There are no sure things in real estate investment, but there are tried-and-true rules that investors use to hedge their bets. One of them is the 1% rule. If you're thinking about getting started in commercial real estate, have this rule in your toolkit.
What is the 1% Rule in Commercial Real Estate?
The 1% rule is a guideline that many real estate investors use when evaluating potential investment properties. It states that an investor shouldn't buy a property unless the rent should be equal or greater to 1% of the property's purchase price.
To calculate the 1% rule, divide the rent by the purchase price and multiply by 100. If the property isn't currently rented and you're unsure what it would rent for, ask your real estate agent for their input.
What are the Downsides to the 1% Rule?
The rule doesn't take into account the other expenses of owning a property which can have a big impact on your investment's success.
It doesn't consider the mortgage, acquisition fees, and closing costs to buy the building. Neither does it account for the ongoing costs of ownership such as maintenance and repairs. And it also doesn't include homeowners insurance and taxes.
Because of this, most investors use the 1% rule as a screening tool besides other evaluation methods. A realtor who's experienced in helping investors find properties will help you evaluate some of these other factors.
Should an Investor Always Follow the 1% Rule?
While it's a screening tool, the 1% rule isn't the only method to judge a rental property. Sometimes it's a good idea to not follow the rule.
If the property you're considering buying is in a poor location, one where the crime rate is rising or the schools rank low, it might not matter if it meets the rule. A property that requires significant repairs could eat up all your profits, and one with poor tenants could make collecting rents a chore. The building's quality, location, and tenants still matter.
What is the 70% Rule?
The 70% rule helps investors decide if they're paying too much for a property. The rule states that you shouldn't pay over 70% of the property's after-repair value or ARV. It's very helpful if you're thinking about buying a property that needs a lot of work.
If a duplex is on the market for $200,000 and has an after-repair value of $220,000, it's over-priced. That's because 70% of its ARV would be $154,000. This rule helps protect investors against unexpected repairs that may be revealed once you tear down walls and fix up a home.
What about the Gross Rent Multiplier?
The gross rent multiplier is another valuable calculation for investors who plan on holding long term. It's used to determine the time it'll take to pay off your investment.
To calculate it, divide the total amount you're borrowing to purchase the property by the monthly rent. For a $150,000 property that rents for $2,000, this would be 75 months or 6.25 years.
If your goal is to buy and pay off properties, you can use the Gross Rent Multiplier to compare multiple rental properties. This is a rough estimation, however, so plan to set aside money from rent for annual maintenance. Most experts also advise budgeting for a 10% vacancy rate.
Clever Partner Agents can help investors find properties that have a great sales price and will bring in dependable valuable rental income. They can help first-time investors grasp these and other concepts necessary to become a successful investor. Reach out and get connected with a Clever Partner Agent today.