I've heard of 1% rule for buying rental properties (1% of purchase price in monthly rental income). Does that apply all the way up to large multifamily as well?
@Jerry Shen large multifamilies of 5+ units are based on current income generated and your local cap rate. I've never heard of anyone using the 1% or 2% rule for these large commercial units. Key is to buy on actual income per month and not potential. Meaning if you buy a 10 unit that is only occupied by 5 tenants, base your purchase on the income produced by 5 tenants not what it could be with 10.
@Ian Tvardovskaya makes sense so buy based on cap rate? What do most cashflow investors target in terms of cap rate?
the 1% thing really should be used to QUICKLY identify if a property is worth looking at in more depth. But reality is there are so many factors that could make something that doesn't meet it work it's almost a useless metric. Likewise, just because the return exceeds 1% it by no means that the purchase is a "good" buy either.
Similarly, just because the 1% rule is not met does not necessarily mean that the purchase is a "bad" buy either.
But yeah the concept is pretty much irrelevant to large multifamilies.
I think the 1% rule just arose as a back-of-the-napkin rule of thumb for SFRs and small multis.
@Jerry Shen , roughly speaking, when you take the "1% Rule" and the "50% Rule" (50% covers all expenses except Principal and Interest) together, you end up looking at a back-of-the-napkin "6% Cap Rule" for commercial properties.
So I guess, the "1% Rule" works about the same as the "6 Cap" Rule!
ie. Not enough information to make a fully informed investment decision on! Cheers...
In agreement with @Brent Coombs The 1% "rule" is really a quick sniff test. It means you will likely pass over great deals and not know it. But also spend time looking at horrible deals.
When screening through 40+ deals a week, yes it helps make things more efficient. But does not and cannot ever replace local market and property knowledge. That part takes time and effort.
@Ian Tvardovskaya The key may be to buying on in-place income, but any half-decent broker will make sure to have the cap rate based on potential, because cap rate is really based on "Year 1" NOI, not in-place NOI. So while it would be great to buy a B-class apartment that is 50% leased and at 1/2 market rents, at a 9% cap on in-place NOI, that's probably not the case!
I always use it. It might just be my location and my class of properties (C+, 2-20 units) but I be very nervous about buying a property that didn’t meet the 1% rule. The only exception I can see is if the rents are under market and you can bring them up. More times then not when I see a property that mess the 1% I start taking a very serious look at it.
@Jerry Shen Cap rates vary based on 3 things I'd say:
a) Class of property
b) Type of property
c) Market the property is in
The pinnacle real estate investment would be a class-A apartment building in manhattan. An investor will never have problems leasing that building out and it could probably be considered as riskless as a treasury yield. This would probably trade at a 4% cap or maybe a 3.5%. On the other hand, if you buy a class-A apartment in Tampa, an investor may be paying around a 5.5-6% cap. Still a strong market, but returns are higher since it's not a top market. For purposed of the average mom and pop buying a small apartment in their local market, targeting something around a 9-10% cap might make sense.
@Charles Kennedy you should look at some of the cap rates (or should I say lack there of lol) in SF ....
@Matt K. I'm guessing 3-4s? I'm really not up to date on the major markets... I work in Atlanta in CRE and am only familiar with rates here.
Here's a ton on info, they're back up to 4% now avg across the bay area...
But here's a older article about them getting down to 2.7% lol
or this gem lol
@Jerry Shen it should be more like 1.5% rule because with MFh you need to have a bigger margin because expenses will be higher with additional amenities. Plus you aren’t being a mom and pop land lord using bubble gum and duct tape to fix stuff.
@ Jerry Shen - What do most cashflow investors target in terms of cap rate?
I can't speak for All Investors, or even 'most' investors, but my target is as High a Cap Rate as Possible WITHOUT being in the 'War Zone'...