Why I ignored the 1% rule

Why I ignored the 1% rule

Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
I'm getting ready to purchase my second SFH rental in a booming Texas town full of new industry. This property is on the same street as my other SFH. Looking at the numbers, here's why I disregarded the 1% rule when making this call. On a side note, the market is so compressed here that finding a 1% property is very difficult because housing supply is very low in the area. Also, these are both pretty turn key properties with no rehab needed. Property 1: 3/2 @ 1,456 sq ft Purchased in May 2019 Purchase price: 167,000 with 20% down Interest Rate: 5.75% (3.75% after refi in process) PITI: 1,197 (1,037 after refi in process) Rent: 1,625 Cash Flow after expenses: 147.52 (308.00 after refi in process) Property 2: 3/2 @ 1,316 Will close in April 2020 Purchase price: 179,900 with 25% down Interest Rate: 3.625% PITI: 1,023 Rent: 1,500 (market comps) Cash Flow after expenses: 191.00 As you can see, my second property isn't even close to the 1% rule, but it cash flows better than my larger home that was purchased last year for 13k less. Why is that? INTEREST RATES! They are insanely low right now, so I'm not wasting the opportunity. Notice my first property is at a 5.75% interest rate that was bought in May last year. I'm in the process of refinancing that one at a 3.75% rate which will bring my PITI to 1,037 and will bring my cash flow to 308.00 within the next 45 days. Should cost me no money out of pocket for the refi. Like I mentioned before, both of these properties are in excellent shape with very little expense having to be put into them, so cash flow is actually much higher (for now) due to low maint costs. Neither of these properties make sense if looking strictly at the 1% rule which is why you have to consider many things when making a decision. I don't mind paying more for something if my cash flow is there....why is cash flow there? INTEREST RATES!! Also, I considered appreciation in this case as well but didn't base my purchase solely off of it. Check out that first property. I bought it at 114 a sq ft and the second one at 136 a sq ft. These properties are literally down the street from each other and are almost identical except for square footage. See the appreciation there on the first property in less than a years time???!!! INSANE! I still consider myself "new" to this although in less than a years time I've purchased two rentals, and bought, rehabbed and sold a flip house. I still have a lot to learn, so I'm open to any comments I get here. We're all learning together! My point of this post is to take advantage of interest rates while you can. We won't see this again for years and years!
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Corby GoadeBusiness Member
Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
6y

I always get a kick out of people from other parts of the country telling someone their deal is "bad" because the numbers are different than the one deal they did six years ago in Kansas. I've said this on these forums so many times it's getting boring to me....a "good" deal is specific to every market and investor. Do you think that no one buys MFH in LA because they don't meet the 2% rule? Of course not- it's just that those investors are too busy being successful to hang out here on BP. 

I work with lots of full-time, retired early, millionaire real estate investors who snatch up SFH and MFH all over the country. They've never heard of the 1% rule, they seem to be doing okay, buying up investments with their own cash and collecting rents. It's all relative. I've been investing for 20 years, quit my job after several decent deals, and I don't think I've ever bought a property that met the 1% rule, let alone 2%.

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  • Property Manager · Lindenhurst, IL · Member since 2016 · 854 posts · 506 votes
    6y

    So you are going to get 5% return ($191 cash flow x 12 months) / ($179,900 purchase price x 25% down) on your money for the 2nd property? That sounds low to me, but that's just me.

    Also, regarding the interest rate, it is true that it is low, but that's what many people have been saying for years, so I'm not sure how it'll go from here. 

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y
    Originally posted by @Soh Tanaka:

    So you are going to get 5% return ($191 cash flow x 12 months) / ($179,900 purchase price x 25% down) on your money for the 2nd property? That sounds low to me, but that's just me.

    Also, regarding the interest rate, it is true that it is low, but that's what many people have been saying for years, so I'm not sure how it'll go from here. 

    That's correct. I'll be getting a 5% COC return on both of these for now. Which is typical for this area because demand is high and supply is low for purchases. Once the refinance for the first one is complete, I'll be right at 9.5% COC which is great for a SFH in this area.

    If we look at Gross rents minus PITI my COC is around 12-13% for these right now (I know this isn't a true COC return). This was the case with my first one all year this year because I had very little to invest in it since it's in such great shape. The same will go for my second. My biggest expense will most likely be the DOM cost, and even that shouldn't be much, if any, over here right now.

    Do you see interest rates getting better? I don't see that happening for a long long time, but I could certainly be wrong....hopefully I am!

  • Property Manager · Lindenhurst, IL · Member since 2016 · 854 posts · 506 votes
    6y

    I have no idea what will happen with the interest rate. 

  • Corpus Christi, TX · Member since 2015 · 32 posts · 12 votes
    6y

    Why 25% down on the second property?

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Jeremy Keeler

    Better terms, although I may go to 20% if it doesn't effect the rate.

  • Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    6y

    Most of us can't comment because we are not familiar enough with the area's exposure to low oil prices and a recession.

  • Corpus Christi, TX · Member since 2015 · 32 posts · 12 votes
    6y

    We're not in a recession. We might be one day soon, but not now.

  • Rental Property Investor · Fayetteville, NC · Member since 2014 · 884 posts · 670 votes
    6y
    Originally posted by @Clint G.:

    I'm getting ready to purchase my second SFH rental in a booming Texas town full of new industry. This property is on the same street as my other SFH. Looking at the numbers, here's why I disregarded the 1% rule when making this call. On a side note, the market is so compressed here that finding a 1% property is very difficult because housing supply is very low in the area. Also, these are both pretty turn key properties with no rehab needed.

    Property 1:
    3/2 @ 1,456 sq ft
    Purchased in May 2019
    Purchase price: 167,000 with 20% down
    Interest Rate: 5.75% (3.75% after refi in process)
    PITI: 1,197 (1,037 after refi in process)
    Rent: 1,625
    Cash Flow after expenses: 147.52 (308.00 after refi in process)

    Property 2:
    3/2 @ 1,316
    Will close in April 2020
    Purchase price: 179,900 with 25% down
    Interest Rate: 3.625%
    PITI: 1,023
    Rent: 1,500 (market comps)
    Cash Flow after expenses: 191.00

    As you can see, my second property isn't even close to the 1% rule, but it cash flows better than my larger home that was purchased last year for 13k less. Why is that? INTEREST RATES! They are insanely low right now, so I'm not wasting the opportunity.

    Notice my first property is at a 5.75% interest rate that was bought in May last year. I'm in the process of refinancing that one at a 3.75% rate which will bring my PITI to 1,037 and will bring my cash flow to 308.00 within the next 45 days. Should cost me no money out of pocket for the refi.

    Like I mentioned before, both of these properties are in excellent shape with very little expense having to be put into them, so cash flow is actually much higher (for now) due to low maint costs.

    Neither of these properties make sense if looking strictly at the 1% rule which is why you have to consider many things when making a decision. I don't mind paying more for something if my cash flow is there....why is cash flow there? INTEREST RATES!!

    Also, I considered appreciation in this case as well but didn't base my purchase solely off of it. Check out that first property. I bought it at 114 a sq ft and the second one at 136 a sq ft. These properties are literally down the street from each other and are almost identical except for square footage. See the appreciation there on the first property in less than a years time???!!! INSANE!

    I still consider myself "new" to this although in less than a years time I've purchased two rentals, and bought, rehabbed and sold a flip house. I still have a lot to learn, so I'm open to any comments I get here. We're all learning together!

    My point of this post is to take advantage of interest rates while you can. We won't see this again for years and years!

    I don't want to come off as rude, but it sounds like you are trying to justify buying bad deals. I hope that you do get appreciation......

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Mike Dymski

    And that's why I post this. Leaving it up to the 1% rule could leave you missing opportunities. Lots to consider when making a decision.

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Justin Tahilramani

    No offense taken man. All deals are specific to your goals. This may not fit your buying criteria but it works for me in my situation.

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Jeremy Keeler

    BTW, we all need to get together again. Been a while.

  • Rod HanksBusiness Member
    Insurance Agent · Dallas, TX · Member since 2013 · 743 posts · 462 votes
    6y

    @Clint G.

    1% is not a rule it’s just a guide. I hope your numbers include property management, maintenance, capx, and vacancy. If your cashflow doesn’t include those numbers you are just playing the appreciation game.

    Rod Hanks Insurance4.9153 Reviews
  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Rod Hanks

    I self manage but they do include all the others.

  • Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
    6y
    Originally posted by @Jeremy Keeler:

    We're not in a recession. We might be one day soon, but not now.

    I can't comment on your area.  Nationwide, Q1 and Q2 2020 GDP (at a minimum) is expected to be recessionary...the train has already left the station...simply from supply chain disruption, reduced exports, and reduced consumer spending.  This has already occurred regardless of where the virus goes from here.

  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    6y

    I always get a kick out of people from other parts of the country telling someone their deal is "bad" because the numbers are different than the one deal they did six years ago in Kansas. I've said this on these forums so many times it's getting boring to me....a "good" deal is specific to every market and investor. Do you think that no one buys MFH in LA because they don't meet the 2% rule? Of course not- it's just that those investors are too busy being successful to hang out here on BP. 

    I work with lots of full-time, retired early, millionaire real estate investors who snatch up SFH and MFH all over the country. They've never heard of the 1% rule, they seem to be doing okay, buying up investments with their own cash and collecting rents. It's all relative. I've been investing for 20 years, quit my job after several decent deals, and I don't think I've ever bought a property that met the 1% rule, let alone 2%.

  • Corpus Christi, TX · Member since 2015 · 32 posts · 12 votes
    6y

    @Corby Goade  I agree with you 100%
    And congratulations on quitting the "job", freedom must taste amazing!

  • Corpus Christi, TX · Member since 2015 · 32 posts · 12 votes
    6y

    @Clint G. Yeah we do. I spoke with Josh via text like back in January I think and he said he was wanting to do another meetup. But I'm down with just getting a coffee. Let me know.

  • Member since 2020 · 137 posts · 158 votes
    6y

    @Corby Goade I agree with you. A good investment can mean a lot of different things. I had to stop following a well know Instagram RE investor who was constantly showing his rent today versus purchase price in 2012. This is insignificant because that same deal can’t be repeated now. People who bought their homes in 1960 could look like geniuses by that measure. I like posts like this one because they remind me that great investments for me don’t have to please everyone else. 

  • Corby GoadeBusiness Member
    Investor · Boise, ID · Member since 2014 · 3k+ posts · 3k+ votes
    6y

    @James York and @Jeremy Keeler- Right? Any property you hold over a period of time eventually becomes a great deal, for better or worse. I could buy a fourplex in my market today for about $750k and collect gross rents around $5k/month. If I posted that asking for feedback right now, I'd be torn apart on BP. If I wanted 10 years and posted the same property, only taking into account systematic rent increases so that my gross rents at that point are $8k per month and I have $400k in equity, people would be telling me what a great investment I made. A deal is relative, time is ALWAYS your friend. 

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Corby Goade

    Very well said, and this is why I made this post. Deals are all relative, and should be catered to individual goals/situations.

    I used to give the 1% rule a ton of weight, and I still look at it when analyzing a deal, but it's not a deal breaker.

    Neither if these meet the 1% rule today, but like you mentioned, rents will go up and then I'll look a lot smarter.

    @brandon Turner says a good SFH should cash flow $200. My new one will be right at it and the older one will be well over that after the refi. Still, neither meet the 1% rule.

    My old CEO used to tell me "you don't take percentages to the bank". I'll never forget that.

  • Member since 2018 · 27 posts · 19 votes
    6y

    @Corby Goade. Especially in the treasure valley there, Corby. With values rising double digit percentages each year for a lot of reasons, even as value growth slows, rents will eventually catch up. I love my Boise, Nampa and Caldwell properties even though none of them are at 1%. Some day they'll create more cash flow but with over 30% CoC gains in large part due to Californians wanting to be Idahoans, I'm fat and happy, laughing at the guys hung up on pulling in $100 / door. But each to their own..

  • Joseph CacciapagliaBusiness Member
    Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
    6y

    Great point. I know people that have been using the 1% rule since rates were 6.5%+. With rates less than half that, it's silly to continue using the same test. Most investors picking up properties in good locations here in San Antonio are buying closer to 0.8%. Of course there are homes at to 1%, but not necessarily in areas that you would want to hold for the long term. Like many people on here, I used to believe cash flow was the only thing that mattered, and appreciation was a bonus. However, I've seen way more investors become successful based on a low cash flow/maximum appreciation strategy than those focused purely on cash flow. I think both strategies can work though.

    Joseph Cacciapaglia powered by Morty
  • Member since 2018 · 27 posts · 19 votes
    6y

    @Joseph Cacciapaglia. I agree. I think diversification is important and am actually BRRR ing one of my properties right now to look at starting to invest in a more cash flow friendly market. Not sure if you'd call it a BRRR though. Bought it last January for $218k. Haven't touched it or even seen it in person. Still have the same tenants and now am able to pull out my investment in a 1st, keeping a barely cash flowing property with $100k in equity. So even though I'm looking for a more cash flow friendly market, I am keeping a keen eye on the appreciation component. It's IMPORTANT

  • WorldWide · Member since 2016 · 1k+ posts · 1k+ votes
    6y

    what happens to your cash flow when your furnace goes out or a roof needs to be replaced? the point of 1% is to have appropriate cash reserves in the long term. when you cash flow $100/door you are walking a very thin line, unless you hold additional cash reserves. as covid19 is demonstrating currently, it is paramount to be well-capitalized. 

  • Rental Property Investor · Corpus Christi, TX · Member since 2019 · 306 posts · 176 votes
    6y

    @Victor S.

    I hear you.

    The one I'm buying now has a 1 year old 25 year roof and I negotiated a brand new inside and outside HVAC system that the sellers will pay for before closing. Two majors taken care of right there.

    In less than a years time I already have enough reserves in my other property to pay for a new roof and HVAC system at the same time if needed.

    Both homes built in 04 so any plumming issues are a long ways away the way homes are built in this area.

    These are all things I take into account before purchasing when I'm paying market prices like this.

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