How to price duplex with 1% rule -- do I use current rent?

Question

I found a duplex I like, it would be my first investment property. Rent for unit #1 is 1100 and unit #2 is 850. Asking price for duplex is $225k. Now using the 1% rule, I should be asking $195k. However the rents are significantly under market. I could probably raise them to 1300 and 1000 no problem (that's still lower 25th percentile for area rents), which would make the asking price of 225 a great deal.

My question: Does the 1% rule work on existing rent or expected rent? If I have to be the one to raise the rents and possibly lose the tenants, I feel like I should be compensated for that with a lower price. Or are my expectations out of line with what actually happens in multifamily REI?

Frank Geiger · Answer

It needs to meet your criteria. What offer price allows you to get $400 cash flow and 20% CoC return for example? I would offer based on the current rents. That way when you raise rents it's like a bonus. I am sure it will need some additional work to get it up to speed.

Jaysen Medhurst · Answer

@Ken Swearengen, a few things:

• Yes, your expectations are out of line. This is a residential (1-4 unit) property. No one cares about your investment or if it will make money. In residential it's all about comps. If this were 5+ commercial, that would be a different story.
• The 1% rule is just a guide. You have to do a full analysis of every property you're considering. Share ALL the numbers here and the community will be happy to double check and offer opinions.
• Why not do both, go for a lower price and plan to raise rents? Asking prices should be ignored. If you allow the seller to anchor your valuation of the property, you'll find yourself in trouble. What are other similar properties selling for (not listed, sold)? Is this property in better or worse shape? How much renovation is required? Figure out a price that works for you then drop it down to give yourself some room to negotiate. You know what the old timers say? "If you're not cringing when you make the offer, you offered too much."

Ken Swearengen · Answer

Thanks for the helpful info Jaysen! Your comment about commercial vs residential makes sense. I am also looking into mobile home parks, which is were that risk compensation idea comes from so it's good to know there is that difference. I'm still in the very initial stages of looking at small multifamily units; I'm scheduling time with our real estate agent to go view this property and get a better idea on condition & comps. And I would never ever ever offer anything but a lower-than-listing price offer! If I proceed with the deal I'll be back on here with more detailed info.