1% rule, 2% rule are BS...

64 Replies

In the book How To Invest In Real Estate, the author claims that a property that doesn't meet the 1% rule will never be cashflow positive.

Here is a proof against it. Buy a property for 500K cash, rent out for 2.5K, subtract 1.25K on operating cost, and you're left with 1.25k in cashflow.

Is the author wrong or am I misunderstanding something 🤔?

Updated 2 months ago

For anyone reading at after August 18, 2020 (9AM PST). This post was made to start a discussion, not bash on the author or the rules of thumb. Taken out of context the application of the 1%, 2% rules may prove very frustrating for a newb like myself.

The 1% and 2% rule is determine by the market the property is located.  I invested out of state so I can make this rule work. 25 years ago this was possible in L.A., but today that is a pipe dream. 

@Łukasz Juraszek

I think more of what that is intended for is a rule of thumb. For example, I look at properties all day. If I stopped to analyze every single listing in detail I would never get anything else done. I use the 1% rule to help guide me to see if a property is worth looking into it further. Generally speaking, if your math falls under 1%, the property might struggle to make decent cashflow. But that’s all relative to what returns you’re looking to get. A 3% cash on cash return such as the example you provided, would not be attractive enough for me to dump $500k in. So using the 1% rule would help me to quick do the math on that real quick to know this.

@Łukasz Juraszek

That was a good question though! I’m still learning myself. It has really helped me to look at properties real quick and know if they’ll cashflow. Almost nothing in Phoenix that I’ve seen meets the rule so I don’t bother analyzing unless I feel I can add value to increase rents.

Agreed. 1% rule is not relevant anymore in good markets. I know in Atlanta you can just about get 0.5 to 0.7 % . 

Bought a SFH in Roswell GA (Good suburb of ATL) for 325K earlier this year. Initial plan was to fix and flip it (ARV -- 450-470K area). However, due to Covid decided to rent it out till end of the year.

I am getting $1850 per month.. - 0.6% 

Yes, you can get 1% in Mid west theoretically but with the current situation I am not sure if you will get your rent in time 

1% rent ratio means 12% gross returns. Then assume 50% expenses and you get 6% net returns. After paying mortgage (assume 20% down) you eke out a small positive cash flow. Thats what the 1% means. But this applies to properties renting for around $1K per month. If your rent is $4K, there is no way your expenses will be anywhere near 50%. Or you can increase your down payment to cash flow.

Cash flow is important only if you are living on the income. Total return is what matters if you are accumulating wealth. That includes mortgage payoff and appreciation which is usually inversely proportional to rent ratio. Which makes sense because investors are willing to pay for the appreciation potential in lower rent ratios.

Originally posted by @Joshua Knapp :

@Łukasz Juraszek

I think more of what that is intended for is a rule of thumb. For example, I look at properties all day. If I stopped to analyze every single listing in detail I would never get anything else done. I use the 1% rule to help guide me to see if a property is worth looking into it further. Generally speaking, if your math falls under 1%, the property might struggle to make decent cashflow. But that’s all relative to what returns you’re looking to get. A 3% cash on cash return such as the example you provided, would not be attractive enough for me to dump $500k in. So using the 1% rule would help me to quick do the math on that real quick to know this.

 They are rules of thumbs.  Trouble is, they are all thumbs, and much like anything else that is all thumbs, they are clumsy, uncoordinated, and fall down a lot.  In other words, they are useless.  I was told that as rules of thumb, they were meant to keep you from wasting time by deflecting you away when the "rule" was not met.  

B.S.  They are nothing more than a lazy way of preliminary analysis.  They will deter you away fro, as many deals you can make, as they will deter you away from the deals you shouldn't make.  They will falsely tell you to continue to analyze, and waste time with deals you (in the end) find out you can't/shouldn't do, as it will tell you that the deal is "potentially" good.

Why not just do a full analysis and get it right the first time?  There's a difference between being efficient, and taking a shortcut.  This is not being efficient.

Leave these rules on milk cartons, where they belong.

Generally what it should mean is that if you finance out of it you are still generating cash flow. Anything that you pay for in all cash will almost certainly generate some cash flow. The idea is meant to give you some way of optimizing the use of your money, which for most people is limited. The "rule" becomes more or less important depending on interest rates, prevailing rental rates, amount to be financed, local costs of ownership (property tax, etc). So you can't oversimplify it as @Joe Villeneuve says above.

It's really a newbie guide. It allows you to make a rapid judgement on whether or not you should even look further. It's not meant to be a tool of analysis, more like seeing if the peg is round or square.

Original poster: (I cant @ your name to tag you lol...)

I think in the book you are referring to, the author is talking about cashflow assuming 20-25% down. So for a 500K property (assuming 4% at 30 years), you are looking at around 2100 for PITI. If you were to add in 1250 in expenses (vacancy, prop management, maint, cap ex, hoa, util, etc), then you would actually not cashflow. Again though, like others have mentioned above, its more of a rule of thumb to quickly weed out properties as you comb through hundres of them. Its not a hard and fast rule. Also, the higher the price point of the property, the less this rule applies.

Originally posted by @Łukasz Juraszek :

In the book How To Invest In Real Estate, the author claims that a property that doesn't meet the 1% rule will never be cashflow positive.

Here is a proof against it. Buy a property for 500K cash, rent out for 2.5K, subtract 1.25K on operating cost, and you're left with 1.25k in cashflow.

Is the author wrong or am I misunderstanding something 🤔?

 Right now it is very hard to find properties that meet those "rules", like the 1% "rule", in a good location, in an interesting city, in a place where there is a lot of demand for property. So I never paid attention to any of those "rules"...

And 2,5k per month on 500k investment is just a poor yield talking generally... but in a very expensive market it can be a good deal if there is also appreciation on that property. 

Another false statement, in my opinion, is that "you do not time the market" saying that I see on these forums all the time. Everyone times the market, even if they do it unconsciously, and researching investments, and executing investment decisions means per se timing the market and chosing the right time to buy or sell.

The rule assume you will put 20-25% down payment, for sure if you but it all on cash most likely you will get it positive cache-flow unless some thing really go wrong . 

in Canada and especially in Ontario 1% rule is no longer applied unless you put large down payment. but for 20% down-payment this is just not possible  at least in large cities. 

@Łukasz Juraszek

Rent $2,500

Managemant - 7% = $175

Maintenance - 5% = $125

Repairs - 5% = $125

Capital expense - 5% = $125

Taxes - (my area..) = $300

Insurance = $175

Debt - (depending on rate) about - $1700

Total expense including debt = $2,725

NEGATIVE cash flow $225 monthly

Buy 2-3% MINIMUM!

“It’s a newbie guide”

I actually disagree, I think as a new investor you should do a full analysis on 10, 20, 50 houses. Use your local taxes, call an insurance company and get what rates would be near you, etc etc.

I think once you have a few deals under your belt, you can go back and analyze what % works for you in your locale doing things the way you do them.

Just because I’m happy with a 0.8% rule of thumb, that’s based on the types of properties I’m looking at. I guarantee a fellow investor who’s picking up $30K dumps (or the one buying $800K mansions) have a different guideline they use.

You're not going to find many 1%-2% deals on the MLS...unless you're shopping in C-D neighborhoods.

Most of these deals you'll have to source off market. We're buying a house near us, 155k, should rent for 1.6k...and rents should keep ticking up from there. 

If that same house was on the MLS being sparred over like the last fish on earth...the house would likely go for 210k or so...and not be a good 1% deal anymore.

Bottom-line ---> it's impossible if you look on market...

"the author claims that a property that doesn't meet the 1% rule will never be cashflow positive."

Well, that's about a GRM = 8. I'd take that in Portland. Especially if rents are below market.

Hate to say it, but you may have to do more investigation than looking at one number before you spend your money.  :)

Originally posted by @Łukasz Juraszek :

In the book How To Invest In Real Estate, the author claims that a property that doesn't meet the 1% rule will never be cashflow positive.

Here is a proof against it. Buy a property for 500K cash, rent out for 2.5K, subtract 1.25K on operating cost, and you're left with 1.25k in cashflow.

Is the author wrong or am I misunderstanding something 🤔?

How about option 3; your absolutely wrong on both knowledge & experience of REI AND on the arrogance of "armchair quarterbacking" that you know better than a top producing investor and educator of REI because.... well simply because you "feel" that way......

Let's start with problem #1, your talking THEORY; made up numbers on a made up deal your simply inventing, which has 0 relevance on reality. Vs the author is speaking from a place of fact, the realized fact and reality of having done many deals and how things come out in reality terms. 

A little lesson for all those who think investing seems oh-so-easy and big $ to be made, take every expense you can think of and take it X2, take all the profits you can think of an divide by 2. 

Over and over I see people project rents with no consideration for vacancies.... this is so novice that only a chain of 4 letter words best describes the level of novice. Next we have property tax's, and REINVESTMENT which call it cap-x, deferred maintenance or what ever THERE WILL BE BIG MAINTENANCE BILLS at some point in time as roof's wear out, windows wear out, carpets wear out and so on and so fourth, assuming that all things are set for life or that $50 a month is enough is idiotic at best. 

Real Estate Investing is easy'ish, Real Estate Investing AND PROFITING is hard earned, methodical and very very detailed

Updated 2 months ago

https://www.biggerpockets.com/real-estate-listings/16-tri-plex-with-opportunity-to

Lots of good advice here.

The 2% Rule is just like any other rule.  Learn to make it work, why it works, and then learn how and when to break it.

Generally, the 2% rule assures you comfy cash flow even if heavily leveraged.

Generally, the 1% rule assures you break even cash flow if leveraged 70% or less.

But as always, you have to take a deep dive into the numbers.

I use "rules of thumb" to quickly weed thru deals that are most likely non-starters.  Also, it helps the cream rise to the top.  Let's say you have 15 roughly identical properties in terms of location, amenities, condition, etc, and the only difference is what they'll rent for.  Well, you'd want to check out the highest rent ones first, correct?  Just so with the % rule.  It's a quick 'n dirty method for analyzing dozens of properties at a glance and knowing where to concentrate you efforts first and heaviest.

Maybe you have time to go thru 2 dozen properties per day so they don't fly off the market before the next Buyer comes along.  I don't, so having a way to give them a quick glance serves me well.

Btw, I am getting 1.7 - 2.2% properties all day, every day in Springfield, MO.  No, we aren't LA or Phoenix, but I'm okay with that.  170,000 population in town...260,000 in the metro area.  It's a nice place to live and invest.

@James Hamling:
Oh come on brother... You know better than that. If you cared to look at any of my other posts you would know that this question was aimed at bringing up the discussion, rather than instigating aggression.

Nevertheless, the fictitious numbers that I brought up were merely an example to illustrate the fallacy of using a rule of thumb, such as the 1% rule.

Thank you.

 

Yes, you are missing something. These rules assume leveraged investments to scale faster and maximize return. ANY rental property investment will cash flow if you pay cash. 

The rules are not BS. They are a high level tool to quickly analyze a deal. Don't get hung up on 1% or 2%. In your market, it may be 0.9% or 0.8% that makes more sense. I would caution you though, that even if you pay cash and have cash flow, you could be buying horrible deals. As I said before ANY rental property will cash flow if you pay cash for it. Even if you choose to pay cash, you should be getting a good return on your investment.

There is a metric that assumes cash purchase, which is called CAP rate. CAP rate takes financing out of the equation and can be used to compare two similar investments.