Multi-Families on the MLS and the 1% rule

[Bill Plymouth]

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?

[Immanuel Sibero]

@Bill Plymouth

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.

Cheers... Immanuel