price per square foot of comparable duplex sales in the neighborhood.
While the cost per finished square foot (fsf) of a property does influence the single family home market, it has little, if any, impact when it comes to investment property.
What determines the value of a duplex?
Rent. Who pays the utilities. Neighborhood. And, to some extent, the amount someone could buy a single family home that’s comparable to one of the units for.
Let’s start with rent. Why is it important?
If one duplex in a neighborhood has a 2000 fsf studio apartment that has a market rent of $500, and another duplex has a four bedroom unit that’s just 1350 fsf, but rents for $1500 a month, which property is worth more?
From a revenue standpoint, the one that generates more rent.
What if you have two identical units duplexes in comparable condition right next door to one another. All four units in each of the two properties rent for the same amount of money.
But in one duplex the landlord pays the heat, resulting in an annual expense of $3000. In the other building, each tenant pays for his or her own heating costs, meaning the second landlord has $3000 less in annual expenses than the first.
Which duplex is worth more? The second, because it generates more income for the investor.
So how do single family homes fit into valuing a duplex?
In some popular neighborhoods, prospective home owners are priced out of the market due to the demand for properties in the area. For example, they may be able to afford a $150,000 two bedroom bungalow near a lake. However, since so many people want to live there, the least expensive single family home in the area is listed for $225,000.
This lack of affordability causes many buyers to explore the option of purchasing a duplex. They are willing to take on the added responsibility of having a tenant who pays a significant portion of their mortgage in order to live in a neighborhood they love.
This was the case with my buyer. He is actually looking for a property to owner occupy.
So when we write an offer on the property he’s interested in, we’re going to look at all of the above factors. The heaviest emphasis, however, won’t be how well it cash flows but rather, how it compares to other owner-occupied type duplexes that have sold in the area.