Real Estate Agent · Philadelphia, PA · Member since 2018 · 416 posts · 396 votes
Hey everyone. I'm looking at multi-families on the MLS, but I'm a little confused. Some of the properties are going for 4-500k in my market, but they don't produce 4k a month in cashflow. When does the 1-2% rule come into play?
I use the 1% (used to be 2%) Rent to Value rule as a quick test if the property is likely going to cash flow when encumbered with a mortgage. It is an inexact metric because the cost of mortgage changes overtime. Interest rate (i.e. cost of mortgage) has been at historic low so investors have been able to get away with 1% as a rule of thumb. But it won't be too long until this rule needs to be revised up when cost of mortgage starts to creep up.
From your question, I think it's worth mentioning that there are two types of "multifamily" and they're often confused. There is residential multifamily and then there is commercial multifamily. Residential multifamily are 2 to 4 unit properties (i.e. duplexes, triplexes, and fourplexes). This type of "residential" multifamily are generally valued the same way as a single family house (i.e. based on sales of other comparable houses). Because potential buyers of these properties include owner occupants, they tend to drive up the value. When analyzing these properties for investment purposes, you will often find that the numbers are way out of wack, especially in sought after areas. For example, 500k properties only generating 2k/month rent which is 0.4% rent to value. In this case, this property is not a good cash flow investment (although it might still be a good investment).
To answer your specific question: When does the 1-2% rule come into play?
Always use it. If the rule seems out of whack, you're probably looking at a "residential" type property. Take it as a sign that you'll have trouble cash flowing when financing the property.
Also, cap rate is generally a very poor, even irrelevant metric when it comes to residential properties. Cash on Cash and IRR are much better metrics.
Rental Property Investor · Kansas City, MO · Member since 2016 · 112 posts · 75 votes
7y
@Bill Plymouth The 1% analysis is a rule of thumb. This is a quick way to analyze investment deals. Of course there are other metrics such as cash on cash, cap rate, etc. I would recommend figuring out which formulas matter to you on what you would call a good deal.
Real Estate Agent · Philadelphia, PA · Member since 2018 · 416 posts · 396 votes
7y
@Michael Pearse Thank you for the response. I'm analyzing deals still trying to make sense of everything. When you look at a properties cap rate, do you use the whole purchase price or only the money you have in the deal?
Real Estate Broker · Hyde Park Tampa, FL · Member since 2019 · 2k+ posts · 3k+ votes
7y
It's the property's asset value that you use. For your analysis purpose, I would use the purchase price first - and then determine the price it would need to be acquired at to achieve the desired cap rate. Hope that helps...
Rental Property Investor · San Anselmo · Member since 2015 · 659 posts · 600 votes
7y
@Bill Plymouth I would first take a look at your goals. Are you looking for cash flow, high appreciation, or a combination of both? One you determine this, you can choose your market, neighborhood, and asset with clarity.
Also, as home values and gross rents increase, the one percent ratio becomes less critical. For example, A roof on a 500k home most likely won't cost ten times the amount of a 50k home. Use 1 percent as a rule of thumb, and then begin your analyses.
I use the 1% (used to be 2%) Rent to Value rule as a quick test if the property is likely going to cash flow when encumbered with a mortgage. It is an inexact metric because the cost of mortgage changes overtime. Interest rate (i.e. cost of mortgage) has been at historic low so investors have been able to get away with 1% as a rule of thumb. But it won't be too long until this rule needs to be revised up when cost of mortgage starts to creep up.
From your question, I think it's worth mentioning that there are two types of "multifamily" and they're often confused. There is residential multifamily and then there is commercial multifamily. Residential multifamily are 2 to 4 unit properties (i.e. duplexes, triplexes, and fourplexes). This type of "residential" multifamily are generally valued the same way as a single family house (i.e. based on sales of other comparable houses). Because potential buyers of these properties include owner occupants, they tend to drive up the value. When analyzing these properties for investment purposes, you will often find that the numbers are way out of wack, especially in sought after areas. For example, 500k properties only generating 2k/month rent which is 0.4% rent to value. In this case, this property is not a good cash flow investment (although it might still be a good investment).
To answer your specific question: When does the 1-2% rule come into play?
Always use it. If the rule seems out of whack, you're probably looking at a "residential" type property. Take it as a sign that you'll have trouble cash flowing when financing the property.
Also, cap rate is generally a very poor, even irrelevant metric when it comes to residential properties. Cash on Cash and IRR are much better metrics.
Hey everyone. I'm looking at multi-families on the MLS, but I'm a little confused. Some of the properties are going for 4-500k in my market, but they don't produce 4k a month in cashflow. When does the 1-2% rule come into play?
The best deals are not often found on the MLS.
Omaha is not an expensive market by comparison, but almost nothing on the MLS works when you run the numbers.
Omaha, NE · Member since 2017 · 46 posts · 24 votes
7y
The market also makes a huge difference. Property taxes in Phoenix are a fraction of property taxes in Omaha. Property insurance in a flood plain tends to be much more expensive than other places. These factors among others skew the "1% rule".