Property doesn’t meet 1% rule but cash flows. What am I missing?

27 Replies

Hi BP community!

I am a relatively new investor in Fayetteville, NC. My first rental property is a 4 bed, 3 bath single family. Purchase price was $150k and current rent is $1,475. My analysis of the property is as follows:

- Income: $1,475

- mortgage (taxes and insurance incl.) $920

- no HOA fees

- no landlord-paid utilities

- I self-manage so no property management fee

- pest control service $30

- CapEx: 10% or $147.50

- Vacancy: 5% or $73.75

$1,475 - $1,171.75 = $303.25 positive cash flow.

In regard to 1% rule, my property is currently sitting at 0.98% yet I’m seemingly still cash flowing $300. Can someone tell me if I’m missing something? Thanks!!

Originally posted by @Jake Wosick :

@Logan L. Congratulations on getting your first property. I agree with Drew 1% is not scientific. If you want to chat more let me know, happy to help. 

It's not even that. I bet this rule has caused more REI to shy away from good deals than saved them from bad ones. It's a shortcut...not a more efficient way of doing it...and there's a huge difference between the two.

A better market in my opinion is a combination of monthly cash flow and cash on cash return. What is your total investment in this deal? I typically look for around $250/month cash flow or more with at least a 12% CoC

@Logan L. , how much do you value your time?  Self manage, and NOT underwriting a fee means you do not value your time at all.  I self manage too, and it is not terribly time intensive, but there should be something in that just to pay yourself. And, while minimal, you might have to pay a few dollars per month for excel or much more than a few dollars for quick books.  Technically, there will also be accounting costs too, but most people don't underwrite those into deals.

Regarding the Capex and repairs budget, you might be over estimating or under estimating. Age and remaining useful life of each system is imperative to understand. Your projected ownership period is also a big factor. If you plan to own a long time (10+ years) and this isn't a new build house, you are probably under budgeting. Things that will likely come up when you own a property over 10 years. Replace HVAC, replace water heater, remodel kitchen and likely bath, potentially a roof or flashing replacement, landscaping work, exterior repaint. Less common, I have had retaining walls fail, fences get destroyed from falling branches in storms, critters getting into attic, etc.

None of this is guaranteed, and the shorter your ownership, the less likely any of these major items will come up.  It is your choice if you budget and reserve for them, or don't.  Personally, I reserve for all of this, since a new roof today will still need replaced in the future, whether I have the money saved or not.  

@Joe Villeneuve I just searched the forums and saw that those numbers were “typical” to be honest. It was my first property and I didn’t know what to expect. I feel that I am able to refine those numbers a bit now.

Logan, the 1% rule is really a suggestion.  It looks like you have ok cashflow, but if you paid yourself a management fee the return would be a little lower.  The way homes are appreciating in this market and the average rent increases are 7-10%< I think the deal is great.  Go find some more.

@Pratik Shah

The house was built in 1974 but fully renovated in 2019. I believe the roof is about 7-8 years old. I replaced the HVAC when I bought the property. I also thought 20% between maintenance and CapEx was conservative but I guess I wanted to err on the sage side.

Originally posted by @Logan L. :

@Joe Villeneuve I just searched the forums and saw that those numbers were “typical” to be honest. It was my first property and I didn’t know what to expect. I feel that I am able to refine those numbers a bit now.

 Typical to what?

@Evan Polaski Thanks for your reply! That makes sense, I will start to add a property management fee to pay myself. Also thank you for clarifying the CapEx/repair costs for me. I have seen posts that just use "x" percent each month without much explanation. I appreciate your help!

@Andrea Lane thanks! The current rent for this house is low for the area, once I adjust that I will be able to add a management fee and still improve the cash flow a bit. Thanks for your reply, I’m excited to start buying more!

@Joe Villeneuve haha that’s a good question. It was my first property and when I saw “typical,” I didn’t have a reference point to adjust my numbers to. It was basically just a guess based on percentages that other investors deemed “normal.”

Here's your first real lesson in setting values and analysis.  Never use words, or synonyms of words, such as "typical", "adjust", "basically", and "percentages" (they lie), "guess", and/or "normal", ever again.  They are the words used by those that are letting others dictate what you do, and relying on them for their knowledge (which may be less than yours), as a substitute for facts.

Originally posted by @Matthew M. :

@Joe Villeneuve so what do you use to forecast future expenses if not what’s typical?

Comps, for rents and for sales of similar properties, based on the same size, within a tight geographical area (micro-market), minus costs and or expenses for the properties within that market (micro-market actually), and the resulting cash flow and or profit that can be made, compared to the minimum required cash flow and/or profit required at the specific timeline in the REI Plan I am following at that time.

What you are missing is that the 1% rule has nothing to do with cash flow. It is a rough rule of thumb to estimate where rents should be relative to purchase price. You need other numbers to calculate cash flow, like mortgage payment and expenses. 

If you pay cash for a property, ANY property will cash flow. If you 100% finance a property, it may barely cash flow, but may still be a good deal. That is because with $0 into a deal, even $1 of cash flow is infinite return. Cash on cash return is a better metric than cash flow in my opinion. 

I know I am late to the party and it seems you have good answers. Your numbers look fine to me. Houses like this are our bread and butter business. Just place good tenants and you will do wonderful.

Don't use % for capex and maintenance, these costs are derived from fundamentals and tenant base. Vacancy should be higher as well, and adjusted for tenant base. D neighborhoods of course has higher bad debt. A neighborhoods might also have shorter tenant stay. Vacancy is a catchall for turnover vacancy, make ready cost, and bad debt. Also, apply property management fee even if you self manage to stress testing your asset.