A lot of people want to use the one percent rule to determine how much rents should be but I like to use it to determine the true value of a property, especially in depressed markets like Detroit.
These days you can buy a property in Detroit for about $10k rehab it for $10k and rent it for $700-$800 per month. The problem is that the market value for these properties still hovers at around the all in for $20k and if you are lucky $40k. The problem with this is that from a mathematical perspective it doesn’t make any sense.
For those playing at home, there are certain numbers used to value a property that is held for income. This is the one percent rule and the cap rate.
The one percent rule says that the monthly rent for your property should be one percent of the total value. So if you have a $100,000 property your monthly rent should be $1000. People who get this are happy because these days folks are getting like .8 percent of the value.
The reason folks are getting low numbers and happy about it is because they have been sold the multi family hype by Grant Cardone and Bigger Pockets. Buy units, thousands of units, is the rally cry these days. All from the uneducated and ill informed. This is problematic. It is a problem because real estate isn’t just real estate. Real estate is finance, economics, taxes etc, not just construction costs and comps. It is a lot more technical than the little buzz words newbs have learned.
Back to Detroit. What I am finding is that we buy these homes for income so they should be valued based on their income not comps. Therefore we can approach this two ways; we can approach this using a cap rate and we can approach it using the one percent rule. Cap rate first.
Cap rate is the return that you get on a property if you bought it for all cash. This doesn’t take into consideration the debt you use to buy it which is another flaw I find in the multi family hype. So cap rate of 4 percent is par for the course in LA. On a 2mm dollar building that would yield you 80k per year in net income not including debt service. The mortgage on that building would wipe out your cashflow and that’s why I don’t invest locally, the numbers don’t make sense. You are working for free.
Lets use the same caprate analysis on a Detroit property. If you have a 4% cap rate on rents at $700 per month times 12 that gets you a valuation of $210,000!!! Meaning that if you invest $210,000 and get $8,400 per year that is a 4% ROI.
If we make the cap rate higher, which is typical when you have higher risk C and D class neighborhoods, the valuation of a Detroit property is $105,000 at an 8 cap and $84,000 at a 10 cap. But you can buy the property an be all in for $20k This is a huge opportunity if you know your math. The high end profit is $190,000 at the $210,000 valuation and $64,000 on the low end. All while you cashflow.
Now lets look at the 1% rule. If you rent it for $700 a month then the property is worth $70,000. If you rent it for $800 then the property is worth $80,000. Yet we still value single family based on comps? Maybe they do but I don’t. I make my own rules.
If the 1% rule says the home should rent for 1% then the reverse is also true. The value of the home should be 100% of the rents. Take what they are paying and multiply fam. Use math to your advantage not their opinions and their validation that surprisingly enough serves to give them an advantage when it comes to sliding over that low ball offer.
You have to remember that their values are fake fam. They downplay your value, steal your assets and then say its worth a bunch of money once they own it. This is what led me to start doing my own analysis and coming to my own conclusions. Based on this analysis our company is closing in on the million dollar number and will continue to do so, on the low, using what we know while just listening to them tell us its not worth anything. Ok boss.
The point of this post is that sometimes you have to challenge the rules you live by. Sometimes you have to place a high value on what you own without their appraisals or their approval. This is the choose yourself of real estate. Choose to see what you own as valuable even if they don’t agree. Choose to place a number on what you own that is in accordance with the math not the tarnished name and brand created by the media they own. Be smart fam not a pawn fam. In the words of Jay Z, set your price and live your life. The opportunity is in the things they tell you not to own and the places they tell you not to go. Load up while you can, dumbo.
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