1-4 Units vs 5+ Units VALUATIONS
^The Funny thing is, I actually have no clue why they are valued different but the lenders decided that and we’ll dig into how that evolved next week.
Somebody asked me last week why he could buy a 4-unit and barely move the needle on his net worth, but his buddy bought a 12-unit and "magically" made $300K appear out of thin air a year later.
Nothing magical here. Its just following the money principles and doing the math. Same tenants. Same rent checks. Priced in two totally different ways.
Once you see it, its hard to unsee and it may change your investment strategy.
Game #1: The house game (1–4 units) A Great Into to Real Estate.
Anything from a single-family rental up to a 4-unit gets valued like a used truck or piece of equipment.
What's it worth? Whatever the similar one down the street just sold for.
That's it. That's the whole thing. It's called the comp method which is short for "comparables." The appraiser pulls what similar properties sold for nearby, adjusts a little for a finished basement or an extra bath, and lands on a number. It makes it easy for you to do the same on zillow but also hard because its almost opinion based. And its really based on what the next buyer is willing to pay based on market conditions.
Here's the part that should bug you: the rent barely matters.
You can have a tenant paying you top dollar, never miss a check, treat the place like their own and your house is still worth whatever the neighbor's house sold for. Because most people buying a house aren't doing math. They're buying a place to raise their kids. They're emotional. They're comparing kitchens and finishes not cash flow.
1-4 unit rentals can be great for cashflow and a easy intro into the game of real estate for this reason.
Game #2: The business game (5+ units)
The second you hit 5 units, the rules flip. Now your building gets valued like a business.
Nobody cares what the building next door sold for. They care about one thing: how much money does this thing make?
The whole valuation comes down to one back-of-the-napkin formula we touched on last week:
Value = Net Operating Income ÷ Cap Rate
Lets re-visit those definitions:
Net Operating Income (NOI): all the rent that comes in, minus all the costs to run the place (taxes, insurance, repairs, management). What's left over before the mortgage. The “profit” - BUT NOT CASHFLOW the building throws off.
Cap Rate: the return buyers in your market expect. Think of it as the going interest rate for that kind of building. In a lot of markets right now, call it 6–7%.
I.E. from a prior newsletter “The cap rate is the return on investment you would receive if you bought the property in all cash. This is a great way to compare a real estate investment to a stock or bond investment because typically, you cannot use leverage (debt) to buy stocks or bonds.”
Let's run real numbers.
Say you've got a 10-unit building making $68,400 a year in NOI. Buyers in your area want a 7% cap rate or return on their money for their risk.
$68,400 ÷ 0.07 = about $977,000.
Now watch what happens when you do what professional operators are supposed to do. You raise the rents to market rate: $1,000 a unit up to the $1,250. You add another $30,000 a year to your NOI - now $98,400
$98,400 ÷ 0.07 = about $1,405,000.
You added $30,000 of income. AND The building gained roughly $416,000 in value.
Read that again. Thirty Grand of extra profit created over four hundred grand in value. That's not a typo. That's how the business game works.
We call it forced appreciation — and it's the closest thing to a cheat code in real estate.
In the house game, you sit and wait and pray the market goes up. You have less control. Still more control than the stock market thats for sure.
In the business game, you drive the number. Every dollar of profit you create gets multiplied. At a 7% cap, every $1 of new annual income is worth about $14 in value. At a 6% cap, closer to $17. You don’t have to wait or hope the neighborhood valuations go up. You're building the value with your own wits and hands.
This is exactly why I am not looking to buy anymore single family rentals.
It's why 3865 Old Post Rd — the run down 22 unit we picked up and are rebuilding is the kind of deal that that fits into our business plan. We're not waiting on the market. We're manufacturing the income, and the value creation will follow. A very large part of this deal is construction. We are doing what is a called a multifamily value add. Not just raising the rents on existing units, we are instead rebuilding units to command much higher rents - 2x.
We will dive into value add real estate underwriting next week. This is buying a shitty piece of real estate and adding value through re-construction. This is where you can really set yourself apart from the crowd of buyers who don’t know their construction numbers.
The people who build America should own a piece of it. 🇺🇸
Napkin Math one more time:
1–4 units → priced by comps. The market decides. You're a passenger.
5+ units → priced by income ÷ cap rate. You decide. You're the driver.
Go build something you control.
— Alex Appolonia Appolonia Construction LLC | The Appolonia Ownership Project