Please clarify my Real Estate Math

[Thomas Kambadzi]

I am seeking a second opinion on whether I am doing this right. If I am looking for properties that pass the 1% rule, say for example the property is going to cost a hypothetical figure of $1M, it means I should be able to charge a monthly rent of $10k for it to pass the 1% rule.

In this case the annual gross revenue would be $10 * 12 months = $120K

Then it means the cap rate for it would be 12%? (i.e. $120K divided by$1M * 100 = 12%).

This being said I have been scrubbing the (Canadian) MLS for a while now and haven't yet seen any multifamily property advertised with such a cap rate. The average I see is around 6%. I have also read that high cap rates are red flags for high risk investments. Is it then even realistic to look for such a cap rate (i.e. 12%) when shopping? 

Some properties would meet the math if they were bought, renovated and re-rented at up-to-date market rents however after reading online I am realizing that landlords can be in trouble for "renovicting" tenants of the previous owner with the sole intention to increase rent afterwards. 

All the above being said; how are people in Canada actually buying positively cashflowing properties were you can put "real" money into your pocket every month, starting from day 1?

[David C.]

The 1% rule is based on gross rents. Cap rate is based on net rents. Thus, need to multiply $120k by the expense ratio (generally understood to be 50%, although it can vary depending on property) before using it in the cap rate formula.

Using your example …

1% rule: Gross annual revenue would be $10k * 12 months = $120k … as you said.

Missing step: Net rents are $120k * 50% = $60k

Cap rate: $60k/$1M = 6%

So, a 6% cap rate is the same as the 1% rule.

This is roughly speaking of course. These are all rules of thumb.