Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
5y
Guessing on a different level. Not all properties have the same taxes, insurance, etc... Where does that come into play here? Just learn how to actually do analysis, and avoid the shortcuts. These shortcuts are not time savers, they are deal killers, or rationalization justifiers. Either way, in the end they waste more time than they save.
Plymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
5y
Guessing on a different level. Not all properties have the same taxes, insurance, etc... Where does that come into play here? Just learn how to actually do analysis, and avoid the shortcuts. These shortcuts are not time savers, they are deal killers, or rationalization justifiers. Either way, in the end they waste more time than they save.
Investor · Tacoma, WA · Member since 2015 · 28 posts · 11 votes
5y
@Joe Villeneuve maybe “rule” was a bit too strict. In this case, it’s more of a guideline. It can be used as a starting point and a quick/dirty way to analyze a deal.
Generally, if property taxes and insurance are the reason you’re not cash-flowing, it probably is not a good deal to begin with.
By no means should the 10% “rule” I’m suggesting be used a substitute for actual analysis and due diligence.
Just curious, do you have real life example where you could not apply this concept?
@Joe Villeneuve maybe “rule” was a bit too strict. In this case, it’s more of a guideline. It can be used as a starting point and a quick/dirty way to analyze a deal.
Generally, if property taxes and insurance are the reason you’re not cash-flowing, it probably is not a good deal to begin with.
By no means should the 10% “rule” I’m suggesting be used a substitute for actual analysis and due diligence.
Just curious, do you have real life example where you could not apply this concept?
Call it a "rule", call it a "guild", doesn't matter, it's still trying to apply the worst kind of arbitrary numbers (percentages), to a property, and making a decision of your next action from it. That next action may not be buying, but it is whether or not to go on analyzing that property.
Taxes and insurance impacts CF, but higher T&I doesn't mean it won't CF.
How many examples do you want to see? I bet I can find more where this doesn't apply than can be found where it does apply.
My suggestion would be to stop looking for a shortcut that, by your own admission, isn't a substitute for analysis. Then why do it? Instead, start looking for stacks of needles...analyze markets instead of individual properties. By doing so, you are by default analyzing all of the properties in that market, at the same time.
It's the market that dictates if the deal is good. not the numbers found from one stand alone property. Many a REI has found that one property, where the numbers look great, but they can't rent or sell it...and can't figure out why. There last words the same as their first words,..."this is a great deal. The numbers look great".
The value of any property is not based on the stand alone cash flow or profit. It's based on the surrounding properties that make up the market that stand alone property is in. That, is the most important reason, why this "rule/guild" is a waste of time. Sorry.
Investor · Tacoma, WA · Member since 2015 · 28 posts · 11 votes
5y
@Joe Villeneuve agree with everything you just said. Positive Cash flow does not mean it's a good deal, there are many factors to a REI that do not show up on paper.
This is merely a tool to add to your deal analysis toolkit. However, if a deal does not cashflow I would not invest in it.
@Joe Villeneuve agree with everything you just said. Positive Cash flow does not mean it's a good deal, there are many factors to a REI that do not show up on paper.
This is merely a tool to add to your deal analysis toolkit. However, if a deal does not cashflow I would not invest in it.
All squares are rectangles, but not all rectangles are squares.
Investor · Greenville, SC · Member since 2016 · 5k+ posts · 13k+ votes
5y
A $100k property with $625 per month rent will not come close to cash flowing. The P&I payments will ~$450, leaving only $175 for vacancy, management, insurance, taxes, utilities, repairs, maintenance, and cap ex reserves.
Investor · Tacoma, WA · Member since 2015 · 28 posts · 11 votes
5y
@Mike Dymski Sorry I didn't explain my assumptions. For my business model: all utilities are paid by the tenants (the PITI comes out to about $450), 8% vacancy, and self-managed.
In my market where the median home price is $500k this concept will work better for multi-units. $100k SFRs here locally getting $625/month is not likely, I was using it more as an example to show the math.
@Mike Dymski Sorry I didn't explain my assumptions. For my business model: all utilities are paid by the tenants (the PITI comes out to about $450), 8% vacancy, and self-managed.
In my market where the median home price is $500k this concept will work better for multi-units. $100k SFRs here locally getting $625/month is not likely, I was using it more as an example to show the math.
Based on your own assumptions (a word a REI should NEVER be using doing analysis):
Price = $100k DP = 25% (why not 20%) Loan = $75k Terms = 4%, 30 yrs MP = 358/mo PITI = 450 (your number) TI = $92 (seriously?)
Rent = $625/mo Rent - PI = $267/mo TI + CF = $267/mo (I seriously doubt this is enough to cover TI, much less TI AND CF)
10% Rule = $750/mo 10%R - PI = $392/mo TI + CF = $392/mo (I seriously doubt this is enough to cover TI, much less TI AND CF worth buying the property for)
@Mike Dymski Sorry I didn't explain my assumptions. For my business model: all utilities are paid by the tenants (the PITI comes out to about $450), 8% vacancy, and self-managed.
In my market where the median home price is $500k this concept will work better for multi-units. $100k SFRs here locally getting $625/month is not likely, I was using it more as an example to show the math.
Yeah, won't cash flow. P&I will be about ~$350. Insurance and taxes will be well above your $100. You will have utilities during unit turns. You need R&M, turn costs, and cap ex reserves, which are some of your largest expenses. And need to account for property management. That is not an investment return...it's a job that needs to be compensated (whether it's you or 3rd party). The property should support PM too because life events happen and investors often need to pivot over time. $625 of rent for every $100k in value will not cash flow in any market in the country.
@Joe Villeneuve good catch, with a DP of 20% this increases our rent to $833/month and should improve the numbers.
There's always assumptions in REI, it's a matter of reducing and validating them.
Rent isn't based on any percentage of anything. Rent is based on similar (actually the same) properties in the micro-market the specific property is in.
Taxes and insurance aren't based on any standard percentage, they're based on the specific micro-market the property is in.
Using shortcuts to save time, is going to do nothing more than waste time, and lead you in an uncontrolled arbitrary direction based on a universal assumption(s) that is usually based on the person using this method's own set of goals...trying to prove them. Then when this "guess" does prove them (surprise!!!), and they try to rent or flip the property based on the results of this "guess", they can't figure out why it won't rent/sell for what their analysis "proved" to them. Go figure?!
Assumptions in REI is just another way of saying "fudge factor". When you start using them, particularly to improve or prove a desired result, you're going to go broke.
Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
5y
@Awet Hagos
Personally I want 1000/month for every 100k purchase price +rehab…. The 1% rule. A little below is ok if I know I can push rents. Your deal would not work for me for the reasons @Mike Dymski mentioned.
Investor · Tacoma, WA · Member since 2015 · 28 posts · 11 votes
5y
@Max T. I also find the 1% rule does not scale well with larger purchase prices. For example, a $700k triplex can still be a good cash-flowing deal without collecting $7k/month.
Investor · Philadelphia, PA · Member since 2015 · 3k+ posts · 3k+ votes
5y
@Awet Hagos
No i would probably need the same ratio for the larger deal as well. My duplexes all beat the 1% rule. I don’t have any tris and nothing close to a 700k price point.
Investor · Richmond, VA · Member since 2016 · 164 posts · 114 votes
5y
@Awet Hagos I like that you have criteria and goals. I'm learning anytime someone posts about their point of view. Over the years I've put together a spreadsheet where I plug these few numbers in to see what a deal will do for me. It has the insurance and tax rates for my area, plus the maintenance that I feel comfortable with. The only real variables are the rent charged and the purchase price. It spits out a few different metrics (cap rate, ROI of cash flow, ROI overall, etc,). Ever thought of building a tool like this that you can keep on your phone? Comes in very handy for me! Hope all is well.
I'll throw my hat in with @Mike Dymski and @Joe Villeneuve. While I applaud you for your effort and creativity and the work you've done thinking about the numbers and wrestling with how they interact will most certainly serve you well in your investing this "rule" doesn't have a lot of applicability.
If you are in the SFR game you have to start out by defining your micro area, like Joe mentioned. Once you find one or two areas you like and start doing the stubby pencil work, seeing what rents are for homes in those areas and then plugging that income number into homes that for sale to arrive an idea of what price gives you what return metrics. Once all that work is done then you can come up for rules of thumb for investing in your specific micro area, but not before.
And as an aside, residential RE don't have cap rates, since that metric only applies to stabilized assets and by definition resis can never be stabilized.
@Max T. I also find the 1% rule does not scale well with larger purchase prices. For example, a $700k triplex can still be a good cash-flowing deal without collecting $7k/month.
Do you notice the same?
The 1% rule doesn't work either. Any rule that uses a percentage as a rule...won't work. There is NO universal percentage. There are NO universal numbers. There are only numbers that are specific to a micro-market, and then a specific property in that market. Period.
...and calling it a guild or guideline is just semantics.
I came up with a new way to quickly evaluate if a deal will cashflow.
I call it the 10% Rule: if annual gross revenue is at least 10% of the financed amount (after putting 25% down) then it’ll most likely cashflow.
For example, $100k property (25% down), you do $75k * .10 = $7500 annual revenue (you need at least $625/month to cashflow).
Thoughts?
0.625% rent to purchase ratio is a poor representation of the 1% rule. It is my belief that non-commercial MF will be initial cash flow negative in all markets even the high rent markets with a 0.625% ratio. The maintenance/cap ex is too high on small unit count RE.
The 1% rule "works" only after you have accurately calculated expected expenses in your market. There are markets were the 1% rule is too aggressive (mostly lower rent markets, but also potentially markets with high prop tax, high HOA or melo roos, and/or insurance) and other markets were the 1% rule is quite conservative (in my high rent market, I can be confident of positive cash flow at 0.75% ratio at 80% LTV). I am confident of my cost estimates because 1) I have taken the time to mathematically calculate expected cap ex 2) I have been doing this for quite a few years. I have pretty much repaired/replaced every cap ex item.
It is another issue on how many new investors have done any analysis on maintenance/cap ex. Most pull some percentage of rent out of the air without being able to justify it. Most do not even know what it costs to replace a hot water heater on a weekend.
So your rule is a way too aggressive derivative of the 1% rule. The 1% rule has many short-comings, but it is a lot less aggressive than your rule.
An investor could calculate the ratio for cash neutral for an "average" unit in their market. That number can be used to quickly determine if a more thorough analysis is warranted. Only home run cash flow properties could by-pass this more extensive cash flow analysis, but why not calculate it even on the homerun property?
Nothing substitutes for a detailed analysis prior to purchase. This is not limited to cash flow, but COC, ROI, return from value add, etc.
Investor · Tallahassee, FL · Member since 2013 · 77 posts · 24 votes
5y
@Awet Hagos
I have just found this calculator https://apps.apple.com/us/app/cds-rental-calculator/id1503244257. For apple users. CDs rental calculator works well. Plug in the numbers gives cash flow and over all return after debt service
Rental Property Investor · Atlanta, GA · Member since 2019 · 11 posts · 6 votes
5y
@Awet Hagosi just wanted to mention that at least for me, I have found myself having to stick a lot less to percent rules once I narrowed down my criteria. At that point I filtered out the majority of the deals and the ones that were left are amazingly similar from an analysis perspective, making it pretty straight forward to glance at the face value and have an idea if it has some potential at being a good deal.