What deal analysis rule of thumbs are you using in your market?

Question

Good day everyone! Here is a question for buy and hold rental properties.

What deal analysis rule of thumb are you using (1% rule, 2%, 50% etc etc), and for which Chicago neighborhood or suburban Chicago market do you use it for?What Capitalization rate are you seeing?

Thank you!

Jonathan Klemm · Answer

Hey @Anjali Khetarpal, Long time no talk!

I don't really use any rule of thumbs anymore.....I guess 1% rule, but it's really just something I mentally run through my head.  It really depends on the area you are looking in.  If you are on the North side none of those rules work, but you have to go into it knowing you aren't banking on cash flow.

Andrew Holmes · Answer

@Anjali Khetarpal - A few people have pointed it own the Taxes outside the city will dictate the numbers. For single families we use Net Cash Flow of $ 400. For 2 Flats about $ 750 total cash flow, 3 Flats about $ 1150 4 unit about $1400.

This is on a 2 or 3 year lease. We don't do any year leases. Also the way we calculate cash flow is that first 6 months cash flow is all put aside.

For single family properties and small multi unit buildings personally cap rate is not a good indicator. We always have to have 20% equity after Purchase+Rehab+Carrying Cost until the property is rented out. The equity is based on a very conservative appraisal for refi. Flip value does not count because they will be much higher by 10 or 15%.

Ex. Berwyn 2 unit

Purchase Price: $ 136,000

Rehab: $ 46,000

Carrying Costs: 12,000

All In Cost: $ 174,000

This is a cash purchase so cost of money if calculated would be another 8K. I did not consider that in this example.

Property appraised for $ 232,000 on a Refi Appraisal.

Refi amount $ 174,000

Property is rented for $ 1400 Each unit ($ 2800 Total Rent Collected)

Taxes + Insurance $ 8K per Year

Common Area + Garbage + Heat/Water - $ 250

Laundry Income on Unit is about $ 900 per year but we do not count that as income

Cash Flow: $ 887/Month with zero out of pocket.

We want 25% Equity. Minimum of 40% cash on cash return if cash is stuck in the property

Cash as mentioned above and a DCR (Debt Coverage Ratio): 1.66 or higher.

Since we only do 2 to 3 year leases. Average tenant renewal rate is about 76% and average tenant stays in the property for about 4.8 years.

It's a rather strange way of doing number but it's very conservative compared to the conventional wisdom.

Mitchell J. · Answer

Like Henry said, this is highly dependent on the area and the type of property.

A good rule of thumb I like to use in A areas (Lincoln Park / Wicker Park / Bucktown / Lakeview / etc.) is 0.75%.  That is, the gross monthly rent should be 0.75% of the purchase price (e.g. $400K property should get you at least $3000 per month in rent).  Most properties in those locations won't fit this criteria, but many will - you'll need to understand the (1) types of property configurations (2) locations  and (3) the market rent / types of tenants that will work for this criteria.  This rule of thumb will guarantee that you get some decent cash flow that is worth your time, even in these A class locations.  The only exception is you are buying cheap $200K 1 bed condos in these areas... then 0.75% doesn't really matter because you're only getting $200-250 a unit in cash flow which is nothing to write home about.

You can actually hit 1% in these areas as well - with very little rehab and value add.  But the key there is to buy below market value, which is harder to do until you have more experience and connections.

Henry Lazerow · Answer

Really depends on the area and number of units. Bridgeport/mckinley/brighton can still find around 1% on 4 units. Other areas not 1% but due to so little turnover and almost no tenant issues can still be similar numbers. It will also depend on taxes many suburbs have higher % rents but also higher % taxes I like to run all the numbers and look for at least some positive cash flow and a good deal compared to comps in neighborhood.

John Warren · Answer

@Anjali Khetarpal cap rates in most of my areas in the near western suburbs are hovering around a 5.5-6.5. I would say most solid areas are a 6 at best. I actually really like using the price to rent ratios you mentioned, and I like deals where the pro forma rents can surpass 1% and ideally get as high as 1.2-1.5% depending on how the utilities are set up. Occasionally, I am able to see a deal that is even higher than that but most nice areas you are lucky to get over the 1% rule these days.

Tony Angelos · Answer

@Anjali Khetarpal it's really dependent on the area for sure. Cap rates have been shrinking, even on the south side I'm seeing buildings under 6 caps.

Francis Rusnak · Answer

Really is different for every area specifically because of the taxes. But rule of thumbs are always great to whittle deals through the funnel; so I'd say 1% is a minimum on Chicago area deals with the high taxes. If you want more cash flow go to South Side of the city; more appreciation on the North Side as general rule.

What deal analysis rule of thumbs are you using in your market?

Most Popular Reply