Should You Add A Unit to Your Minneapolis Investment Property?

One of the most common strategies real estate investment gurus suggest is to buy a duplex, triplex or fourplex, and add a unit to it to immediately increase cash flow. While this approach makes a lot of sense, it isn’t necessarily always the right fit.

For example, the cities of Minneapolis, St Paul, and several surrounding suburbs have modified their zoning to allow accessory dwelling units (ADUs). And yet, we haven’t seen a massive influx of these “granny flats” because building them is so expensive. In fact, I’ve heard estimates well over $200,000 to add a carriage house unit.

Upscale additional units will add to the revenue a property generates. Even if the unit above rents for $2000 more a month, however, it may take nearly a decade to pay for itself.

Of course the counter argument is the additional unit also adds value to the building itself, meaning it may sell for more one day. This may or may not be true. Why?

The biggest pool of buyers for small multifamily properties, and the ones willing to pay a premium, are owner occupants. These are often first time home buyers or empty nesters looking to reduce their own housing expenses and perhaps, avail themselves of an opportunity they may otherwise be unable to afford.

The basic economic principle of supply and demand tends to inflate the value of a duplex compared to a triplex, fourplex or apartment building. That’s because many first time duplex buyers don’t want to start their careers as landlords with more than one set of tenants. And those who are downsizing just aren’t interested in the hassle.

Adding a fifth apartment to a 4 unit building causes one more complication. Banks consider any property with 1-4 units to be residential property. As a result, they are eligible for low down payment loans that are amortized over 30 years.

On the other hand the bank views a 5-unit property. That means a buyer must have a 20 percent or more down payment. Tougher still, the mortgage may be amortized over 20 or 25 years. Shorter repayment periods result in larger monthly payments, making cash flow a bigger challenge.

More importantly, the bank actually requires a commercial property to cash flow. In fact, the amount of money it generates largely determines the appraised value of the property. There is less emphasis on this in financing duplexes, triplexes and fourplexes, which usually results in them selling for more on a per unit basis.

While adding an additional unit can be a terrific way to increase revenue, it’s also important to consider your long-term goals and the best strategies to achieve them.

If you’d like to know how adding a unit would impact the value of your property, give me a call. I’m always happy to help.