The 1% Rule Thumb For Cash Flow

9 Replies

So I Just listed to Postcast #272 and I learned the 1% Rule of thumb "If a property rents for 1% or close to what you pay for it more than likely has positive cash flow" 

Your thoughts ?

Hi Juan, Our 4-plexes cash flow very well 1%. That said: Financing requirements make a big difference. If I finance 100% of the purchase price, the interest on the HELOC used for the down payment will likely eat up my cash flow, even at 1%. Taxes can also get you. A disregarded entity pays far less in taxes than you would in another structure that incurs double taxation. Insurance costs, special assessments, sufficient provisions for capital expenditures, property tax increases, legal bills, etc can all pop up and force you into the red. Moral of the story, do your due diligence properly. A simple rule can guide you but it can also get you in a lot of trouble. Feel free to PM me to discuss further.
It refers to monthly rents as 1% of the purchase price or total cost to get the unit rent ready. If you buy turn key or currently occupied, it's just the purchase price. If you buy and put in some cash to get the place up to par, go with the all-in amount. And to clarify, the downpayment has nothing to do with the 1% rule, sorry if I wasn't clear. What I meant was that the 1% rule may not give you enough gross revenue to cashflow if you have a hefty interest payment every month. As a conservative estimate, I like to do the quick math like this when evaluating a property: 1 Gross Revenue minus 10% for vacancy, minus 10% for repairs, minus 2% for credit loss gives you a rough estimate of gross operating income. Subtract your monthly expenses and mortgage payments and if there is $$ left over, the property deserves further attention. If (Gross Revenue X 78%) - operating costs - mortgage payments is > $0, it looks good. Again, it's quick math (my accountant would not approve) but it gives me a good idea of what we are looking at and if it makes sense to invest the time, energy, and money into writing a contract and going through the due dilligence. I haven't used the calculators on BP (I joined after my last acquisition) but I hear they are quite good. Just don't get caught in analysis paralysis and spreadsheet yourself to death! Cheers!
@Juan Lara In my area the 1% rule is a good starting point. I have a duplex at 1%. However, it also had brand new Hvac before move in, 5 year old roof, and probably low capex for the immediate future.
Originally posted by @Andrew S. :
It refers to monthly rents as 1% of the purchase price or total cost to get the unit rent ready. If you buy turn key or currently occupied, it's just the purchase price. If you buy and put in some cash to get the place up to par, go with the all-in amount.

And to clarify, the downpayment has nothing to do with the 1% rule, sorry if I wasn't clear. What I meant was that the 1% rule may not give you enough gross revenue to cashflow if you have a hefty interest payment every month.

As a conservative estimate, I like to do the quick math like this when evaluating a property: 1 Gross Revenue minus 10% for vacancy, minus 10% for repairs, minus 2% for credit loss gives you a rough estimate of gross operating income. Subtract your monthly expenses and mortgage payments and if there is $$ left over, the property deserves further attention. If (Gross Revenue X 78%) - operating costs - mortgage payments is > $0, it looks good.

Again, it's quick math (my accountant would not approve) but it gives me a good idea of what we are looking at and if it makes sense to invest the time, energy, and money into writing a contract and going through the due dilligence.

I haven't used the calculators on BP (I joined after my last acquisition) but I hear they are quite good. Just don't get caught in analysis paralysis and spreadsheet yourself to death!

Cheers!

 I think these rules as bandied about on BP  suggest cash flow happens with 20 to 25% down .. so when they say 1% rule that is positive cash flow with those down payments...  every thing cashflows if you pay cash.. 

100% leverage on any rental in most instances in my mind is high risk.. not sure why anyone does that .. other than the BRRR method you borrow 100% and you cant exit without writing a significant check.. most folks with limited experience in real estate don't realize that to exit your rental.. if you needed to.. you have sales commish.. very rare to sell yourself without it.. you have closing costs and you have recapture and usually some seller credits to help buyer with their closing costs and inspection addendums.. I use 15% as a bare minimum to exit.. So that 20% as a down payment simply means your not writing a check to sell in a non appreciating market.

If you pay cash and BRRR and get value add you can get equity and if you sell you just use that equity that you forced for your sales load..

Keep in mind real estate on average turns every 7 to 8 years.. even though 90% of folks going into rentals say they will never sell LOL..

were it does work is in a 1031 roll up.. once you go down that road you are in the game until you die.. or your going to have major recapture and or tax pay back.. unless U do a charitable remainder trust which I like a lot for high net worth sellers.

@Juan Lara The one percent rule I think is a good starting point. But as rates rise I think you will need to up this. If your interest rate is 7 percent and you buy a 100k rental at 20 percent down and rent is 1000, I think that may not work well depending on taxes and what not. As such I used to do mostly 1 percent but will probably do more 1.5 percent rule type stuff going forward as rates rise. I will also put more down, since my goal is free and clear real estate anyways. Probably 30-35 percent eventually.