The 1% rule for commercial property is a general guideline some investors use to quickly evaluate whether a property could generate positive cash flow, although it’s much more common in residential real estate. For commercial properties, it works a bit differently due to higher costs, leases, and expenses. Here’s a breakdown:
Basic Idea
The 1% rule suggests that a commercial property’s monthly rental income should be at least 1% of its purchase price.
Formula: Monthly Rent≥1%×Purchase Price\text{Monthly Rent} \geq 1\% \times \text{Purchase Price}Monthly Rent≥1%×Purchase Price
Example:
- Commercial building purchase price: $500,000
- 1% of $500,000 = $5,000
- Monthly rent should be at least $5,000 to meet the 1% rule
Why It’s Useful
- Quick screening: Helps investors filter properties without detailed financial modeling.
- Cash flow estimate: Provides a rough idea of whether rent could cover mortgage, taxes, and expenses.
Limitations
- Commercial leases vary: Triple-net (NNN), gross, or modified leases affect actual cash flow.
- Expenses are higher: Maintenance, property management, insurance, and vacancies can eat into the 1%.
- Not a strict rule: Many successful investors ignore it and rely on more detailed metrics like cap rate, cash-on-cash return, and NOI (Net Operating Income).
Here’s a simple table showing how the 1% rule roughly applies to different types of commercial properties.
Keep in mind these are general guidelines—actual rents and expenses can vary widely.
| Property Type | Purchase Price Example | 1% Monthly Rent Target | Notes |
|---|---|---|---|
| Office Building | $500,000 | $5,000 | Higher vacancy risk; consider long-term leases. |
| Retail Space | $750,000 | $7,500 | Foot traffic and tenant type heavily influence rent. |
| Industrial/Warehouse | $600,000 | $6,000 | Lower maintenance costs; often more stable tenants. |
| Multi-Family (Commercial Units) | $1,000,000 | $10,000 | Easier to achieve 1% due to multiple units; watch management costs. |
Key Points:
- The 1% rule is just a quick screening tool, not a full financial analysis.
- Always factor in vacancy rates, operating expenses, taxes, and financing costs.
- For commercial property, metrics like cap rate and cash-on-cash return are usually more accurate.
Related
What is a commercial appraisal?