Can any one explain me why you guys use monthly gross rent divide by00.2 to get purchase price multifamily.I was searching100s property to find one good and everyone was overprice almost in a half .
I was searching100s property to find one good and everyone was overprice almost in a half .
That’s exactly right. The vast majority of new landlords pay retail for their property and then go out of business in a short period of time due to lack of cash flow. Search “operating expenses” on this forum and you should begin to understand.
You are also correct that there are hundreds of properties that are not good deals for every property that is a good deal. You didn’t really think this was easy — did you?
I don’t think I’ll ever find a multifamily for $50K where the monthly gross rent is $10K ($10K divided by 0.2)!!
Typo. Kris meant 2% (.02). In your case Comreinvestor, this would be $50000 x .02 = $1000 per month
I suggest that this is a regional number. Use 2% in California or New York City and let me know how many properties you buy. In the mid-west, which did not enjoy the meteoric appreciation as other parts of the country (the rust belt in particular), rents are relatively high and home prices are still relatively low. Thus, the method works well there. I have a feeling that those who advocate this method to screen deals are generally located in these regions. The approach is not without flaws though.
One problem with this method is that you’ll tend to miss properties with below market rent and gravitate toward relatively high rent deals. Using the example from above, let’s say market rent is $1000 per month. At $1000/.02, you’d be happy to pay $50000 for the property. If you found the same property rented for $500 per month, you might say it’s only worth $25K ($500/.02) and pass on it. You’ll argue that since you know your area well, you know the rent should be $1000/mo. If that the case, you probably have an idea of the value of the home anyway and don’t need this criteria.
Unknowledgeable out-of-state SFR investors should be especially wary of this method and commercial investors should ignore it. Commercial is valued on income so you want to find the low rent deals in the area – not rents limited by a 2% of asking price screen.
I’ll add that those I know who use this approach to screen SFR deals, use 0.8% to 1% and they do very well. It’s not a hard and fast number.
Thank you for respond.Yes.I meant 0.02 not0.2 sorry my mistake.If I understand This formula dos not work in every part of country.I live in Chicago area and I am looking for property with positive cash flow but the price are very high for exemple
monthly income $4825
If I use 0.02 formula I can not pay more than$241.250.That is not real.Last year similar properties sold for $599.000-610.000.How they can be good investment? Iam new in real estate investing all I know is from books and tapes.I want to buy multifamily property and I am looking for every good advice.
You should pay $241,250 or less.
I learn something new every day. According to you guys money is different depending on the area you live. Money is the same in the few states I invest in. When your bank accounts go negative, just explain to your bank that money is different in Chicago.
Do NOT invest using .8 - 1% and use the 2% rule where you live or don’t invest.
Thank you Iron Range.Can you explain me why you use 0.02 formula.Why we can not use any different number?
1 + 1 = 2. This is true for Minnesota or Chicago. I’m not sure why people are telling you differently.
Rent = $1,000 duplex for $50,000
500 Net income (this is your profit - mortgage)
- 350 ($50,000 Mortgage pmt at 7.5%)
= 150/2 units = $75 a unit profit (you want $50- $100 profit a month per unit)
Thanks again Iron Range.Can I use this formula for large number of units for example 50 or 100units?
I do and it has worked out for me. If you go onto websites like loopnet.com you will see a pattern. Around 50% of all the rent goes to expenses other then the mortgage. On top of this formula, I also like to look at the Schedule E. I’ve never found a method easier or more accurate then the one listed above.
I use $50-100 a month per unit as a guide for bidding. I use $50 because that is the minimum I will accept. I use $100 as the max because if it cash flows over $100 a month per unit, then I will “typically” pay full asking price. I don’t need any more properties so I don’t follow that rule much any more. I like to bid lower then the purchase price even if it is already low. Just to see what will happen. Most of the time it’s rejected but I usually can get a few thousand off even a great deal. I recommend using the $50-100 a month.
Thanks again Iron Range. One more question about example from above.Why you use purchase price 50.000 to calculate mortgage payment without down payment?
Iron Range is exactly right. You do need to get about 2% of the acquisition cost (purchase price + rehab cost) per month if you want a property to cash flow. It is absolutely ridiculous to say that this is different in California than it is in Indiana, Ohio, Michigan, or any other flyover state. It is true that many people made money with appreciation in the bubble areas, but they aren’t making it NOW. In fact, many of those people who bought investment property in the last year or two in these bubble areas are now suffering; have lost a lot of money; and many have had their property foreclosed upon.
The problem with this idea is that speculating on appreciation is nothing more than gambling. Sometimes you win and sometimes you lose. Since I operate a full time rental business, I can NOT afford to lose and I do not gamble. I only buy properties that I KNOW will cash flow and I only buy properties that will have a minimum of 30% equity at closing.
Why you use purchase price 50.000 to calculate mortgage payment without down payment?
We use the total purchase price to calculate cash flow because there is a cost to the money. Whether you borrow the entire purchase price or use a down payment, there is a cost to every penny. So, we consider the cost of the money. Whether you pay 8% to the bank for the money or lose the ability to earn 8% on the cash you put down, it is still costing you 8%. Therefore, we consider the entire purchase price in the cash flow equation, as it should be!
Does this formula give you the value of the property or does it give you the price you need to purchase it for to make good cashflow?
It is a screening tool to tell you the maximum price you can pay for the property and still receive an acceptable cash flow. Please note, you still need to do a cash flow analysis (using real world expense numbers) and other due diligence.
Myself and a few others posting here have debated the usage of the 2% number and the GRM versus the cap rate. Let me put my two cents in concerning a multi family I recently purchased. 3 unit building generates $1,750/mth. Using the 2% rule you would be willing to pay up to $87,500. This property was listed for $150,000. I bought it for $135,000 using cap rates to evaluate the building. I make just over $600/mth on this building. Obviously, that’s right at $200/unit/mth, which according to previous posts is pretty damn good. If I would have used the 2% rule and offered no higher that $87,500 I would have been laughed at. Instead I know the local cap rates and what rates I’m willing to buy at and still make good deals, better than $50-$100/unit these people are talking about. Learn about Cap Rates, stay away from 2% or you will be searching forever.
You paid too much for that building. You may not realize it yet, but unless you bought the cash flow with a big downpayment, you certainly will not have a cash flow of $600 per month.
Here are the numbers:
Gross Rents: $1,750
Operating Expenses: $875
Mortgage ($135K, 30 yr, 7.5%): $944
Monthly Cash Flow; $69 LOSS (OUCH!)
I would STRONGLY suggest that you learn and understand operating expenses before you buy anything else. Iron Range is EXACTLY right, math is the same everywhere.
I have owned that building for 4 months now, the property is stabilized and that’s what the numbers are. Where are you getting that I have $875/mth operating expenses? You are investing in the wrong asset class my friend. My holdings are all student housing. Guess how much annual expense I have to market the properties. $20 a week twice a year, once for each semester, $40 total or $3.33/mth. Too insignificant to even calculate into NOI. Taxes and Insurance are about $200/mth total. In 4 mths my maintenance has totaled $30, totaling about $7/mth, once again insignificant with regards to NOI. Legal fees=$0 besides closing the property. Management =$0, do it all myself. The other fees you speak of are way too inconsistent and unpredictable to calculate into NOI, so I use a number of 5-7% which would be about $140-$175, usually this number is $0 though.
Here are the real numbers:
Gross Rents: $1,750
Operating Expenses: $200-$250
Mortgage ($135K, 30 yr, 5.99%)-I’m smart enough to do these deals on the residential side because of lower rates=$808
Monthly Cash Flow: $650 to the good side (GREAT!)
I would STRONGLY suggest that you learn and understand student housing and before you buy anything else. With the 2% method a person could be looking forever for a diamond in the rough when they could have obtained a handful of good performing properties in that same amount of time.
I have owned that building for 4 months now, the property is stabilized and that's what the numbers are. Where are you getting that I have $875/mth operating expenses? You are investing in the wrong asset class my friend.
Four whole months - huh? That’s funny!
In 4 mths my maintenance has totaled $30, totaling about $7/mth,
And since you have 3 units, your total maintenance expense is only about $2.33 per unit per month! I would like to congratulate you on having the lowest maintenance expense of any landlord on the planet! Want to make a SUBSTANTIAL BET that that is going to continue? If you were being more realistic, $175 per month would have been closer to the truth.
It’s also funny that you think I own a different asset class. I have EXACTLY the same class of tenants that you do. In fact, I have more student rentals than you do and I can tell you for a fact (based on a little more than 4 months experience) that students are very hard on rentals. When will you realize this? When school is out and the lease is up.
Legal fees=$0 besides closing the property.
Again funny! You’ve only got THREE UNITS. I evict about 1% of my tenants per month and at that rate, you should be able to go 33 months before you have an eviction. However that doesn’t make it insignificant. If you have a very routine eviction, that could cost $600 in legal fees, court costs, and setout fees (or more depending on your state). In addition, that will normally cost you at least two months of vacancy (one after your deposit is gone) and of course you will have whatever cleanup/damage is left. If there is absolutely no damage (rare), then your looking at $1,185. More typically, in an eviction there will be some damage and occassionally very significant damage.
Management =$0, do it all myself.
What you’re really saying is that YOU WORK FOR FREE! Someone is managing that property (in this case you) and you are free! I manage my own rentals also, but I get paid to do the management. Maybe fuel and vehicle expense are free in your area, but not here in Ohio. Insignificant - no.
The bottom line is you blew it. Your numbers are WAY off and this will become apparent over time. If you do better in the future, that will mitigate the loss on this building. If you buy a bunch of buildings like this one, you’ll soon be out of business.
Odds are that in 4 months you wouldn’t have to replace a furnace, the roof, etc. But in a few years? Sure these things come up along the way. Maybe you didn’t have any of those expenses so far, but they will come. And that’s where you will see the repair expenses skyrocket. This is why you buy low enough to cover all of the expenses, not just the day to day stuff. Eventually a big item will break or you will have a messy eviction, once factored in I’ll bet dollars to pesos when you average out your real cashflow for the year it won’t be $200/month.
A dollar may be a dollar everywhere in the states (except for California. California dollars appear to be different) but the 2% rule will not work in some parts of the country.
There are places where if you try to use the 2% rule, you will never ever be able to purchase anything.
It’s absolutely beyond me why any tenant would pay $1000 a month in rent for a place that they could purchase for $50,000, but I guess some of you have tenants who are even dumber than mine.
Real estate is a local game and if you want to play locally, you need to figure out how it is played locally. And if you want to purchase using the 2 % rule, apparently, you have to move to Indiana.