Are these rules of thumb realistic?

Question

As I read some of the rules of thumb for real estate investing, I can't help but question if they are realistic or simply wishful thinking.

For example, 70% rule says you should by a house with total cost including rehab cost of 70% after rehab market value. How can that be? Effectively it is like buying a house with 30% discount. Why won't someone else offer to buy it with ONLY 25% discount?

Another rule says you should rent your house for a 2% (net? gross?) monthly return. That means a $200k house needs to rent for at least $4000 a month! That is pure fiction in my world! It is a miracle to rent it for $2000 a month as far as I can tell.

I am curious if other people here think these kind of "Rules" are realistic at all? (Or simply ways successful investors use to snob newbies.)

Mike Makkar · Answer

@Jesse Li, I'm a numbers guy and my first set of properties adhered to the 10% discount and 1% rule. The last property I found was 17.7% discount and 1.82% rent. Finding a property like this in a B-class community was sheer luck and some creative renting arrangement.

But, I think this is possible. As investors, we gain better understandings of our market and become skilled at negotiating deals, we'll definitely find 30% discounts and 2% gross-rent properties. However, we may have to make trade-offs in our criteria. Shifting from A/B to C-class properties. Buying properties that are older.

2% rule is (Monthly Rent / Purchase price). The easiest way to satisfy this rule is not to increase the numerator, but to decrease the denominator. Its easier to find a 50k to 75k property that rents for 1000 to 1500 a month, than a 200k property that rents for 4000 a month.

As far as why somebody would unload a property for 30% discount! You're capitalizing on somebody's inability to handle financing the property or desperation for quick cash or changing life circumstances. Not the most pleasant to think about, but c'est la vie in real estate!

Bram Spiero · Answer

@Jesse LiI guess the real question is how set are you on flipping houses. If you are, you will have to figure out to make those rules of thumb work. They are rules of thumb so they are not cast in stone but you should maintain the principle of there being enough profit in doing a flip to make it worth your while.

If you are having trouble finding deals, try identifying whole salers in your market or maybe identify a different market to farm.

Bram Spiero · Answer

If you are looking to flip, you are really making your money at purchase. You'll have a hard time finding a good enough deal on the MLS. You need to be very careful that you take all your expenses into account when considering a flip. These include cost of purchase, cost of rehab (assume that you will go over budget), cost of holding the house between purchase and sale, cost of sale. The reason people use the 70% rule, especially when starting out is to ensure they don't go under water on the deal. Once you gain more experience you may risk smaller margins or learn to walk away from deals that don't make sense because working on a flip for 6 months in order to make 4k may not be worth your time.

Joshua Howaniec · Answer

Im new to investing so have your grian of salt handy, but in my own floor biz I found that when I gp into a project without "rules of thumb" ee's get to many hours, oversights in materials are made, in all expenses go up and profits go down. That said I imagine rules of thumb are a target margin to protect you from breaking even or worse losing money.

Brian Larson · Answer

I disagree that the 'good times are gone' RE is cyclical and there is money to be made at all stages. Sure, you may not find a deal that is 40-50% of its ARV in abundance like 2009 but at the same time, did you have a ton of cash at that time to pounce? few of us did.

But the good news is that the market is healthier and financing is easier to come by (HML are generally cheaper than back in 2009, conventional is way easier to work with these days) and many of us have a little extra money to invest.

You can still get deals and i highly recommend hooking up a solid pipeline of deals through wholesalers. How do they get the deals? lots of ways, but a good wholesaler with steady diet of deals is very valuable.

good luck

Anthony Dooley · Answer

Real estate is investing is very specific down to the street or neighborhood. Rules of thumb are very general. For rentsl property, I use an acceptable cap rate to determine value. I first determine the possible rent the property will generate. Then deduct typical expenses like taxes and insurance. This net income is then divided by a rate of return that I am willing to accept. This equals my top offer on a property. If the seller won't accept, I keep looking.

Jay Hinrichs · Answer

@Jesse Li  these rules were spawned out of the POST GFC  08 to 2011 melt down.. in those days in many areas including FLA you could easily find those properties. I bought foreclosures in Fort Myers for 30k a door that rented for 800.. and flipped them for 50 and 60k.. I bought homes in Atlanta many almost brand new for 30 to 50k that rented for 800 to 1200.. I bought 54 of those.   The reason we bought those was because it was one of the best buying sessions in history.. and lending was frozen by and large..   And there were deals like that IN AZ  NV  inland empire of CA central VAlley of CA etc.

The other areas were these are located and they are still there are in dead and dying rust belt cities or cities with more houses than people.. and or high poverty rate or demographic of heavily dependent on government assistance.. many times in the urban core areas of the bigger US cities.

One of the folks I like in Indy made a comment on another post.. Indy was touting new condos down town .. that great his point was there is over 5800 vacant homes in the same area.. rehab those first was his thought.. these are the areas that these rules work in and were spawned out of .

the same homes I was buying in Fort Meyers for 25 to 35k in 09  sold in 2005 as new construction for 200k.. they never met the 1% rule then or the 30% rule or another rule.. the rules came into play through a once in a lifetime melt down. and its here to stay in the C and D class areas that take a special investor to work

So for most folks its old news and not germane to todays market frankly.. old and tired ready to be put to bed

Randy Johnson · Answer

I'm new at this but in my area those hard rules don't apply. I live in the las vegas area and I've seen a lot of homes being flipped. I don't have the cash or any investors to flip as fast as these homes are moving right now.  Those hard numbers are hard to find but i believe I'm seeing value in buying these fast flips as buy and hold properties.  I've found a few flips that will held a 1% return on the purchase price. .....does that sound good? Any and all replies would be helpful.

Gary Ytreeide · Answer

In my opinion the rules of thumb are targets to shoot for.  You don't always hit the target but if you can come close you will probably come close.  I work in the area about 30 miles of Corpus Christi.  Primary buyers are retirees, 2nd home and an occasional winter Texan that plans on moving down here.  A house under $100,000 is usually a tear down and our insurance is out of site.  Meeting those rules of thumb is a challenge.  You will not pick up a whole bunch of deals real quick, but with patience (which few real estate investors have) you should do ok.

Someone mentioned A,B,C  properties.  That is usually used to classify commercial property.  Where I work most commercial properties would be a "C" with a few "B-"s thrown in.

Are these rules of thumb realistic?

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