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Buy or Build?

Rehabbing an older building in a good location can look good on paper, but rehab dollars are notoriously uncertain, making it difficult to develop an accurate pro forma. For example, it would be wise to include a large construction fudge-factor cost (20 percent would not be excessive) on any pro forma for a rehab project. Likewise, yearly maintenance costs on an older structure can be very unpredictable. Even the amount that you’ll be able to charge for rent might turn out to be lower than you expected because of the perceived desirability of new vs. older property.

Offsetting some of these risks, many municipalities offer deferred (no interest and no payment until you sell the property) or very-low-interest loans to entice landlords to update and upgrade rental property in blighted areas (often called redevelopment zones).

New construction. If you’ve been building single-family homes, transitioning to two-to-four unit construction should be easy (see Accepted Fire Barriers for Multifamily Housing). You can use the same set of subs and — if you keep the building height at two stories or less — the same design team you used to draft single-family plans.

Building five units or more pushes you into another category that typically involves more stringent requirements and — in some jurisdictions — the commercial code instead of the more familiar residential code. In most areas, your plans for five units or more will also require the stamp of a licensed architect, and you may need a commercial contractor’s license to build them.

Financing becomes more complex and expensive, too. While a building with up to four dwelling units would typically qualify for a residential mortgage, most lenders consider a building with five units or more to be commercial property, financed by mortgages with stricter underwriting requirements, significantly higher down payments, higher interest rates, and more expensive origination fees and appraisals.

Insights From Experience

There are some upgrades I think are worth including in my projects, despite the slight increase in construction cost. For example, even when two-hour fire barrier walls aren’t required by code, I usually build them anyway. This not only makes my apartments quieter and safer — it also makes it much easier to turn my rental units into condominiums if the opportunity presents itself.

I also believe in good-looking buildings that enhance rather than detract from the neighborhood. Typically, small multiple-unit projects are built within older subdivisions, because that’s where you’re most likely to find affordable lots with zoning that allows apartments. Unfortunately, many apartment-building developers have earned a reputation for “slipping in” misfit structures that suck the charm out of these heritage neighborhoods. In reaction, neighborhood groups may draft strict neighborhood standards that are challenging to comply with architecturally if you want to remain economically viable.

Even when I’m not compelled to, I always try to build structures that look like they belong. In addition to making it easier to attract better tenants, paying attention to curb appeal goes a long way toward stretching the strict financial parameters set by an investor when it comes time to sell the building. You can get a better price for a better-looking building.

Turnovers cost money, so you want good tenants to stick around. To give them a feeling of privacy and ownership, I try to give every unit a separate exterior entry. I make sure interiors get plenty of daylight and are well-ventilated with quality bath and kitchen fans. I tie the bath fans to the bath light — to make sure they’re used — and, in the kitchen, supplement the range hood with a ceiling exhaust fan that vents to the exterior. I tie this fan to the light as well. These touches make living more pleasant and reduce damage due to indoor humidity.

I include garages in my projects whenever possible. They really only need to accommodate one car, and can be either detached or attached; both configurations work well. I also include a laundry room in every unit, rather than try to maintain a common laundry facility with coin-operated machines. 

Finishes. In an apartment, finishes need to be durable. Carpet may be initially less expensive than wood or laminate flooring, but it’s harder to keep clean and doesn’t last nearly as long. Even sheet vinyl and vinyl composition tiles last five times as long as carpet.

If you’re angling for high-rent clients, a few tasteful details will go a long way. For example, granite kitchen countertops are a reasonably priced upgrade — and so is a wide bathroom vanity with designer faucets, a large mirror, and nice light fixtures.

To save on maintenance costs, I install painted wood window sills (drywall sills always get damaged). I avoid casement windows, because I don’t like replacing cranks, and I avoid bifold and bypass closet doors so I’m not changing tracks at every turnover. I also furnish entry doors with a deadbolt and no locking knob, so tenants are forced to have a key in hand when they lock the door behind them. That way, I don’t have to respond to 2 a.m. lockouts.

Fernando Pagés Ruiz is a developer and former home builder who lives in Boulder, Colo.