Cambridge, MA · Member since 2017 · 42 posts · 6 votes
Seems impossible to get 1% in booming cities like NY, Boston and San Francisco... in Boston you are lucky now to get 1/2%. Maybe with development you can get 3/4% but its hard. I often think about the places that get the 1% or more and feel they are a lot more work and with very little to no appreciation. The appreciation you gain in just a few years in one of these mentioned cities may equal the total "bonus" cash flow you get renting out a 1% rule home for 10 or 20 years?. If this is the case I don't see the sense. what I do see is that not everyone has the money to buy "big" in places like In Boston which 500k is a purchase price starting point and although you just get your 1/2 % your making a killing on the short term appreciation. For areas far outside the city (the 1 % or more places) your starting point can be only 50k or so and your pulling in that "bonus" cash but it seems like so much more work, more/tougher tenants, more reno etc.... Just my guess.. .curious what others think?
I always laugh when I read posts about investing this way or that way being "the" way and I admit I do the same.
The reality is it depends mostly on the each investors initial financial situation and their goals in investing.
Some invest as a means to earn a income, others invest to grow wealth. Those starting investing for income need monthly positive cash flow to put food on their table to feed their families and pay for their investment. They do not have deep pockets to supplement a tenants rent or to buy cash flow with their own money. Why would they pay cash in advance to generate monthly income, seems counter productive. If they already had the cash they would be investing to grow wealth. They depend on cash flow to pay bills and grow wealth simultaneously , all be it slowly.
Those starting with the goal to grow wealth can invest in over priced areas where descent rent to property price are unattainable. They can pay cash to create the image of cash flow and supplement that cash flow out of pocket since income is not necessary to support their life style. They already have a sufficient level of wealth to afford this option while speculating on appreciation. In areas where appreciation is historic the level of speculation is minimal, the ability to grow wealth almost a certainty. When buying groceries is not their goal in investing why mess with table scraps in the form of positive cash flow.
Is there a right way and a wrong way, a good way and a bad way. Obviously not since the method chosen is specific to a individual investors perspective, needs and goals. To disrespect one method over another is hypocritical. I have in the past, and likely will in the future, be hypocritical.
However both options for investing (only two of many) have the potential to achieve their personal goals. Both are investing their right way.
As others have said, the 2% rule is a quick screening rule that is applicable in many markets. There is not way you are going to meet the 2% rule in the Boston / Cambridge area.
That being said, I have a multifamily in Cambridge that is around .8% and it cash flows nicely.
Additionally, the 50% rule can be way off in our area. However, while it won't be 50% a year, you will have huge expenses in chunks. In the Boston area you aren't going to replace a water heater for $400 or a furnace for $1,000. You need to have a big cushion for capital expenses.
You should target the highest rent-to-purchase price ratio possible. However, just because a property doesn't meet a 1% or 2% threshold doesn't necessarily mean it won't perform. There are many other factors to consider including:
Quality of the tenant base ... how often are you going to have to turn over the apartment?
Potential appreciation ... can a case be made for the area to appreciate in the near future?
Tax rates, landlord-paid utilities, cost of repairs/maintenance
This year I acquired two multi family properties just north of Boston and neither meet the 1% threshold. The properties have averaged a combined cash flow of ~$3000 per month, leaving a nice buffer for vacancy, repairs, and property management costs. The properties are also located in areas likely to appreciate in the future.
A 1% rent-to-purchase price ratio is great, but not the end all be all.
If an Investor only knows the 1%, 2%, GRM, CoCR, etc. Rules (or guidelines), then you are not going to understand what the other calculations are which WILL help you in other kinds of Markets.
The problem is without knowledge of the other calculations (think IRR, DCF, NPV, etc.) and how to apply them, you can actually get yourself in trouble despite qualifying for the 1%, 2%, etc. rules.
I often point out how a friend of mine, let's call him Bob.... bought cash flowing properties outside of NYC where he lived.
His properties did not appreciate. He did maintain about a $1k per month Cash Flow from 2004 to now.
HOWEVER, because he lived in an apt in NYC, where is rent in 2004 was around $2,600 per month... eventually he started paying $4,600 per month for the apt he lived in.
So what's the point on having a $1k per month Cash Flow in an out of state property when your rent climbed up by $2k? I call that a Negative cash flow despite the Investments being a positive cash flow because his NET, the difference between the rent he used to pay, which increase $2k and the cash flow of $1k, is NEGATIVE $1k.
I suggested he move his family to the area he invested for cash flow. NOPE...... he likes the great amenities of a City like NYC.
The other funny thing was had he actually bought his property in 2004, he probably would have made at least an increase of $500k in Appreciation, but probably as much as a $1 Million.
I think what's not being taken into consideration is the OPPORTUNITY Cost of investing in different markets.
All of this is an educational thing. When you are only knowledgeable of a few ways of calculating your Investments, you can only see things that one way.
Expand your knowledge. You may still decide to buy using the 1% rule, but at least you would have chosen it after you have done ALL your analysis.
Inevitably, I use the IRR. It helps me make that decision based on a 10 year projection on any property and putting in some conservative assumptions. I've been doing this for 2 decades and the returns..... incredible.
But most importantly..... I had secured my shelter in the ONE of the most expensive place in America. And I had done so cheaply by buying in 1997.
Today, you may think.... wow.... but properties are $1 Million!!! HOWEVER.... guess what that property will be worth in 10 years from now.
If you are getting out priced at $1 Million..... you certainly won't be able to buy at $2 Million in 10 years from now.
Do consider Opportunity Costs and other calculations than the normal, simple ones that are being tossed around.
Personally I used the 1% rule heavily when looking at properties to weed out the ones that will not perform. BUT I only used that rule after I analyzed a dozen properties in my local market and found that the ones that had good cash flow had at least a 1% return/purchase price.
That is to say that the "rule" is not so much a rule as it is a metric that can help with judging property at first blush. Obviously nothing will replace actually sitting down and running the numbers for an individual property but when my agent sends me 30 places to look at it's a good way to discard the bulk of them that I know won't work based on that simple rule.
Again, that "rule" varies greatly by market/location and personal goals but I personally find it useful if the rule number is vetted and decided on based on actual numbers.
Focus on cash flow and affordability instead of something that does not work for you.
People in CA are perfectly happy with 2% cap rate and negative cash flow since the properties have appreciated 12-16% each year since 2012. Is 500K in 5 years equity less important than % rule?