How important is the 1% RULE?

Question

I am looking at property in the Cape Girardeau, Missouri area.  The rental market is very strong for single families, especially with an abundance in healthcare occupations and a large university.  The problem is that it is hard to find a good property that works with the 1% rule.  I am curious if any of you purchase properties that don't quite work with the 1% rule and what you do to make these work with your rental portfolio.  I appreciate any advice or replies.  Hope everyone is having an awesome day!

Stephen Schott · Answer

@Bleau Decker the biggest thing about Cape Girardeau is finding your demographic and setting your own price point. Also if houses are continusly rented and are grandfathered in past Missouri state law for some tenancy regulation you can, add some bedrooms to most properties here and rent to college students. Also it depends on what you are basing your 1% on. Is it the appraised value of the property or the amount of money YOU have invested? For example I have a property that, cost me 38k and it took 22k in renovations. So 60k total. It appraised for 106k and I rent it for 1,800 a month to the baseball team at semo. We are about to finish an identical property next door to this one and rent it to more baseball players. In these examples I make 3% a month on my cost. But make 1.7% on appraisal value.

Bleau Deckerd · Answer

Makes a lot of sense. Thanks for the feedback. I’ve been concentrating on figuring out what areas of Cape to concentrate on prior to pulling the trigger on something. Just out of curiosity, on your first baseball house, were you able to do the BRRRR plan?

Ned Carey · Answer

@Bleau Deckerd the 1% rule is not very important because it is a tool to pre-screen deals. It is only one of many ways to do that.

That said, few properties will cash flow at below 1%. Most I look at would not cash flow even at 1%.  Cash flow is only one metric of performance of an investment. Appreciation and equity build up are other factors that the 1% rule does not take into account.

It could be you are looking for the wrong types of properties or the wrong sub market. Not all price ranges  make good cash flowing investments.  Also you are looking at a very high point in the market cycle. Of course there are going to be fewer good deals when the  market is this strong..

Mike D'Arrigo · Answer

@Bleau Deckerd The only thing that is important is the bottom line cash flow and COC return. The 1% rule is not a meaningful metric and is only helpful when doing a comparison of properties with similar costs and operating expenses.

Stephen Schott · Answer

@Bleau Deckerd yes. We actually opened a line of credit on this property based on 75% of its appraised value. The house next door we bought with this line of credit and will finish the renovations. Then mortgage the house to pay off the line of credit because we will be well below 75-80% costs.

I have one rule when finding properties in the area, it's that I will never go into a property for more that 65 cents on the dollar. Which means if I know the property appraises for 100k finished, and I know there are 20k in renovations, I doing everything I can to purchase that property for 45k or less. You don't find those deals on turn key investments, they do require more work. And most of the time they aren't listed, they are found through networking and sleuthing neighborhoods haha..but this strategy would keep you under leveraged, keep your net, worth high, and will always create the necessary cash flow given you are doing all the other things to rent your peppery to good tenants.

Bleau Deckerd · Answer

Adam.  Thanks for your reply.  I do understand the 1% rule.  However, I was curious if anyone has had any success with any single families where the 1% rule does not quite work out.  For instance, there are several houses in our area listed between $100k and $120k that would rent for around $900.

Adam Gollatz · Answer

The 1%(2%) rule is a thumb rule or a guideline to help you quickly analyze a deal for cash flow. If you are looking for cash flow, it is extremely important. Its going to be market and price point specific. What I mean is that a 400k property bringing in 4k a month will likely cash flow. A 50k property at 500/mo rent will likely lose money every month.

Your best bet, analyze several different deals at different price points in your target market and start to see where the breakeven point is for cash flow. Factors like taxes, expenses, and financing terms will also impact where the breakeven point is. Again, its just a ballpark to determine whether a deal warrants a closer look.

How important is the 1% RULE?

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