Rule of 100, 1% Rule, or whatever it is called
Real Estate Investor · St. Louis, MO · Member since 2008 · 47 posts · 0 votes
In looking at rental properties with a realtor, he mentioned the rule of thumb of looking for something with gross rents of at least 1% of the purchase price. What are your thoughts on this? Do you use this rule? If so, how do you use it?
This seems like an overly simple analysis. Don't you need the expenses, etc. to figure out if the deal is good. I can easily see situations where the rent meets the 1% criteria, but expenses cause negative cash flow or the cost of borrowing ruins the profitabiliy. Maybe the rule is used as screening criteria to help determine if you want to do any further investigation?
"Magic Rental Formulas" are common with investors for sifting through the hay stack to find the needle, but an experienced investor is still going to crunch an actual income expense statement on the property before they put it under contract.
Now the 1% rule of thumb completely depends on your market. In my market my number is 2% or a monthly gross rent multiplier (GRM) of 50. A monthly gross rent multiplier allows easy computation of general price from rents. Rents minus utilities multiplied by 50 should be my highest purchase price. A 1% or 100 monthly gross rent multiplier are a dime a dozen in my market. When you crunch an income/expense statement, including maintenance and vacancy, you most likely won't even be cash flowing (depending on insurance and taxes) on a 100 monthly GRM. If I remember correctly I think a 90 monthly gross rent multiplier (7.5 annual GRM) is the highest you can realistically go to cash flow.
Realtors are NOT investors. Be careful when you are trusting a non-investor with investment advice. Determine your magic numbers on your own and then take them to a realtor. Unless you are in a HIGH appreciating area then a non-cash flowing property is not a good investment startegy.
Oh, one quick follow up if I didn't already mention it. I do have a rental in Hillsboro that I have owned about 3 years and owe about $140,000 on get $1,025 a month on and have a buyer for it we hammered out a price of $205,000 (Appraised value is the one for $210,000) I plan to do a 1031 and buy a duplex as soon as I find one (then I'll write the paperwork) I like with the proceeds
Very nice indeed! To be honest I was leery when you said you could sell for that much appreciation given current market conditions (especially rent vs. buy), but if you're actually getting that kind of return then you're at least sane for renting that low. :lol:
Here in Hawaii, it is impossible to find a property that meets the "1% rule". In fact, after expenses, you're lucky to find a property that receives 0.5% in annual net rent. True 4% cap rates are the norm here, 5% rates are around but not common. 6% rates are extremely rare (or the property will require major rehab to achieve) and 7% is impossible to find. If I could handle the cold, I would move to a state with better prospects. My understanding is that it's impossible to find a property that meets the 1% rule in metro or higher end areas.
1% rule will not work in Las Vegas. Here 300k house will rent for $1500 or 1/2%. In rural areas of the state it will work.
8)
I've been looking at the multidwellings for many years (off and on) About 6 years ago, I was seriously looking into getting one on a particular street. Rent was total $1600/month and they wanted less than $100k for the property.
Now just this week, a multi on the same street as the one 6 years ago now has a rental income of $1800/month and the guy wants 170k for the property.
I always thought the income set the value of the property since no one but an investor would buy. The problem is, this guy paid $150k, guy before him 125k, then 6 years ago, it was about $100k same as the one I wanted 6 years ago.
If rents don't go up much in 6 years, how can these prices be justified? Everyone here is talking about 2%+, but I can barely get 1% on anything unless I go into the worse neighborhoods in the city. Property seems to have appreciated but rents are not going up. Will they ever increase?
Houses in this area are selling near 90k and renting for $550, where 5 years ago, they were $55k and renting for $550. I'm completely baffled...Probably because I'm such a Newbie
Debtfree, over the last 5 years this has been very common in many markets. Values have appreciated exponentially but rents have not. Rents appreciate quite a bit slower than values do. Eventually they will balance out but I wouldn't expect anything as dramatic as the value appreciation.
My goodness! $90,000 for a house? How big is the lot? How big is the home? Where is this?
Rents haven't been keeping up with prices here in Hawaii either. But the rents have gone up a lot. I would say rents are up about 50% in the last 6 years (whereas property values are up about 100%). But before that, rents were flat for about 8 years. So we may be in for a long period of flat rents. That's what I suspect at least.
debtfree,
The vast majority of rentals are offered and sold at retail. That is the reason that the majority of new landlords fail. If you want to be successful with rentals, you must buy at a BIG discount.
I've heard this often as well. However, I think it's just more guru nonsense.
I read a government report a couple of months ago (I think it was a Census Bureau report). At any rate, it had a bunch of statistics about rental properties in the U.S. One of the things that stuck out to me is that a huge percentage of the rental housing in the United States is owned by individuals, the majority of which have very few units. What strikes me about that fact, is this idea that mostly professional investors own rentals. That is simply wrong. What we really have is a bunch of continually changing newbies who own the rental supply.
You can see this for youself if you belong to a REIA for any period of time. There are a few serious investors and a continuous stream of ever-changing wannabes and newbies. The vast majority of the wannabes never buy a single property. The vast majority of the newbies that do buy a property will never buy even 5 and will be out of business in a short period of time.
The price is artifically high because one newbie is selling to another. Obviously, they all paid too much which is why none of them kept the property. Who would sell a property that is making a good profit every month? So, it's just the greater fool theory - (there will always be a greater fool to pay more when it doesn't work out for me).
What I find in my area is that I have to buy properties at about 1/2 of the market price to make them a good rental. That is why it is difficult to be successful in the rental business. You've got to do the WORK to find appropriate deals. To do this, you've got to find someone who is DESPERATE to sell. Disgruntled landlords are a great source of desperate sellers. Look hard and you'll find them in most areas (maybe not the bubble areas).
Good Luck,
Mike