I'm looking at property in the state of Oregon, which has had amazing appreciation but poor (starting) cashflow. Basically the only properties I have found that break 1% are in rural areas, or dumps, or both.
I'm looking specifically at fourplexes to owner-occupy, and at best I've found something that hit 0.8% so far, but most hover between 0.6-0.7%. I'm wondering if it would be a poor investment to disregard the 1% rule in this case? I'd like to start accumulating properties in my area (by owner occupying, then moving out a year later), but only if it makes sense financially.
Basically, I want to know if:
1) Is it sound strategy to ignore the 1% rule in areas with high appreciation, and
2) Is it alright to ignore the 1% rule for fourplexes? (1 roof, lower costs, etc).
Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
6y
When I started investing, I was way too focused on cash flow, and it led me to less than desirable markets and assets. I was cash flowing fine, but not building any real wealth. It took me longer than it should have, but I finally learned from my more successful clients. Most of them disregard the 1% rule. They're looking for properties with strong rent growth and appreciation. Areas like that don't usually provide great cash flow day one, but often have a higher total return over your hold period. They also tend to cash flow very well in years 3+. In my market, you usually see those properties sell closer to 0.8%. If you look at where your returns come from, cash flow usually makes up a small percentage of the total return. By forcing every deal to hit an arbitrary cash flow hurdle, you inadvertently rule out some of the better investments.
Investor/Real Estate Agent · Portland, OR · Member since 2014 · 198 posts · 119 votes
6y
Hello @Tyler D'Alessandro,
It is really difficult to get a rental property in Oregon that hits the 1% rule. In Portland .8% is considered really good. I tend to focus more on cap rates when I am analyzing deals because I really have to get into the numbers to see if something is going to work out.
I like to see cap rates at or above 5.5% with obvious potential for improvement. For instance the rents are under market or water/sewer/garbage could be billed back.
I generally don’t follow the 1% rule or any other of the formulas that are out there. I am aware of them, but I tend to rely on actual numbers. They are a good tool for starting out, but you will realize they don’t work in all situations and you could miss out on a deal. I rely on the cash flow number. I tend to hold properties long term. I do not rely on appreciation as that can fluctuate dramatically up and down and you can’t count on it at least in my market.
Rental Property Investor · Orlando, FL · Member since 2015 · 353 posts · 269 votes
6y
@Tyler D'Alessandro I am out in Central Florida so the 1% rule works in my markets. But it’s more of a tool that I use to create a funnel or filter of properties I look at, so I’m not overwhelmed with analyzing everything that’s on the market for cash flow. Not every 1% rule property is good or bad, it boils down further to the real numbers.
Investor · Wilmington, NC · Member since 2016 · 211 posts · 262 votes
6y
I think the 1% rule works for a certain price range. The lower the purchase price, less likely the 1% rule will cash flow. Buy a property for 35k and rent for $350 a month and you aren’t going to cash flow. Buy a 300k property and rent for $3,000 a month and you should be cash flowing. Yes, exceptions exist. I view the 1% rule as a quick guide in a certain price range only.
Philadelphia, PA · Member since 2017 · 824 posts · 1k+ votes
6y
The 1% rule has been taken completely out of context. It was an evaluation rule (possibly Brandon Turner's) that said "hey, if this property doesn't meet the rule, I'm going to exclude the property from further analysis." That's my understanding on the 1% rule.
Every property should be evaluated on specific numbers, but if you know in your area that you can't make money unless that rule is hit (or another rule) then you can use that to exclude the dogs and perform further analysis.
For instance, I invest in a town in NJ. I know that unless its a 2% rule property, I probably won't make money. Why? Taxes mainly, but also the utilities can be expensive. So, yes, if its a $1000 per month rental, I need to pick it up at $50,000 to meet my return needs. Some people may read that and think that's crazy, but in this particular town, its required.
Lender · San Antonio, TX · Member since 2020 · 1k+ posts · 1k+ votes
6y
When I started investing, I was way too focused on cash flow, and it led me to less than desirable markets and assets. I was cash flowing fine, but not building any real wealth. It took me longer than it should have, but I finally learned from my more successful clients. Most of them disregard the 1% rule. They're looking for properties with strong rent growth and appreciation. Areas like that don't usually provide great cash flow day one, but often have a higher total return over your hold period. They also tend to cash flow very well in years 3+. In my market, you usually see those properties sell closer to 0.8%. If you look at where your returns come from, cash flow usually makes up a small percentage of the total return. By forcing every deal to hit an arbitrary cash flow hurdle, you inadvertently rule out some of the better investments.
Developer · New York City, NY · Member since 2015 · 812 posts · 718 votes
6y
1% rule is BS in major metro areas. Anyone uses this as a "rule" is in the wrong game. Yes, you can use it as a guide, but much else you're just spinning your wheels and going now where. We have plenty of NJ/CT/PA/IL properties that around around .7% and net around 2k - 4k per month. As for someone who said paying for utilities, aside from a house meter for hallway lights, I am not sure what "utilities" you are discussing. Utilities, are usually paid by the tenants, aside from section 8, water, sewer and garbage.
When I started investing, I was way too focused on cash flow, and it led me to less than desirable markets and assets. I was cash flowing fine, but not building any real wealth. It took me longer than it should have, but I finally learned from my more successful clients. Most of them disregard the 1% rule. They're looking for properties with strong rent growth and appreciation. Areas like that don't usually provide great cash flow day one, but often have a higher total return over your hold period. They also tend to cash flow very well in years 3+. In my market, you usually see those properties sell closer to 0.8%. If you look at where your returns come from, cash flow usually makes up a small percentage of the total return. By forcing every deal to hit an arbitrary cash flow hurdle, you inadvertently rule out some of the better investments.
I'm starting to head in this direction as well. I bought my first property in a high cashflow but basically 0 appreciation market. The cashflow is nice, but with that cashflow also comes much higher maintenance costs in comparison to the price. For example a new roof on my 50k cashflow property will cost the same as a new roof on a 150k property located elsewhere.
Right now I'm looking for a good mix of the two. I'm not going full-on on the appreciation train, like the 2-cap negative cashflow buildings in San Francisco, but more like a healthy cashflow that also will have average or above average appreciation over time.
The math makes a lot of sense to me. If you were to leverage @ 20% down, and if we assume average appreciation to be 3%, you're getting 3x5 = 15% gains on average per year from appreciation alone. Plus rent increases down the line means this is my preferred long-term strategy. I see you're located in Texas, and there are a few markets out there that I've been looking at. Texas seems to be a bit of a sweet spot when it comes to healthy cashflow along with appreciation.
That's a great observation. I moved to San Antonio a couple of years ago in large part due to the favorable real estate economics here. I believe this is going to be one of the best rent growth and appreciation markets over the next several years, and you can still get positive cash flow in many parts of town.
Tyler, start your negotiations at 1.1% and see how far you negotiate. Most properties I’ve purchased have been purchased at 90-91% of asking.
Thanks Mark. I'd like to do this but it would be an incredible lowball in my area. For a deal I'm looking at now, his asking price is at about 0.55%, with current rents. With reasonable market rents, it's about 0.78%.
I'd need to offer about 2/3rds of asking to get 1.1%, of market rents.
Rental Property Investor · Las Cruces, NM · Member since 2017 · 65 posts · 38 votes
6y
It just depends on your market. I have never been anywhere that the 1% rule works. I wouldn't have bought any properties if i relied purely on that rule.
Specialist · ID · Member since 2015 · 121 posts · 53 votes
6y
@Tyler D'Alessandro
In these type of markets, buying with terms directly from seller is the best way to have some cash flow. 1% is generally,ignored and getting low enough monthly note payment that allows for true costs and some cash flow, is more important
Flipper/Rehabber · Pittsburgh · Member since 2018 · 6k+ posts · 5k+ votes
6y
@Tyler D. I think @Joe P. nailed it, this is a screening rule. You wouldn't want to base an offer on it, because if you're making an offer, you should have already done a much more detailed analysis than just plugging numbers from the Internet into a calculator. Repairs might be low or high, tenants might be responsible for all or no utilities, etc.
Investor · St Louis, MO · Member since 2017 · 250 posts · 181 votes
6y
@Tyler D. Don't ignore your rules of thumb, those rules are set in place for a reason. If you are serious about house hacking, build more relationships so that you can find the deal that you want, or move to a state where you can find more 1% rule deals.
In these type of markets, buying with terms directly from seller is the best way to have some cash flow. 1% is generally,ignored and getting low enough monthly note payment that allows for true costs and some cash flow, is more important
What do you mean by that?
I'm looking to get primary residence financing from a normal bank.
Rental Property Investor · Navarre, FL · Member since 2019 · 913 posts · 640 votes
6y
@Tyler D. Like others have pointed out, the 1% rule is not the be all end all. It's a good starting point to help you identify early in your research of whether it is going to work, and how it stacks up against other properties. I have several properties that didn't hit the 1%, in fact they are at 0.75%. And they cash flow. Am I an instant millionaire with them? Uh, no. But over time, they'll be paid off by someone else and they're buying me a bunch of beers while I wait.
I'm looking to get primary residence financing from a normal bank.
With a morgage from a bank you have very little control with how much your monthly payment is going to be except for putting more down.
but if you have the owner finance it ,everything is negotiable. That is one good way to make sure you have positive cash flow by setting the terms of your monthly payment. At that point, price and interest and length doesn't really matter much, as long you got your payments low enough to support the property
When I started investing, I was way too focused on cash flow, and it led me to less than desirable markets and assets. I was cash flowing fine, but not building any real wealth. It took me longer than it should have, but I finally learned from my more successful clients. Most of them disregard the 1% rule. They're looking for properties with strong rent growth and appreciation. Areas like that don't usually provide great cash flow day one, but often have a higher total return over your hold period. They also tend to cash flow very well in years 3+. In my market, you usually see those properties sell closer to 0.8%. If you look at where your returns come from, cash flow usually makes up a small percentage of the total return. By forcing every deal to hit an arbitrary cash flow hurdle, you inadvertently rule out some of the better investments.
This is a good thing to think about Joseph, and makes a lot of sense. I see a lot of big companies around ATL (hedge funds likely) buying homes for $250k, and it rents for $1,500. Maybe they know something I don't about the area, and the growth in rent/appreciation.
What do you look for in determining strong rent growth and appreciation?
I"m guessing more B/C neighborhoods that are in rapid growth? (as compared to established communities)
Realtor · Boulder, CO · Member since 2016 · 3k+ posts · 5k+ votes
6y
@Tyler D'Alessandro this question is often asked on here. It's possible this rule causes more confusion than it does provide guidance. There is no one "rule" that applies evenly to all markets, sub markets and micro markets around the world. Similar to how one needs to know their local market intimately to know what a good cap rate is for a specific location, you'll find a lot of variation on what constitutes a good rent to purchase price ratio. For example in a location with flat appreciation, savvy investors may look for a 2-3% ratio in order to have a better chance of having a decent overall return and not lose money. Meanwhile in a high appreciation market, .75% might be the best one can expect, but increases in rents and property value might make the overall return better over time than a 2-3% ratio in a different market. So it's market specific. Your market is probably similar to mine (Denver area). It's somewhat rare to find 1% deals here, and the ones that are out there are typically in less desirable locations, maybe with high crime or close to industry, or they are in poor physical condition and have extensive deferred maintenance, or they require management-intensive strategies to operate like renting by the room or they have other issues. Looking at my own investments, I've gotten better overall returns on properties I purchased closer to .5% than 1%. This is due to the location of those .5% properties being much better, which means more significant rent increases in a shorter time period, less vacancy, better tenant base that takes care of the property, higher appreciation... just better performance and overall QUALITY. So I don't pay much attention to the 1% rule other than as a very rough rule of thumb. I would highly recommend learning to evaluate properties based on the overall expected returns from all the ways real estate provides returns: cash flow, appreciation, principle pay down, depreciation tax benefits, cash on cash return (CoC), internal rate of return (IRR). I use cap rate as an indication of value more than the 1% rule because the 1% rule tells you nothing without expenses factored in. Since you're looking for a property to live in, offsetting your own living expenses by having your tenants pay your rent is another big factor for you, and you'll want to pick a location where you will enjoy living. Like any metric for RE, it's a function of supply and demand. Higher rent to purchase price ratio/higher cap rate= less desirable property= higher risk. I'd be looking to get the worst property in the best neighborhood you can afford, and then improve the property to the standards of the surrounding more expensive properties to force appreciation and gain instant equity. If you can cash flow a little or at least cover most of your living expenses in the meantime, awesome. Focusing entirely on the rent to purchase price ratio seems to be more important in a cash flow-only strategy, such as one might deploy in a market like the Midwest. It's not as useful and may even be a distraction in other markets like ours where rents and property values are increasing. Good luck!
When I started investing, I was way too focused on cash flow, and it led me to less than desirable markets and assets. I was cash flowing fine, but not building any real wealth. It took me longer than it should have, but I finally learned from my more successful clients. Most of them disregard the 1% rule. They're looking for properties with strong rent growth and appreciation. Areas like that don't usually provide great cash flow day one, but often have a higher total return over your hold period. They also tend to cash flow very well in years 3+. In my market, you usually see those properties sell closer to 0.8%. If you look at where your returns come from, cash flow usually makes up a small percentage of the total return. By forcing every deal to hit an arbitrary cash flow hurdle, you inadvertently rule out some of the better investments.
This is a good thing to think about Joseph, and makes a lot of sense. I see a lot of big companies around ATL (hedge funds likely) buying homes for $250k, and it rents for $1,500. Maybe they know something I don't about the area, and the growth in rent/appreciation.
What do you look for in determining strong rent growth and appreciation?
I"m guessing more B/C neighborhoods that are in rapid growth? (as compared to established communities)
In the short to mid term, I find the best indicators for rent growth are number of apps/inquiries and days on market for recent rental listings. The days on market can be found in the MLS in my market. The only way to get the number of apps/inquiries is by talking to the listing agent or PM. This is where having an in house PM and leasing team is very helpful. I'm constantly discussing areas with my PM to figure out the rental demand in each neighborhood. When we have a ton of interest in a given area, it gives us confidence to push rents.
For appreciation in the short to mid term, I like to look at the number of offers that new listings receive. Having multiple offers drives up bids, and therefore creates appreciation. This is another metric that isn't published anywhere that I know. You have to regularly talk to agents that are selling in those areas to get a good handle on it. Days on market is a good secondary indicator, but I don't think it's quite as good as actually knowing the number of offers that are coming in.
In the long run, population & employment growth and and new housing supply are probably the best indicators for the MSA as a whole. Home prices relative to competing markets is another important consideration. These were the main factors that lead me to move to San Antonio a couple of years ago, and why I expect this market to outperform.
Picking neighborhoods in the long run tends to be a little more difficult. It is more art than science, because it has to do with local tastes, which tend to change over time. Looking at which schools are popular, which employers are growing, and which areas are thought of as up and coming is a good place to start.
I know a lot of people like to look at historic rent growth and appreciation. I think these can be a good signal to check out certain areas, but they are trailing indicators. It's possible that the area has passed it's prime in both regards, and you can only see that by looking at what's actually happening today.
Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes
6y
@Tyler D. the 1% rule is just one of many metrics you can use to evaluate a property. Do not look at the rule as a firm 1%. It is really the ratio of monthly rent to purchase price. The rule can be adapted to suit the market and type of property. Some people use 2% and others use 0.8%. Just be mindful that if you go too low, the math doesn't work. What the rule gives you is a quick high level analysis of a property.
There is mathematical logic behind 1%. Let me illustrate an example using a property that costs $100,000 rent would be $1000 per month using the 1%.
Purchase price $100,000
Down payment 20% is $20,000
Commercial loan with 20 year amortization at 4% interest
Principal and Interest is $485 per month
Insurance $50 per month
Property taxes $150 per month
Repairs $50 per month
CAPEX $50 per month
Vacancy $50 per month
Property Management $80 per month
Utilities $50 per month
TOTAL monthly expenses is $965 in this example
In this example the deal barely cash flows using the 1% rule. Of course if you start changing variable, it affects the cash flow. Longer term on the loan, lower interest rate or lower expenses will all increase cash flow. Higher or lower down payment has a significant effect on cash flow.
Still math is math and there are some unavoidable realities. At some point a property cannot cash flow unless you pump major cash into the deal. Some would argue that is just buying cash flow and it reduces your return.
To answer your questions:
1. Don't ignore the rule. Calculate all your expenses and figure out how you can modify the rule to something that makes sense for your situation. Maybe not 1%, but maybe 0.8% works better.
2. The fact that it is a fourplex has no bearing on the 1% rule. You still calculate repairs, vacancy, CAPEX and property management using percentages of rent. I know some people say only 1/4 is vacant, but it happens fours times so the total vacancy is the same. One roof, but it is bigger. Four units means 4 fridges, 4 stoves, four showers, four toilets.
