Accurate rule of thumb?

Question

I recently read about a rule of thumb for apartment investments and I'd like some BP member feedback.

The rule of thumb goes like this: "For every one million dollars of real estate you own, it should be cash flowing $2,500 per month."

This number seems a little low to me, since you would have to own a ridiculous amount of  apartments to ever set yourself free financially.

Has anyone heard of this rule of thumb, and if so what are your thoughts? It's not making a lot of sense to me when I run the numbers.

Will Barnard · Answer

A much better rule of thumb is to take the gross rents, assume 50% will go to expenses and the other 50% is left for debt service and cash flow. Then, decide what return you want. If 10%, then make sure the NOI based on the 50% rule delivers a 10 cap or better. If you accomplish this feat, a $1m building would deliver $100k of cash flow without leverage.
Leverage would lower your cash flow, but if done correctly, allow you to buy more units thus increasing it.

Joshua Andrews · Answer

Will and Ned,

Thank you both for your feedback. It appears to be a broad stroke rule of thumb and was a little discouraging when I read it initially. Seems like there is a large variable of leverage which would not make it too terribly accurate.

I know rule's of thumb are just that - a rule of thumb. It's nice to hear your thoughts on this one. Thank you both!

Will Barnard · Answer

Of all the rules of thumb, this has to be one of the worst and it is not accurate at all as amount of debt leverage is not included so no way to measure anything.
Lets assume no leverage, $2500 monthly net cash flow is $30k a year on $1M invested is a measly 3% return. You could almost get that in a long term CD! No thanks.

Ned Carey · Answer

Joshua Andrews of course it is not accurate. It is a "rule of thumb"

Lets do some math.  $2,500 a month is $30K a year

So you have a 1 Million dollar building. At a 8% cap rate that is $80,000 a year in net operating income.  Lets say you bought it with 80% financing at 4.75%, amortized over 30 years.  Your payment would be $50,000 a year roughly.

So lets subtract it out.
$80,000 NOI  minus $50,000 mortgage payment is $30,000 a year or  Hmmm $2,500 a month.  How a bout that.

Well if you owned it free and clear you could be financially free.

I never heard of it before and I was surprised how it worked out. But remember it is a rule of thumb.   - Ned