Appraising a multi-unit property is usually more complicated than appraising a single-family home. Two-, three-, or four-unit buildings are sometimes subject to confusion when it comes to arranging a loan for purchase or refinancing.
Generally, appraisers use the market approach when appraising these properties. They will look at sales of comparable properties, typically within the past 12 months and within a 1-mile radius in a suburban market. However, the income approach—determining the fair market rent of each unit based on comparable rents for other properties—often comes into consideration. This is especially true if there aren’t many comparable sales to be found within an acceptable time frame or geographical boundary. The cost method—comparing the cost of buying the property with the cost of building new—often bears looking at if the property is less than 10 years old. If sufficient comps exist, it’s best to stick to like-kind properties, comparing duplexes to duplexes, fourplexes to fourplexes.
Approaching multi-unit appraisals
Nikole Avers, Nashville, Tennessee–based QC review appraiser at DartAppraisal, says all three approaches are relevant to these multi-unit appraisals.
“On a single-family purchase, you think of the property in terms of the borrower/buyer moving in and living there,” she says. “If it’s a duplex, triplex, or fourplex, the purchaser probably is not going to occupy it, so their thinking, in terms of why they’re buying, will be different. Their approach to value won’t necessarily be the sales comparison approach. Sales comps are still important, but you want to give more scrutiny to the income approach. This gives you a fairer set of checks and balances. You should be able, by using both approaches, to determine the value very well.
“One crucial difference between single family and these multi-unit properties is that the comparison basis changes. Other than location, primary considerations in single-family residential assignments are generally gross living area, the number of bedrooms, and style. In two- to four-family residential, location still tops the list, but the first consideration is not price per square foot. Gross living area isn’t the first thing investors think about. They have to think like a renter. Renters think ‘number of bedrooms,’ so price per bedroom is a major consideration. We review the rental comps and look for well-supported gross rent multipliers.”
The cost approach—comparing the purchase price of a property to what it would cost to build new—is often relevant to newer properties, Avers adds. The cutoff point for considering the cost approach, she says, is usually 10 years.
“The collateral underwriter is gradually shifting the market to a more uniform appraisal,” she concludes, “and appraisers are noticing this. From single-family, to two to four units, to condo appraisals, lenders want appraisers to be more uniform in their approaches and appraisals. Appraisers need to write a little more and realize that the people they communicate with—the appraisal management company—are a second set of eyes on their reports. We’re their backup group. We want to make sure the appraisal, the appraisers, and the appraisal management company all look as good as possible.”
Many of these properties, Avers points out, are conversions from large single-family properties, so “highest and best use” will come into play. Should the property convert back to single-family for best value? Has the owner added a unit that violates the housing code, such as a basement apartment? If so, the new owner won’t be able to use that unit as part of the income stream.
These multi-unit properties are usually considered residential properties, and thus are eligible for premium fixed-rate financing through Fannie Mae and Freddie Mac. A building of five units or more generally requires a commercial loan. If a property has been zoned as a single-family unit, the income generated from an attached “mother-in-law” unit may not be considered when securing the loan.
Determining appropriate financing
Scott Sheldon, senior loan officer with Summit Funding in Santa Rosa, California, says appraisers should consider whether the purchaser of a multi-unit property will be living in one unit and renting out the others, or renting out the whole property.
“You can use fair market rents to figure out how large of a loan the buyer qualifies for,” he says. “You can buy more house and qualify for a higher loan by leveraging those rents, up to the maximum county loan limits. Here in Sonoma County, if you’re living in one of the units, you could buy a fourplex for up to $1 million, with 5 percent down, or do the same with an FHA loan, on a 30-year fixed rate in both cases, paying maybe 4.625 percent rather than 4.3. For strictly rental property purposes, you have to put 25 percent down, but you can still use the rental income to qualify—using the rents already in place. I recommend doing this if you can find a suitable property, rather than buying a single-family home, because the rents will pay your mortgage.”
The comparable sales approach will almost always be the primary criterion for appraisal of these properties. However, if the buyer is seeking a commercial loan—even on a two- to four-unit property—the income approach might come into play. This is especially true when refinancing more than one property with one large loan. A lender will, in these cases, usually want to see proof of the tenants’ leases and security deposits, and some lender will want to see that the tenants’ rent payments have been current for the past several months. (In the qualifying process, 75 percent of the gross rent per unit may be used to offset the projected monthly payment.) However, while these may be the lender’s criteria, they are not part of the appraisal.
If the appraisal is for a refinancing, the lender will often require the owner to have held the property for some time (generally 12 months) before allowing the use of the reappraisal, even if significant improvements have been made. In any case—original purchase or refinancing—the interest on the loan will be a little higher than for a single-family purchase, since the variables inherent in a multi-unit rental property increase the lender’s risk. The appraisal fee will usually be higher, too, since each unit must be examined separately.
Learn more about these methods in our course: Appraising Small Apartment Properties.
Article by Joseph Dobrian. Joseph Dobrian has been writing about commercial and residential real estate, and real estate-related finance, for more than 30 years. His by-line has appeared in The Wall Street Journal, The New York Times, The New Yorker, Real Estate Forum, Journal of Property Management, and many other publications. He is also a noted novelist, essayist, and translator. His website is www.josephdobrian.com, and he can be contacted at email@example.com.
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