The Stupid 1% Rule
I think the 1% rule (monthly gross rent = 1% of price) is misleading and getting blown out of control here.
I have been looking at some multi's and rule of thumb should be 2% to get positive cash flow.
e.g. $100k property, if you get $2000 in gross rent, that's $24k/year. operating expense is more like 1/3 - 1/2 of it, let's say $10k to cover tax, ins, management, maintenance, utilities if any, vacancies.
That leaves $14k, debt service is about 7k, so it flows 7k/year, which is an acceptable number for a $100k property. Let's say you got this thru normal financing, closing cost 5%, down pay 5%, you spend about $11k to get into the property, the cash on cash return is about 60% still not too bad.
Now if you follow the so called 1%, you are guaranteed a negative cash flow.
What am I missing here.
Mortgage - Keep
150,000 Sale Price
0 Inspection
0 Earnest
75 Application Fee
15,000 10.00% Down
3,750 2.50% Selling
0 0.00% Points
0.00% Kickback
0 Fixup
18,825 Initial out of pocket
18,750 Bring to Closing
153,825 Initial Cost of House
135,000 loan
853 6.500% 30
50 Ins
126 Tax
0 PMI N
200 Wate, Utilities etc
1,229 Estimated Costs
1,229 Actual
3,000 Rents
1,771 Income
112.87 ROI Out of Pocket
59.02 ROI Monthly
If you can find many deals that have these kind of ROI, let me know. The fact is that the 1% is good for beginners to let them have a rule of thumb. If you told them 2%, they would never get a deal.
Brenda
Given the number of properties out there, not all investors have the luxury of spending several minutes checking every lead.
The 1% rule should be treated as a quick way to eliminate properties that are surely to have negative cash flow. After narrowing down a huge list of potential properties, the ones that pass the 1% rule still have to be analyzed in detail and then can you make a more informed decision whether to pursue them or not.
I agree. The 1% rule is a starting point when doing a quick evaluation.
Ron
In PA maybe...
In FL, if you get the 1% deal, jump on it.
Duplexes here are around $200K and rented for about $13K-$14K a year.
Less expenses, less mortgages, YES, you get negative flow...
They are sold, usually in less than a week though, because they are resold $220K the next month or so...
First, the 1% "rule" is a guide, not a rule. Second, it should 1% of the FMV of the property, not necessarily the purchase price. As an investor, your goal is to buy discounted properties. Hardly works if you solely base your rent on what you paid for it.
If you are going to be renting property, you should become very knowledgable in the actual rental values of properties and not simply use a "guide." Depending upon the area, the actual rents may be higher or lower than 1% of FMV, sometimes a big difference.
The reason for the 1% is that, in general, most rents will fall close to this number. Take your example, in most areas, a $100K FMV home will rent for between $800-$1200 per month. I doubt that there is an area where a FMV of that price will command a 2% or so rent because in order to get that kind of monthly ($2000), you'd have to have a special home like a lake lot or something, which would drive the FMV up higher than $100K.
Just to so a point, take your example again. If you pay $100k for the property and rent for $1000/month, following the 75% "rule" that lenders will use, meaning 25% of gross rent is deducted for expenses, vacancies, etc., you'll get the following:
$95K loan @ 6% interest for 30years = $570/month P&I. Even if you add in an extra $100/month for "added" coverage, you'll still have a bank estimated cashflow of $80/month ($750-$670), which will actually lower your DTI ratio, and you'll have an actual cashflow of $330 minus your actual operating costs, which should usually be less than 25% of gross rent.
Roger
An old time landlord here in Orlando says that she made all her money in appreciation, not in the rents. Each person has to evaluate their own situation. I initally bought real estate just happy to break even because I wanted enhance my retirement planning. But now I am looking for income and my criteria is different. But also, I am spending many more hours on real estate and can be more selective.
I wish I could get 1% of FMV for my rental condo! Of course, the RE market here is kind of out of whack.
Don't forget about the tax deduction on interest. Be sure to talk to your CPA or attorney before taking my advice - just 'cause I'm doing it doesn't necessarily mean that you should too!
-e-
Good thing Dave is on top of things.... Read the article... There is your answer.. http://www.thecreativeinvestor.com/modules.php?name=News&file=article&sid=523&mode=&order=0&thold=0
It was your post, and a couple of others that inpired the article that Chris (sKauGhTiEe) pointed you towards. I agree 100%.[ Edited by hibby76 on Date 03/17/2004 ]
Like all other rules of thumb, Hibby. th 1% rule is supposed to make actual thought unnecessary. The more general the rule the more it disguises the actual thought necessary. Buy low, sell high is true. But when you sit down to think about a deal it doesn't really help much. Whats low? whats High? which is this?
Same with 1%. Good for the first 30- seconds after that you will have to use actual thought.
mark