The 2% Rule doesn't work 50% of the time
Ok I have acquired over 120 units of rental property and have used the following rules: 1) Purchase properties in areas that have a geographic Impediment to growth. 2) Don't purchase a property that you wouldn't be willing to live in. 3) Make sure it cash flows when you buy it. Because of the economic downturn of the last couple of years I have added a couple of more rules 4) Only buy in name brand cities 5) only buy properties for less then replacement cost.
Now for the heresy part. I use a 1% rule. I'm not saying this is the only way to make money but it has worked for me.
Let me explain the rules a little: 1) and 2) work hand in hand. A geographic impediment to growth is something like an ocean, a lake, a mountain, a river. The best is a Peninsula. San Francisco is a good example of this. As far as rule number two goes there are two different axioms that go along with this. First off is that I'm assuming that you want to live somewhere you like. If you like it then other people will like it too and it will grow. Secondly if you are willing to live there then you are probably comfortable with the people who live there and understand them well enough. The reason for these rules is that if you have limited space and more people who want to live there then there is room for then rents will go up.
The third rule is all about cash flow. Don't pay for someone else's idea. Oh this will be great if you put a new roof on and then paint it and add new carpet it will rent for $500. Look at what it is getting for rent now and then pay what it is worth right now as is. I use a complex formula I look at all expenses and compare the expenses to similar buildings and if they are in the range then I use them. If they are too low I use averages. If they are too high I try to figure out why they are high and then use the high numbers and go in with a plan to lower those expenses. For instance on the latest building I bought the water bill is running $28k a year. That was higher then the average for the area. As I inspected the building I found out why the water bill was so high -- leaky faucets and 5.5 gallon per flush toilets and no low flow shower heads. I figure I can cut the water usage in half by replacing the toilets with 1.6 gallon toilets, fixing leaks and adding low flow shower heads. That saves $14k a year and will cost me $12.6k. Payback time 1 year. When I buy a building the expenses run around 45% to 50%. After I have owned the building for three years or so they run at 32% to 37%. This is partly due to raising the rent and partly due to decreasing the expenses.
Now I only buy in name brand cities. There have to be jobs I am avoiding secondary and terciary markets b/c I don't know what the economy is going to do.
I figure if I can buy something for less then it costs to replace a unit then there are not going to be a lot of people building new units. If it costs $175k per unit to build a unit (not a high figure in CA metro areas) and I can just cash flow buying at $86k a unit the market isn't going to be flooded with new units.
So now the 1% rule. Every where that I buy buildings have rents closing in an average of $1k per month. I don't look at a building unless it is close to a cost of monthly rent times 1000. I think the math is the same as a 1% rule. I get a lot of calls from Realtors and they say that deals like I want are hard to find in California. I agree they are.
At this point in my career I can ask my property management firm what the average expenses are supposed to be. They have 1000's of units under management and know the numbers off the top of their heads. Before I had to beg the numbers off of appraisers or other property owners.
Between appreciation and cash flow I have done well. Right now the goal is to use money I have to invest to build some speculative, buy some wholesale or flip properties and take the profit pay off the buildings I have so that I own them outright. At that point I won't have to work any harder then I want to.
So what is your investment strategy?