Before I got started in real estate investing, it seemed like a scary proposition. Finding a good place to start is a challenge. It does not seem realistic for most people to start real estate by buying a large apartment community. So, where is a good place to start?
This is where a fourplex can come into the equation. It is larger than a single-family residence and benefits from being built from the ground up to be run as a business rather than a home. This article will answer questions about what a fourplex really is, help you decide if it is a good investment for you, and how to acquire a fourplex.
What is a Fourplex
A Fourplex is a multifamily residential building with four units under the same roof.
There are a few different layouts of a fourplex. The most common type is the stacked fourplex, where two units are on the first floor and two identical units above them. A less common version of the fourplex is the townhouse-style, where four individual townhouses connect under one shared roof.
Some other names for a fourplex:
- Four Family
Is a Fourplex a Good Investment?
Investing in real estate can be a great vehicle to help you achieve your financial goals. If you have decided that investing in real estate is a good choice for YOU, then the question becomes, is a fourplex the right type of real estate to invest in.
Compared to investing in single-family residences, there are some notable differences. The first is that you will have four doors under one roof. This can cut down on maintenance and administrative expense. Here are a few maintenance items that are impacted by these economies of scale:
In the other direction of scale, there are some benefits to a fourplex compared to a larger apartment building. Most of these will come down to the cost of entry. Learning how to operate a fourplex before trying a 12-unit or 40-unit property allows you to learn while the stakes are still manageable.
The fourplex also benefits from qualifying for traditional residential financing. This helps in both the purchase and sale. A fourplex still qualifies for Freddie Mac 30 year fixed mortgages, whereas larger apartment complexes will qualify for commercial lending, usually an adjustable rate on a 25-year amortization. When you are selling a fourplex, qualifying for traditional mortgages means your potential buyer pool is larger than it would be with a 5 unit building.
The Pros of Fourplex Investing
- Capital-gains – The increased property value over time can be considered capital gains as opposed to earned income. Of course, speak with a CPA on the specifics of how this may impact your tax situation. The capital gains can even be tapped into in the form of a cash out refinance, offering investors flexibility in how much equity to hold in the property.
- Depreciation – Another benefit of rental property investing is the potential tax breaks from depreciation.
- Maintainance Under One Roof – As previously mentioned, the maintainance is more consolidated than owning multiple SFR's
- Lower Vacancy Risk than SFR – By having 4 units instead of 1, when a tenant moves out, you will be at 75% occupancy rather than 0% occupancy of a SFR. This can be a big deal for cashflow because at 75% occupancy you should still be able to cover the mortgage. In an SFR, every month that it goes vacant, you have to pay the mortgage with funds out of reserves.
- Built for Business – Most SFR's are built for homeowners. They are made to have amenities homeowners are looking for, and are not necessarily designed for efficient operation on the long term. Fourplex's are usually built with keeping maintianance costs down. They are often a box, the plumbing is stacked one on top of the other, compact floorplans, all leading ease of maintainance.
The Cons of Fourplex Investing
You are interested in investing in real estate, but your friends and family asked what you will do when you get a call at 3 am about a broken toilet. This proverbial toilet problem seems to pop up anytime someone considers investing in real estate. Out of everyone I know, probably managing thousands of units collectively, I have never heard of someone actually getting this call.
Let's consider some of the cons of investing in a fourplex:
- Not 100% Passive – Even though the time commitment of managing an apartment can be overstated by many, there is still work that needs done from time to time. Even with a maintainance person on call, automated online rent collection, or even a property management company in place; There is still work to be done by the owner.
- Desireability – Fourplexes are kind of an inbetween asset. They do not have enough units to be able to offer many of the amenities that are offered at luxury apartment communities. They are usually in residential neighborhoods and on a lot that is the same size as a single family lot. Both of those asset types are likely more desireable than a fourplex to potential tenants.
- Tenant Turnover – Because of the issue previously mentioned with desireability, fourplex's traditionally have higher turnover than both SFR's and larger apartment communities. Each tenant turnover can cost the owner money in turnover related expenses and vacancy.
Househacking a Fourplex
Househacking is a great way to invest in a fourplex. What is househacking?
Househacking is buying a property to live in a part of it while you rent the rest of it out.
The biggest benefit to househacking is that the tenants are paying the mortgage for what is typically your biggest living expense. Your housing. The other major benefit is in financing.
Financing a fourplex for a house hack can be a great thing. You could pay as little as a 3.5% down payment with an FHA loan. In addition, there are relaxed qualifying criteria and even down payment assistance options with the first-time homebuyer program.
Acquiring a Fourplex
So you decided you want to buy a fourplex. That is awesome! Well, good luck finding one. See you. Later! Just kidding, I wouldn't leave you hanging like that.
When evaluating investment opportunities, you will go through a process to source, compare and underwrite them.
When determining and setting your criteria, you narrow in on what type of properties you are looking at for investment. In addition, you will be considering which neighborhoods you are looking in, whether you want a distressed property that may need renovations, or a property that is fully renovated and ready to go.
Knowing your criteria will be important because in the next step of deal sourcing when the person you are trying to source a deal from asks you what type of property you are looking for, you want to be able to say something more intelligible than “a good deal.” Trust me.
- Real estate agents: Probably the most obvious place to start your search. Real estate agents can help you source deals from the MLS.
- Brokers: Fourplex's are in a weird quasi-commercial category where commercial brokers sometimes get them and list them for sale. Letting brokers know you are in the market to buy one is a good idea. Often brokers work fourplexes as pocket listings. This means they do not market them to the public, they only shop them to buyers they know.
- Wholesalers: Finding wholesalers wholesaling fourplexes is somewhat challenging. They are usually few and far between. However, it happens, so I recommend getting added to their lists.
- Property Managers: Property managers have contacts with many owners and often know when owners are thinking about selling. Property managers will be more likely to let you know of an upcoming deal if they know they will retain the building under their management.
- Direct To Seller: Contacting owners of four families directly is an advanced move that can save you money compared to buying through an agent. You also may be able to find a building at a location that is a better fit for you than what is currently on the market.
Underwriting a Fourplex
When underwriting a potential deal for a fourplex, you will have to ask yourself a series of questions to gather data.
- What is the rental market like?
- What is the market-rate for rents?
- What is the cap rate for this type of property?
- What is the standard vacancy rate in this area?
- What interest rates can I expect to pay on this investment?
With the data, you can then make the calculations on the property's cash flow. Finally, when you find a profitable property that meets your criteria, it is time to offer.
A fourplex will be appraised using the comparative sale method. For example, if the building is four single bedroom apartments, the appraiser will compare the sale price with other nearby fourplexes with single bedroom apartments. Many investors will talk about this in terms of per-unit costs.
Because it is a commercial investment, it is worthwhile to consider the cap rate. Not every four families will operate the same way. Some share utilities; others are individually metered. There is a difference in the desirability of different units, so the rent they will receive will be different. By determining the cap rate, you can determine if this investment will have positive or negative leverage.
When you get a property under contract, it is a good idea to have contingencies for inspections. This period is called the due-diligence period and is the time when you evaluate whether the assumptions you made in the underwriting phase are accurate to what is really going on in the property. For instance, you might have made an offer based on a 12-month historical statement, but in the due-diligence period, you will want to compare this to what the actual leases say.
How Much Down Payment is Required?
Most traditional loans will require 20-25% of the purchase price as your down payment. However, if you are house hacking the fourplex, some loans are as low as a 3% down payment.
Besides a down payment, some banks require you to set aside a reserve account. Therefore, it is a good idea to ask your bank ahead of time if they have reserve requirements so that you can plan accordingly.
Building a Fourplex
Buying a fourplex is not the only way to get involved in investing in fourplexes. You can also build a fourplex. There are some benefits to building a fourplex versus buying one. One major benefit is building apartments with floorplans that match what the market is looking for in an apartment rather than what is out there in the existing housing stock.
The process for building a fourplex is a little more involved than buying a pre-built one. You will have to buy a property, verify the zoning allows for multifamily construction, get the plans made by an architect, choose a builder, and manage the construction process.
Since there is currently a housing crisis in America, there is a demand for more housing. By building a fourplex, you are meeting that demand, and in many cases, the market will reward the fresh addition to the housing stock with high demand for the new rentals.
How Much Does it Cost To Build A Fourplex?
It will depend on how many bedrooms and bathrooms you have in each unit. It is usually the most cost-effective to build all four units the same size in a stacked fourplex. The easiest way to estimate costs is to multiply the total square feet of the building by the average cost per square foot to build.
- studio apartment: 500-600 sq ft
- 1 bed apartment: 600-850 sq ft
- 2 bed apartment: 1000-1300 sq ft
- Shared common area: 250 sq ft at minimum
So using these averages, if you were building a fourplex of one-bedroom apartments of 700 sq ft each, you are looking at a total building size of around 3,050 sq ft.
The average commercial construction cost is between $125-$200 a square foot. At $150 a square foot, the construction would cost 457,500. This does not include the land, architecture, or financing costs for construction.
Owning a Fourplex
When considering investing in a fourplex, the process of buying it is fundamental, but managing the property will have a larger impact on the overall success of the investment. Even if you bought right, an improperly managed apartment building would quickly lose money.
Deciding on whether to hire a professional property management company or manage the fourplex on your own will have a huge impact on the amount of time this investment takes and your outlook on it. A property manager will handle items as they arise much more efficiently as they are used to dealing with them.
Many people living in one of the fourplex units decide to manage the building themselves. So it takes no time to go to another unit and fix a problem is great. Though property owners often get annoyed because they may be too accessible for tenants this way.
Responding quickly and communicating well are two of the most important aspects of property management.
If you decide to rent out the property yourself, you will be responsible for advertising the building for rent. Zillow, Facebook Marketplace, and Craigslist are the most popular outlets to list apartment vacancies.
When renting out an apartment, setting screening criteria is important. Research fair housing laws before you place your ad and start screening tenants. Here are some common screening criteria:
- 3x monthly income compared to rent
- no previous evictions
- positive landlord references
You will definitely want to add to and tweak this list as you see fit.
Differences Between Fourplex and Duplex
The biggest difference between duplexes and fourplexes is that duplexes are two units and fourplexes are four units. That is fairly obvious, but it has some significant implications on how they behave like investments.
Duplexes can often be converted to single-family residences. In my market, there are neighborhoods that SFR's are going for a top-dollar where apartments are relatively stagnant. So being able to convert to an SFR gives you one more potentially lucrative exit strategy as an investor.
Duplexes are also more attractive to owner-occupant investors. Many duplexes feel more like living in an SFR, where a fourplex is a lot closer to an apartment community.
Because of these reasons, in my market, the rental economics of fourplexes are usually much better than duplexes.
When is a Good Time to Buy a Fourplex?
The perfect time to buy is when prices are low, interest rates are low, lenders are lending, and rents are high. Barring that, pretty much any time is a good time to buy so long as you have adequate cash reserves and the property has a satisfactory cash flow for you.
A fourplex is a residential housing unit where four units are under one roof. Fourplexes are a great segment of residential real estate investing. However, there are pros and cons to investing in a fourplex.