Anywhere else the 1% Rule doesn't work out?

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Anywhere else the 1% Rule doesn't work out?

Kevin Gerace
Investor · Wallingford, CT · Member since 2013 · 28 posts · 4 votes

So there must be other places like my town. The average (decent shape) 2 family home is selling from 250k-325k. And the average rent is $1100-$1300. These numbers don't work out for the 1% rule. Everything I've ever read on here, or heard on the podcast is that if you don't make at least 1% a month you will lose money. The only way I can see these landlords around me making money is if they have owned the property for years before the prices inflated.

The reason I've been thinking about this is because a 2 family a few down from mine has been lived in by a hoarder for the last 50 years, and no maintenance has been done to the property in this time. It literally looks like the Munsters house. He passed away a few weeks ago and i walked over to speak with the family who is here this week cleaning the house out. They are from Arizona, I'm in Connecticut. He voiced not wanting anything to do with the property, but when he asked me what I would pay for it, I said "in the 70's"... He almost just walked away from me. I couldn't get a hard number out of him, but he did mention a number around 140k. 

This seems outrageous to me. The entire house needs to be gutted, the entire exterior needs to be redone. The 2 car garage is cinder block, but the roof is caved in. Massive trees near the house. Plus the entire house is full. 3 floors of garbage. 

I've had my eye on this property for a long time, but I think it will need about 140k-160k to fix, do other people think my price in the 70's is low balling him?

I think if the units were nice I could rent each floor for $1200. ($2400 a month total) I want to buy in my town because it is nice, it's just so expensive here.

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Account Closed
Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
10y

Kevin,

@David Faulkner is correct. Seems like you're on the right path. You just need a little fine tuning. I don't know if you have access to the MLS or Redfin.com or the equivalent. Study those markets. You will see a pattern between neighborhoods and the rent to property value ratio. Once you have a good understanding of these parameters, you will spot a good deal from a mile away. In the quest of doing your research, you may identify some investors who are getting some sweet deals that never hit the market. Wouldn't it be nice if you're in that circle? :>)

What's the ARV of the property after you renovate it? That would determine whether or not you're low-balling the guy. As David mentioned above, buying in expensive markets can be very profitable compared to cheap markets. Once you got the formula figured out, I promise you will look at expensive markets with a different set of eyes. :>)

Thanks for the mention David. Those 1% deals are doing good and on the verge of doing great. My partner and I got lucky this year. We just hope the luck will continue into 2016. The deals that I bought at the courthouse steps during the downturn are doing 1.4%-1.5% now. However, they're worth 2.5-3 times now so the rent to value is about 0.6%.  :<(

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  • Manolo D.
    Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes
    10y

    All over California, it is almost non-existent. That's 10% in fees for the flipping, 150k in repair, 270k in arv, you are there, 70k is enough. Unless you are confident you can sell it at 325 or more. I'd say 100k is a safe number, with a hoarder, you might need to remove down to the floor joist.

    2Reply
  • Tony Velez
    Hvac · North Haven, CT · Member since 2015 · 298 posts · 79 votes
    10y

    Why not New Haven? It has the least vacancy rate in the country. Also West haven is decent as well

    0Reply
  • Kevin Gerace
    OP
    Investor · Wallingford, CT · Member since 2013 · 28 posts · 4 votes
    10y

    @Manolo D. @Tony Velez

    My plan would be to buy and hold, not flip, and yes I'm sure it needs to be gutted to the studs. The family was in the house in full body plastic suits and respirators. 

    I'm hesitant to buy rentals in west or new haven because I feel the quality of tenant would be so much lower, higher vacancy etc... Wallingford, is great, just expensive, that's why I thought this would be a good opportunity to get in a little under the market price

    0Reply
  • Tony Velez
    Hvac · North Haven, CT · Member since 2015 · 298 posts · 79 votes
    10y

    Wallingford is nice. What town is the house you are interested in?

    0Reply
  • Jerome Foster
    Uniondale, NY · Member since 2015 · 1 post · 0 votes
    10y

    i am sure it does not apply to ny, long island, and northern nj either

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y
    Originally posted by @Manolo D.:

    All over California, it is almost non-existent. That's 10% in fees for the flipping, 150k in repair, 270k in arv, you are there, 70k is enough. Unless you are confident you can sell it at 325 or more. I'd say 100k is a safe number, with a hoarder, you might need to remove down to the floor joist.

    Yep ... guess that means that (according to the rule) nobody ever makes any money in REI in CA, right? :)

    3Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y

    @Account Closed how are all those 1% deals in the Bay Area going for you? To the OP, buy-and-hold in nice (expensive) areas can be done VERY profitably, and Minh is the master. Forget about 1%, but beware of negative cash flow, and focus on value add. You seem to be on the right track, but need a little fine tuning to pull it off safely and sucessfuly IMO.

    2Reply
  • Account Closed
    Investor · San Jose, CA · Member since 2012 · 2k+ posts · 3k+ votes
    10y

    Kevin,

    @David Faulkner is correct. Seems like you're on the right path. You just need a little fine tuning. I don't know if you have access to the MLS or Redfin.com or the equivalent. Study those markets. You will see a pattern between neighborhoods and the rent to property value ratio. Once you have a good understanding of these parameters, you will spot a good deal from a mile away. In the quest of doing your research, you may identify some investors who are getting some sweet deals that never hit the market. Wouldn't it be nice if you're in that circle? :>)

    What's the ARV of the property after you renovate it? That would determine whether or not you're low-balling the guy. As David mentioned above, buying in expensive markets can be very profitable compared to cheap markets. Once you got the formula figured out, I promise you will look at expensive markets with a different set of eyes. :>)

    Thanks for the mention David. Those 1% deals are doing good and on the verge of doing great. My partner and I got lucky this year. We just hope the luck will continue into 2016. The deals that I bought at the courthouse steps during the downturn are doing 1.4%-1.5% now. However, they're worth 2.5-3 times now so the rent to value is about 0.6%.  :<(

    4Reply
  • Manolo D.
    Contractor · Los Angeles, CA · Member since 2015 · 4k+ posts · 1k+ votes
    10y
    Originally posted by @David Faulkner:
    Originally posted by @Manolo D.:

    All over California, it is almost non-existent. That's 10% in fees for the flipping, 150k in repair, 270k in arv, you are there, 70k is enough. Unless you are confident you can sell it at 325 or more. I'd say 100k is a safe number, with a hoarder, you might need to remove down to the floor joist.

    Yep ... guess that means that (according to the rule) nobody ever makes any money in REI in CA, right? :)

     Well, just no positive cash flow. Appreciation is still money, but only after you sell it.

    0Reply
  • Jacqueline Carrington
    Investor · Corona, CA · Member since 2014 · 746 posts · 372 votes
    10y

    I think you're wrong about New Haven and West Haven.

    1Reply
  • Kevin Gerace
    OP
    Investor · Wallingford, CT · Member since 2013 · 28 posts · 4 votes
    10y

    Thank you everyone for your responses. @Account Closed I guess you may be right. I am just not very familiar with that area. I am familiar with wallingford, and meriden. I suppose I could look there as well. It's just what I'm comfortable with right now, also it would be nice to get a rental only 2 houses down from me. 

    0Reply
  • Rick SantasierePro Member
    Real Estate Broker · Granby, CT · Member since 2015 · 694 posts · 317 votes
    10y

    MF in class A areas in CT are pretty frothy.  Investors can't make any $$ in West Hartford for instance because buyers are paying ridiculous prices, living in one side, and renting the other.  I have seen several this year go for well over 15% more than the #'s say they are worth.  Which is why a "value add" makes sense (if you can find a good one).  Low balling makes sense, especially if you are newer to investing because your rehab costs could be off.  

    0Reply
  • Jacqueline Carrington
    Investor · Corona, CA · Member since 2014 · 746 posts · 372 votes
    10y

    @Kevin Gerace yes unfamiliar. I suggest driving around any town you may be interested in investing with and then reaching out to a realtor who works in those areas to learn more about the market(s).

    New Haven and West Haven offer a great selection of properties, are near several universities and can make investors money and can get quality tenants if your application guidelines target quality over quantity.

    0Reply
  • Steven Eitreim
    Rental Property Investor · Hamel, MN · Member since 2015 · 54 posts · 48 votes
    10y

    I'm dealing with the same situation near Minneapolis.  Rent is trending well below 1% of what you could acquire a decent property at.  However, the market is robust, so I'm going to use the following strategy:

    While the market remains solid, I'll flip.  With higher-priced real estate areas, your potential for return (in terms of $, not necessarily %) is higher.  A 30% value increase in a high-priced area is much more lucrative than a low-priced one.  Then, if/when the market corrects to a lower cost point, I'll switch to buy-and-hold (hopefully cash flow is more reasonable then).  And later on, if values get back to "robust" levels, you could sell with the appreciation, or continue renting and cash-flowing at the favorable level.

    This is all coming from a newbie, so take it for what it's worth.  A response that's likely been voiced hundreds of times over the years on BP

    1Reply
  • John D.
    Rental Property Investor · La Quinta, CA · Member since 2014 · 1k+ posts · 779 votes
    10y

    "All over California, it is almost non-existent"

    @Manolo D. Don't be so quick to paint all of CA with such a broad brush.  There are lots of us that have no problem with 1% and may even occasionally see 2%.

    1Reply
  • Bruce Runn
    Investor · Minneapolis, MN · Member since 2014 · 743 posts · 927 votes
    10y
    Originally posted by @Steven Eitreim:

    I'm dealing with the same situation near Minneapolis.  Rent is trending well below 1% of what you could acquire a decent property at.  However, the market is robust, so I'm going to use the following strategy:

    While the market remains solid, I'll flip.  With higher-priced real estate areas, your potential for return (in terms of $, not necessarily %) is higher.  A 30% value increase in a high-priced area is much more lucrative than a low-priced one.  Then, if/when the market corrects to a lower cost point, I'll switch to buy-and-hold (hopefully cash flow is more reasonable then).  And later on, if values get back to "robust" levels, you could sell with the appreciation, or continue renting and cash-flowing at the favorable level.

    This is all coming from a newbie, so take it for what it's worth.  A response that's likely been voiced hundreds of times over the years on BP

    0Reply
  • JD MartinBusiness Member
    Moderator
    Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes
    10y

    I live in one market and work in another. The market that I work in 1% is non-existent, but if you can break even you stand to make some serious appreciation money. The market I live in 1% is simple, 2% is very difficult. 3 of my units that rent for $650 each have all-in (purchase+rehab) of $48, 45, and 42, which works out to 1.35, 1.44, and 1.55, respectively. But those are full rehab numbers (new roof, new HVAC, kitchens, etc) so my % will improve with inflation in the near term as I've already absorbed the bulk of capex on those properties. 

    Every market is different. Some markets make little sense to buy for rental purposes but make big sense for appreciation. Some markets have little appreciation but will make a killing on rent. And some markets have neither, which is a death spiral!

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    0Reply
  • Bruce Runn
    Investor · Minneapolis, MN · Member since 2014 · 743 posts · 927 votes
    10y

    I'm in Minneapolis and have bought 4 duplex/triplexes in the past 2 years and average 1.20--1.25 .  I buy places that need some renovation in order make them really nice so I can raise the rents so I get higher than average rents/more appealing-additional bedroom/new kitchens/baths ect so the rent is higher over the long term.  All my places are in Uptown as well so cost is higher but rent is higher as well.  I may look at review 50 places and look at 10 before 1 meets my criteria so I found being highly selective has been the key.

    1Reply
  • David K.
    Home Inspector and Real Estate Investor · Bloomington, MN · Member since 2015 · 38 posts · 9 votes
    10y

    @Steven Eitreim and @Bruce Runn, I'm in the Twin Cities Also. I have found a couple good rentals in the last few months that beat the 1% rule. One house in Blooomington that I'm rehabbing now. When it's done, my total cost will be about $140k and will rent for $1,650. One in S Mpls for 99k that is renting for $1,350. That one will need a rehab when the renter moves out, but she loves the place. 

    Both of these are 1-1/2 story houses, post-war, and have 4br, 2ba. They are not large considering the 4br's. That's probably what pushed them over the 1%.

    I look at appreciation and reduction of mortgage as well as cash flow when doing the analysis on these.

    0Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    10y

    I'm in LA--same problem. Unfortunately numbers just don't work in a lot of the desired areas. I've always bought out-of-state because of it.

    0Reply
  • David Krulac
    Mechanicsburg, PA · Member since 2013 · 3k+ posts · 2k+ votes
    10y

    Just sold a place here rent $37,320, sale price $300,000, beats the 1% rule by $73,200.

    Just sold another place where the monthly rent was 1.9% of the purchase price.

    Not every place in PA has those returns, only the ones I sell. 

    0Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y
    Originally posted by @Kevin Gerace:

    Thank you everyone for your responses. @Account Closed I guess you may be right. I am just not very familiar with that area. I am familiar with wallingford, and meriden. I suppose I could look there as well. It's just what I'm comfortable with right now, also it would be nice to get a rental only 2 houses down from me. 

    If ARV is 275, at an offer of 70 + 160 in repairs puts you all in at 230 or 83% of ARV. If you were to flip it, you wouldn't be making all that much after holding and transaction costs. If you were to hold it, it would hit your beloved 1% rule then, but what would it cash flow with all the expenses, financing, and income factored in? ... those are the hold #s you'd need to run. I like to invest in properties where both the flip and hold numbers work (one for plan A and the other for plan B). Then, look at the historic price and rent trends over the last 10-20 years and assume that both will revert to this mean over the next 2 years or so (if the market is frothy at the moment, this might hurt you, if it is a buyer's market it may help). Finally, use all these numbers, including purchase price, repairs, rental income, expenses, and sales price or cash out refi after X number of years (you can play with these parameters) and calculate IRR on the series (can use the excel function to do this) ... this is your total return, over the life of the investment, including ALL sources of profit. Even if you don't end up buying the place, I think doing this analysis, playing with the numbers, and seeing where and when your profits come will be a good exercise and inform your investment strategy.

    So, no I don't think that 70 would be low ball at all if these numbers are correct considering the work you'd be putting in and risk. That doesn't mean that it won't sell for more, just means that you probably don't want to pay more if this is what your analysis says. I haven't seen the property, but 160 in repairs would mean it is in ROUGH shape ... you may try scrubbing those numbers. I hope this helps!

    1Reply
  • David Faulkner
    Investor · Orange County, CA · Member since 2015 · 2k+ posts · 3k+ votes
    10y
    Originally posted by @Steven Eitreim:

    I'm dealing with the same situation near Minneapolis.  Rent is trending well below 1% of what you could acquire a decent property at.  However, the market is robust, so I'm going to use the following strategy:

    While the market remains solid, I'll flip.  With higher-priced real estate areas, your potential for return (in terms of $, not necessarily %) is higher.  A 30% value increase in a high-priced area is much more lucrative than a low-priced one.  Then, if/when the market corrects to a lower cost point, I'll switch to buy-and-hold (hopefully cash flow is more reasonable then).  And later on, if values get back to "robust" levels, you could sell with the appreciation, or continue renting and cash-flowing at the favorable level.

    This is all coming from a newbie, so take it for what it's worth.  A response that's likely been voiced hundreds of times over the years on BP

    Very good plan ... I like the way you think! A few additional comments ... The analysis I advised would tend to agree and point to flip (shorter holding period) as plan A in hot markets. This business model is based on buying below retail and value add through renovation, not on speculation about market appreciation. I would still like to make the plan B hold #s work (even if I have to force positive cash flow with a lot down, just in case the market turns mid flip). Also, flipping in a hot market you should follow the Tom Cruise Top Gun mantra "I feel the need, the need for speed!" This not only minimizes your hold costs but also minimizes the risk of the market turning on you mid flip. Finally, your profit margin also acts as your margin for safety against such risks. Basic philosophy is to structure the investment not only for maximum rewards, but also for minimal risk. All stuff you probably already know, Steven, but spelling it out for the benefit of others.

    1Reply
  • Account Closed
    Investor · Central Valley, CA · Member since 2012 · 6k+ posts · 3k+ votes
    10y
    Originally posted by @Account Closed:

    Kevin,

    @David Faulkner is correct. Seems like you're on the right path. You just need a little fine tuning. I don't know if you have access to the MLS or Redfin.com or the equivalent. Study those markets. You will see a pattern between neighborhoods and the rent to property value ratio. Once you have a good understanding of these parameters, you will spot a good deal from a mile away. In the quest of doing your research, you may identify some investors who are getting some sweet deals that never hit the market. Wouldn't it be nice if you're in that circle? :>)

    What's the ARV of the property after you renovate it? That would determine whether or not you're low-balling the guy. As David mentioned above, buying in expensive markets can be very profitable compared to cheap markets. Once you got the formula figured out, I promise you will look at expensive markets with a different set of eyes. :>)

    Thanks for the mention David. Those 1% deals are doing good and on the verge of doing great. My partner and I got lucky this year. We just hope the luck will continue into 2016. The deals that I bought at the courthouse steps during the downturn are doing 1.4%-1.5% now. However, they're worth 2.5-3 times now so the rent to value is about 0.6%.  :<(

    I had an agent contact me today with 1% deals, both in the Central Valley, small towns.  1 is a 7 door deal (4 houses, 1 triplex), the other is a 4 plex.  Trouble is the quality of the props and the tenant pool.  So, you've got 7 doors at less than $70K per door, and rents over $700.  But just yuck to operate them.  Difficult tenant pool (small town poverty), old props that you can keep going but will be headache.  So the 1% rule isn't everything.  :)

    4Reply
  • Bruce Runn
    Investor · Minneapolis, MN · Member since 2014 · 743 posts · 927 votes
    10y
    Originally posted by @David Faulkner:
    Originally posted by @Steven Eitreim:

    I'm dealing with the same situation near Minneapolis.  Rent is trending well below 1% of what you could acquire a decent property at.  However, the market is robust, so I'm going to use the following strategy:

    While the market remains solid, I'll flip.  With higher-priced real estate areas, your potential for return (in terms of $, not necessarily %) is higher.  A 30% value increase in a high-priced area is much more lucrative than a low-priced one.  Then, if/when the market corrects to a lower cost point, I'll switch to buy-and-hold (hopefully cash flow is more reasonable then).  And later on, if values get back to "robust" levels, you could sell with the appreciation, or continue renting and cash-flowing at the favorable level.

    This is all coming from a newbie, so take it for what it's worth.  A response that's likely been voiced hundreds of times over the years on BP

    Very good plan ... I like the way you think! A few additional comments ... The analysis I advised would tend to agree and point to flip (shorter holding period) as plan A in hot markets. This business model is based on buying below retail and value add through renovation, not on speculation about market appreciation. I would still like to make the plan B hold #s work (even if I have to force positive cash flow with a lot down, just in case the market turns mid flip). Also, flipping in a hot market you should follow the Tom Cruise Top Gun mantra "I feel the need, the need for speed!" This not only minimizes your hold costs but also minimizes the risk of the market turning on you mid flip. Finally, your profit margin also acts as your margin for safety against such risks. Basic philosophy is to structure the investment not only for maximum rewards, but also for minimal risk. All stuff you probably already know, Steven, but spelling it out for the benefit of others.

    The great part of Bigger Pockets is people get to see more than one approach so they can figure out which would work best for them and also learn new ways to look at it.

    I advise the opposite approach-  I believe in buying the same multi family, renovating it, renting to get the cash flow and sell in a year and a day so instead of paying the 25-28% federal, 7% state and 12% SS (adjusted for self employee deduction) for an approx. 44% tax rate, I pay 15% federal and 7% state with no SS for a 22% capital gains rate.  If it's a $70,000 gain, I just "kept/made" another $15,000.  I was taught by a very smart mentor, you'll spend more time trying to keep the money you've already made than trying to make more money.  Not only do I make approx. $12,000 in sheltered income from the rent after renovation, I took home 38% more so I kept about $27,000 and 70% more than if I flipped it quick.  I will give you the caveat that I have enough cash and Heloc money leveraged against my other properties to buy more than one place at a time so I'm not dependent on selling a reno in order to buy another but being more particular about the deals you do and making money by leveraging all of the advantages including lower taxes has always been a successful strategy.

    Both scenarios can be winners but you have to decide where on the experience/risk scale you are and I'm a believer in pounding out all the take home money you can get.   We all pay taxes, I just want to pay the least I can.  All markets are different so you have to be able to adjust to the trends and figure out how you come out the farthest ahead at the end of the day.

    3Reply
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