1% rule (or equivalent) for commercial property???

3 Replies

I own several residential multi-family properties, and I'm interested in moving into the world of commercial multi-family. My problem is that when I am analyzing properties, the ROI seems very low compared to the residential buildings I'm seeing. I was expecting economies of scale to make commercial more profitable, but that doesn't seem to be the case? For example, I've been finding that I'm better off (higher ROI) buying two 4-plex buildings vs buying one 8-unit building, which is really not what I had expected!

Everyone knows about the 1% rule for residential multi-family. BUT the 1% rule just doesn't work for commercial multi-family, presumably b/c the mortgage terms are different (higher interest rate, shorter amortization, etc - I can't identify any other reason for this)??? 

What is a good method for your initial screening of a commercial multi-family building?

Ryan.

When looking at the larger deals I like to look at some way that I can make the property more valuable. So wether that be raising rents, lowering expenses, or just managing the property better.

I think that with the commercial space the returns might be smaller because there are also a smaller supply of properties. Which means everyone drives the prices up of the properties that are listed.

Where have you been buying your current properties? I see you're in San Jose. I grew up in San Mateo!

The economies of scale often don't really kick in until you have enough units to keep maintenance personnel working full time.  Until then you are still hiring out individual jobs.  Hopefully with increased discounting as you grow. 

I would expect almost zero difference in scale between a 4 and 8 plex.  

As far as property valuations, do each of them individually. Rules of thumb are a first pass analysis at best. Once you hit 16units on a single parcel, you are required to have an onsite manager in CA. So there's an additional expense to consider. Different asset classes go through different cycles. So 4/8plexes may be the hot item for a time then some intermediate sizes, say 12-40 units, then another class. So this will affect ROI analysis at specific points in time too.

Thanks for the insights. I'm looking out of state for the time being, at least until the California market comes back down to reality.

So do you guys have a quick first-pass method you use for evaluating smaller commercial multi-family - something along the lines of the 1% rule used in evaluating residential multifamily?

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