1% Rule Multi-family Properties – Where are you hiding them, Chicago!?

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BP Community—equipped with many hours of Bigger Pockets podcast listening and forum trolling, the fiancé and I are actively searching for a multi-family property to owner occupy in the City of Chicago. Goal: leverage a 3.5% FHA down payment to acquire and owner occupy a 3-plex (that's a "3-flat" in Chicago, folks!) which cash flows positive in an up and coming area that's close enough to the rough zones to offer bargains but far enough away to feel safe walking our mini schnauzer late at night. For us, cash flow is king; we'll sacrifice appreciation for cash flow in a heartbeat. In good Bigger Pockets faith, we are strictly adhering to one of @Brandon Turner's most sacred commandments: thou shall not purchase an income property with a monthly rental income to acquisition price ratio of less than 1%.

Loved @Brie Schmidt in podcast show 78! Her story resonated with our goals, big time! @Brie Schmidt mentioned her owner occupied Chicago 3-flat property has a monthly rental income to acquisition price ratio of ~1.25%. I was inspired. After scouring over 100 MLS listings with abysmal ratios, @Brie Schmidt's 1.25% simply blows me away! Where are all the 1% properties hiding?!

For your viewing pleasure, I’ve included a snap shot of my “5-minute analysis” process on properties in our Logan Square farm area. Yes, this is a small sample of properties, but, the ratios are representative of a more exhaustive list:

Column “S,” the 1% Rule, reflects values well below the acceptable 1% ratio. Column “T” reflects the acquisition price required to achieve a ratio of 1.05% (my self-imposed minimum). Column “V” is the acquisition price to achieve 1.1% and column “X” achieves my ideal 1.25% (for Chicago anyway).

We realize there are three ways of arriving at 1%: decrease the acquisition price, increase rents, or both. As owner/landlords inheriting lease terms, we will have to wait for expiration for the opportunity to increase rents, hurting cash flow upfront. I have more control over the acquisition price and want to heed the advice of BP contributors everywhere who assert that “investors make their money when they buy the property and realize it when they sell.” With our BP knowledge, we know it’s unacceptable to invest in anything south of 1%; however, the required purchase prices in columns T, V, and X are so dramatically low that that we’re discouraged we’ll find a seller who’ll accept or even take us seriously.

In this mega city, we presume there are thousands of buy and hold investors with properties ? 1% and we want to be one of them. Has the Chicago market appreciated to a place that makes 1% properties scarce? I have a feeling we’re “missing” something here. We’re looking for the Chicago BP community to help us understand this market and point us in the direction of the 1% motherland.

Your comments and guidance would be greatly appreciated!

I listened to that great podcast as well.  I think @Brie Schmidt bought the Chicagoland properties several years ago when prices were cheaper allowing her to beat 1% rent/price. Recent purchases have been in Milwaukee.

@Danny Duran  

Your on the N / NW side...it's a tough landscape in this area of Chicago to make the 1% rule.  And Logan is pretty hot right now...

You are buying the dirt up here so keep that in mind.  If you want to cash flow you have to go South right now 

@Danny Duran To answer your questions: 

As @John Weidner mentioned, the N/NW side has appreciated significantly in the last couple years. It's possible to get well over 1% in Chicago, but you'll need to expand your search to meet your goals. Farther North and NW of Avondale/Irving Park 1% might still be possible. South and West sides definitely, though it may be tougher in areas that pass the mini schnauzer test...

Speaking of your goals, if you're set on becoming cash flow positive in a building you're occupying with only 3.5% down, the 1% rule is likely too low to be useful. I'd suggest using a spreadsheet where you can plug in rent values of the two units you're not occupying, minus all of your expense estimates (mortgage, PMI, taxes, maintenance, etc.) There are tools like that floating around BP…I think @Wendell De Guzman just posted one recently in the forum.

@Joey Nakayama ,

To make the @ work, do the following:
Hold down the shift key and type @?
Look below this Window, and you will see a list of names of people that have posted in this thread.
Click on the name of the person that you want notified via an email, that you responded to them.
If you are a Colleague with anyone that has NOT posted in the thread, and you want them to see your post, hold down the shift key, type the @ and the first 4 letters of their First or Last Name.
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Raymond

@Raymond B.   

Good catch — the names seemed to be linked while I was writing, but when I posted they unlinked somehow. Thanks anyway though.

Since so few hits are discovered on the MLS for these criteria, what is the solution? Looking in other areas is suggested. However, has the value of these areas also risen to a degree where other routes for acquisition are cost effective? Are there such opportunities found in these areas via auction, marketing campaigns, or other approaches "upstream" to the MLS?

@Joshua Dorkin  : Wish we could edit our posts...

Meant to say...

"where other routes for acquisition are ALSO cost INeffective?"

I think the owner occupied portion of things is the issue here. If you were to do a non-FHA loan and rent the entire property and occupy a simple abode in a neighborhood that meets your personal safety criteria how would the numbers look then?

There are a lot of benefits from separating your personal residence from a business investment, perhaps an inexpensive studio or small 1 bedroom in a livable area would allow you a purchase of a three unit in a rougher area where cash flow is good (albeit at the expense of appreciation).

maybe you should look in other areas. here in florida just about every house under se 130000 meet the 1% rule

@Joey Nakayama   while I will owner occupy, I am evaluating the properties as if I amnotgoing to live there. If it cash flows without me occupying one of the units, it's worth a closer analysis. Properties that don't meet the minimum 1% ratio don't have the likelihood of cash flowing. I'm okay with paying for some of the mortgage/expenses each month when I amoccupying a unit; just need to make sure it will cash flow positive the instant I insert a tenant in my place.

When (if) I find a City of Chicago property that meets the 1% rule and I can feel comfortable living in, I will proceed in applying the 50% rule of expenses, etc. I just don't want to analyze tons of listed properties that don't even meet the first screening test: monthly rent to acquisition price ratio ? 1%.

@John Weidner   in the N and NW side where prices have risen and properties are below the 1% threshold, how will the multifamily units on the market attract buyers? I'm trying to understand the psychology of an investor under these conditions. Given that the buyer of a 3 or 4-flat is most likely a small pool of investors conducting sophisticated analysis with rigorous requirements, it seems highly likely that these less than 1% properties will sit on the market for long periods of time. Or, would an investor knowingly purchase an income property with a ratio of 0.7% and stomach the negative monthly cash flow for future appreciation in a Logan Square type area? For this to work, an investor must have significant cash reserves, a high level of confidence that the property will appreciate and that they can exit with a profit after months or years of negative cash flow. Risky.

@Ray Browne part of the allure of owner occupying a 3-flat for me is that my tenants would pay the majority of the interest, tax, property insurance, and FHA mortgage insurance which are all tax deductible. I'm in need of deductions such as this to reduce my taxable income each year. A studio or 1-bedroom place I buy in your suggestion would provide the same benefit, however, the lower amount would make less of a tax impact (smaller loan), and, I would be paying PITI out of myownpocket versus having the tenants cover most of it in an owner occupied situation. In your suggestion, the 3-flat in a rough neighborhood could provide cash flow, but, I would only be able to deduct depreciation, not interest/tax/Ins. on an income property I don't occupy (non-primary residence). Furthermore, I must put 25% down for a conventional loan on a non-owner occupied, income property; whereas, I can put as little as 3.5% down on an FHA loan if I owner-occupy, leaving more capital available to deploy in other investments.

Those of you with tax expertise, please keep me honest on these tax benefits outlined above.

Thanks for everyone's commentary and suggestions. It really helps think through my strategy for this milestone investment. Account Closed  do you have any advice for this scenario? Would love to get @Brie Schmidt's input, too.

@Joey Nakayama   while I will owner occupy, I am evaluating the properties as if I amnotgoing to live there. If it cash flows without me occupying one of the units, it's worth a closer analysis. Properties that don't meet the minimum 1% ratio don't have the likelihood of cash flowing. I'm okay with paying for some of the mortgage/expenses each month when I amoccupying a unit; just need to make sure it will cash flow positive the instant I insert a tenant in my place.

When (if) I find a City of Chicago property that meets the 1% rule and I can feel comfortable living in, I will proceed in applying the 50% rule of expenses, etc. I just don't want to analyze tons of listed properties that don't even meet the first screening test: monthly rent to acquisition price ratio ? 1%.

@John Weidner   in the N and NW side where prices have risen and properties are below the 1% threshold, how will the multifamily units on the market attract buyers? I'm trying to understand the psychology of an investor under these conditions. Given that the buyer of a 3 or 4-flat is most likely a small pool of investors conducting sophisticated analysis with rigorous requirements, it seems highly likely that these less than 1% properties will sit on the market for long periods of time. Or, would an investor knowingly purchase an income property with a ratio of 0.7% and stomach the negative monthly cash flow for future appreciation in a Logan Square type area? For this to work, an investor must have significant cash reserves, a high level of confidence that the property will appreciate and that they can exit with a profit after months or years of negative cash flow. Risky.

@Ray Browne part of the allure of owner occupying a 3-flat for me is that my tenants would pay the majority of the interest, tax, property insurance, and FHA mortgage insurance which are all tax deductible. I'm in need of deductions such as this to reduce my taxable income each year. A studio or 1-bedroom place I buy in your suggestion would provide the same benefit, however, the lower amount would make less of a tax impact (smaller loan), and, I would be paying PITI out of myownpocket versus having the tenants cover most of it in an owner occupied situation. In your suggestion, the 3-flat in a rough neighborhood could provide cash flow, but, I would only be able to deduct depreciation, not interest/tax/Ins. on an income property I don't occupy (non-primary residence). Furthermore, I must put 25% down for a conventional loan on a non-owner occupied, income property; whereas, I can put as little as 3.5% down on an FHA loan if I owner-occupy, leaving more capital available to deploy in other investments.

Those of you with tax expertise, please keep me honest on these tax benefits outlined above.

Thanks for everyone's commentary and suggestions. It really helps think through my strategy for this milestone investment. Account Closed  do you have any advice for this scenario? Would love to get @Brie Schmidt's input, too.

@Danny Duran  

.7% does not mean will negative cash flow.  I know many investors that are happy to break even.

Plus figure Depreciation into the equation...

@Danny Duran   On the tax issue - if you purchase a 3 flat purely as a rental property (not a non-primary residence) you can deduct 100% of mortgage interest, taxes, insurance, building repairs, etc. If you owner occupy, you can deduct only the portion of those expenses not related to the section you live in (2/3rds for a 3 flat, but still 100% for expenses related only to one of the rental units).

@Steven Hamilton II  is a great resource for all things tax related.

@Danny Duran It's very difficult to find a cashflowing multi-unit in the N and NW neighborhoods that meets that criteria. They just aren't listed on MLS and if so, they'll get snatched up immediately.

You'll pay a premium for a move-in ready property in hot neighborhoods, so as others suggested, expand your neighborhoods or look for a place that needs a little work. Some of these places just truly need to have rents increased as they're managed by investors that are reluctant to raise rents or don't research current market rents.

Btw, I'm a big fan of doing an FHA owner-occupied loan for your first investment.

1% is difficult in a hot area...and agree with @John Weidner  that lower than 0.7% does not necessarily mean you're in negative cashflow territory.

At the end of the day, you want to have BREAKEVEN cashflow since you're going to live in one of the units. Instead of being focused on the 1% rule, focus on getting that breakeven cashflow. You can use the Cashflow Analyzer I've given you. You can do a "Goal seek" in excel and find out the price you need to pay to have breakeven cashflow (assuming you factor in 5% for maintenance, 5% for reserves and 5% for vacancy).

Hey all, 

I know nothing of the Chicago market, but I have a few thoughts. You may need to go on the "offensive" to find deals, meaning direct mail, working with wholesalers, facebook ads, driving for dollars, other creative methods. Either that or look further away, but that might not work for your goals, so I dunno! 

And I'll tag @Brie Schmidt  since she's been mentioned in this thread a few times! Perhaps she can add some more thoughts! 

I just bought a NPN off Kedzie and 53 its a Brick 3 flat .I might have to wait another 60 Days to get tittle and time to do the eviction . I did purchase the Hazard Claim insurance the Banks carries . 4500.00 Along with Attorney fees of 2k .....2-- 3 bdrm and 1-- 2 bedrm

Banks appraisal were 1000.00 a month for both 3 bdrm  and 875 for the 2 bedrm.. this was in 2003

Purchased for 67k

Whoa.  Sorry guys, I was out all day looking at property and just saw this thread.

@Danny Duran  - First, thanks for listening to the podcast, glad you enjoyed it!  If you are looking in Logan Square you will not be able to find the 1% rule - that market got too hot about 3-4 years ago.  I bought my deals pre-spring 2013 which is when things got nuts here.  As @Joey Nakayama  and @John Weidner  said, you need to go N / NW to still find deals.  In fact all three of us own property very close to each other in the Old Irving-ish area.  I actually have a client looking over there right now and may have found him a good one after a few months of searching.  Another area that is starting to turn trendy is West Humboldt Park, West Town, and Uptown.  The trick here is to get there before it becomes trendy.  

In fact @John Weidner were just talking this morning about Chicago's tight market. I was telling him how it took us 7 month of looking to find our first deal (even back then) and that they are not commonly on the MLS but after looking at every single listing in our farm area when ours did come on the market we knew instantly. It takes time to sort through all the bad deals for the one you want, you just have to be patient.

It is also hard here as a lot of landlords do not list their current rent, so you have to have a good idea of what units rent out for in the area to run the numbers yourself.  

@Danny Duran Great post man! Not only is it very entertaining, it's very informative. I completely agree with your philosophy of using the FHA loan. I actually just went through this process and bought a 3plex. Try to be patient and wait for a deal to come along. I know for me, I got excited very quickly and wanted to buy the first property I saw. I'm glad I didn't! A couple of months later, I found a property that fit my criteria. as mentioned before, don't be afraid to expand your search area. It doesn't hurt to see what other areas have to offer. Also, tell everyone you know that you are looking to buy a multi unit. You will be surprised how word of mouth will turn into leads.

Funny this post came up, I ran into two agents this past week looking for off market 3 flats in "the square" for personal purchases. Kinda like the stock market...

@Danny Duran  You have to understand the true market rent, not the current lease rent, since many long-term landlords that have 'vintage' 3-flats prefer the "easy" way of renewing leases at a $20-40 bump instead of increasing all the way to market. I expect (recommend) you will be doing some rehab which will increase the rents further and allow you to come closer to your 1%.  

To answer your question on why people will accept a 0.7% in Logan Square: the answer is appreciation. Property values have gone up 10-15% per year over the last couple of years there and the trend seems to be continuing into the foreseeable future. I expect rents are increasing at a slower pace, but still you can build substantial equity by buying a 0.7% deal. Now is a good time to stretch for the deal (RE: income ratios) because the relatively low risk of losing value/putting your equity at risk.

CASE STUDY IN APPRECIATION: I started investing by buying a 3-flat in Wicker Park in 2001 that my wife and I STRETCHED to buy. We lived in it for 4 years and it was a little above break-even when we moved out. Now it generates over $25k per year of cash flow. I levered up to 85% LTV in 2005 (took out $100k equity to buy a home in the 'burbs) leaving about $120,000 in equity. Now with my principal reduction and appreciation we have over $500,000 in equity in the property.

Hey @Danny Duran,

As previously stated the market is very hot in the north and northwest side of Chicago, now. However there is still opportunities in the Chicagoland area that offers the elusive 1% cash-flow your looking for.

I was born and raised in Oak Park, which is next door to Berwyn. Naturally, we would drive through and go shopping in Berwyn. 

Berwyn I believe is up and coming moderate income suburb (haven't you seen the signs all around downtown chicago). Berwyn is 1 of 3 suburbs than have 2 metra stops from Chicago to Aurora (Other 2 stops suburbs, Naperville and La Grange).

I Bought my first 2 flat in 2012 in Berwyn which generates a 2.1% return; with a 3.5% down FHA loan (AWEOME!!!). This Spring I bought my first 3 Flat in Berwyn on the same street (not block) which generates a 1.5% return (10%down). Great deals are becoming more and more scarce on the MLS, at least.

I have a strict rental application process, to weed out the bad apples and so far I have not had any evictions or late rents (crossing my fingers).

Looking through the MLS there is still deals that offer great returns in the Berwyn marketplace for Buy and Hold investors; However there are grey areas/blocks I would stay from. If possible try to stick as close as possible to the Roosevelt and Harlem area. This area touches Oak Park and Forest Park, two suburbs with great schooling systems and on the Berwyn side nicer homes and apartments, its also close to the blue line which is great feature.

If possible stay away from the parts of Berwyn that touches Cicero (near Lombard ave), this area is more marginal with shady slum lords and attracts like minded renters. 

Hope this helps

Tony

I just bought a townhome last month in Oak Park, total cost including rehab is 130000.  Just put it for rent at 1550.  It is little over 1%.  Bought a single family home in Oak Park in 2011 total cost 160000 foreclosure, currently renting for 2400, clearly 1%, appraised for 330000 last month.  Bought a single family home in Forest Park in 2013, $140000 total cost and renting for 1550.  But in today's date it is almost impossible to make numbers in both these suburbs.  I lucked out in the townhome in Oak Park because it was an estate sale, and I bought it cash on day one it was on market and my realtor knew that since it was her boss's listing.  I am not in market to buy anymore because costs are too high except some day I sell single family homes and get a multifamily.

@Danny Duran This is a very informative post and echoes my thoughts, exactly!  I looked at many properties last weekend, mostly 3 flats.  There was one that was basically turn-key (although I could see many improvements it could need over time) in a very hot area of Bucktown proper.  The price was probably below the market--$589K for a 3 flat.  There were already 4 offers on the property when we saw it.  Yet, the cash flow was not there and it was not even close to making the 1% rule.  I spoke with our agent about the low price, with me thinking that it was a calculated move on the seller's part to drive a bidding war.  He was inclined to think that the seller did not realize the true value of this property, since his other properties were in a different part of town. The units were fairly small and the rents very low.  Assuming the property would probably go for over $650K in the end (due to the multiple offers), the rents would have to be increased significantly to even come close to there being positive cash flow.  The numbers totally did not work and I wondered why there were so many offers (probably more came in after I saw it).  It seemed like those seeking this property were not buy and hold investors but rather, people looking to sell in maybe 5 years and bank on the likely appreciation of the property.  I decided to forget about Bucktown, Lakeview and certainly, Lincoln Park, because the numbers wouldn't work at all.  I looked more in Humboldt Park, West Town, Bridgeport and Pilsen.

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