In expensive markets, does the 1% rule still matter?

[Silun Wang]

As a newbie investor around the Denver metro area, I've noticed that the 1% rule never applies to the current prices of our market.

If you are not utilizing the basic 1% rule, what are some other rules/ways you use to evaluate your cash-flow and finding good rental properties?

[Sergey A. Petrov]

I am in Seattle and 1% hasn’t worked here for some time (unless you go outside to pockets with C- properties). Expensive markets are mainly an appreciation / principal reduction/ tax benefits play

[Theresa Harris]

Don't worry about 'rules'.  run the numbers and see where you are at.  I don't know of any markets near where I am where the 1% guideline would work.

[Ryan Williams]

Hi @Silun Wang, this is a great question and you're right, the 1% definitely doesn't work here in Denver. The following is an oversimplification, so take it with a grain of salt, but there's 2 kinds of investment markets:

1) cashflow market - markets like the midwest and south where you can buy into some decent initial cashflow and the 1% rule could still be applicable, but it more than likely won't appreciate too much over time. 

2)appreciation/equity markets - The Denver metro falls into this category. You buy into an investment property and it may break even or make a little return, but the pro is you have a high value asset that is being paid for by someone else and is going to have a ton of equity built up over the years. 

A combination of the two is the dream and what everyone is looking for! haha 

For an appreciation/equity market - you want to look at a variety of factors to determine if it's a good investment - cash flow, cash on cash return, cap rate, appreciation projections. When these metrics look better than the market norms you know that you have a good deal. 

Also, getting creative in appreciation/equity markets is a way to get to returns closer to what you would see with a deal that meets the 1% rule. Incorporating strategies like short term rentals or rent by the room can get you higher incomes and good return on investment in the near term term, rather than just the long term. 

I hope this is helpful!

[Luke Stewart]

I think @Ryan Williams nailed it, the 1% rule doesnt work in Denver, but look at equity. I have multiple goals but one is to house hack a duplex in Denver and that means immediately that I will not be cash flowing or covering the entire monthly payment with the rent collected from the other unit. However I know that the equity gained each month is high and when I move out I should be able to get rents up to have a small cash flow. I think Denver is becoming a big 1031 market. You build up equity then move it into something nicer or with more doors. You just have to shift your mentality about it. If you are trying to replace income ASAP, then an expensive market can make that tricky without STR.

[Taylor Dasch]

I dont use the 1% rule for anything to be honest.  I have one deal that will be at the 1% rule but it doesnt matter to me. I look for: Cash flow-$350/door

Ability to flip the property for a 25% return

Amount of risk involved in terms of the availability of data in the area - if there isnt much activity, I will be a lot more hesitant because it would be harder to estimate ARV as well as rental rates.

Like others have said, in some markets your investment will be appreciating well enough to negate that 1% rule. I have found that appreciating markets will typically have a better ROI. However I am not in the position to purchase anything in these markets nor would I want to since my goal is building cash flow to retire from my W-2.The system you use to analyze properties depends on what goals you have for your investments.

[Chance Noffsinger]

Ryan and Taylor are 100% correct. What is your long term goal? We say the holy grail is finding a property with cash flow and appreciation! Our Boulder property would never hit the 1% rule but we have almost $900k in equity. (I know we should do something with it!) We've invested in OH for cash flow only (2% rule) and invested in Houston for cash flow and appreciation. We invest only in areas where we lived or knew the market very well due to family in the area that could make recommendation re: contractors, etc. We both have demanding jobs and use property managers for OH and TX to make our life easy but either could work for short term rentals. If you do decide to go for short term rental it is imperative to understand local laws especially in areas like Denver and Boulder which have very stringent short term rental laws. You're asking the right questions. Good luck!

[Wale Lawal]

@Silun Wang

When trying to calculate the profitability of an investment property, especially a property located in one of the best places to invest in real estate, other factors are also worth considering. One is the net operating income, which is the profit you make on the property after subtracting the operating expenses. This formula takes into account those factors listed above that the 1% rule does not. You'll also want to think about the internal rate of return (IRR), which compares the future value of the property to what it's worth today.

When considering an investment property, it’s important to not be in the dark on how large of a return on investment the home can provide. In other words, it’s essential to know what you’re getting into before purchasing a property.

Good Luck!

[Cody L.]

I've never bought a property that WASN'T a "1% rule".  And I've bought all over Houston. Good areas and bad.  The only exception were some newish patio homes where I paid about $240k and they rent for about $2,100 (though I get closer to $2,400 now).  Made that exception as they were a bunch of nice detached homes near galleria. 

[Steven Foster Wilson]

Quote from @Silun Wang:

As a newbie investor around the Denver metro area, I've noticed that the 1% rule never applies to the current prices of our market.

If you are not utilizing the basic 1% rule, what are some other rules/ways you use to evaluate your cash-flow and finding good rental properties?

 If it does not work then should you look for a market that does? Would it be worth it then to do OOS investing. I help clients everyday find incredible deals here in Ohio because they cannot make their money go as far in California or other states like that. I think it is always wise to look at all your options and analyze all the potentials. 

[Joe Garretson]

@Silun Wang similar situation for me. New to investing and living in Castle Rock. You can't find a property anywhere that meets the typical rules of thumb. In fact, if you analyze most properties around here, none of them look like good investments. All of them would mean you're hoping for appreciation and the question is, how much room is left for the market here to appreciate? You're seeing lots of listings with higher days on market, price cuts, etc... In my opinion, it's a risky market right now heading into winter. I'm looking at the outskirts of the front range and focusing further out to maybe even the Western Slope. There are opportunities on the fringes for sure. 

[Dave Skow]

@Silun Wang-  resreach the numbers  ( using  conservative  figures )  and  if the results  fit in to  what you need to see  - consider proceeding 

[Kenny Smith]

@Silun Wang

Agree with many of the responses here.  Not sure if anyone else talked about it, but have you read into house hacking?  Even in tough markets like here in Denver, house hacking has the power to possibly get close to that 1% rule if you do it right.

It really all depends on what your goals are? Is it to BRRR, house hack (cash flow), Flip, etc? Many options and possibilities depending on what you are trying to accomplish.

Reach out with any further questions.  Our Real Estate Team here in Denver, The Fi Team, focuses on helping clients find a good house hack that makes sense for them.

[Greg Weik]

@Silun Wang right now, home prices are dropping. A lot.  They're dropping fast in a lot of areas.  Rental rates are pretty stable.  So... If you continue to wait to try to find a "bottom", my best guess is January/February 2023.  The people that have to sell (or think they have to sell) will have their homes listed far below what the market price was even 6-10 months ago.  There will be deals on the home prices, but you will get hit on the back end with higher interest.  It seems like a wash, but I don't think it is, over the long term.  Interest rates will eventually go back down. 

So if you wait for a few months to pull the trigger, acquisition costs will be attractive.  This should be a feeding frenzy for cash buyers.  Assuming you're not a cash buyer, and with interest rates climbing, the numbers still are not likely to be great - in the short term.  Remember, rents are pretty stable around Denver.  This is unlikely to change.  This means if you can weather the interest rate storm, you can refi in a couple of years and your numbers should be solid.