Can a market be profitable below the 1% rule? Austin Tx

Question

Good morning everyone, happy holidays. I have a question and I'm dying to find the answer. I keep hearing everyone talk about the1% rule and how it's important. But I'm looking at the Austin, Tx market for duplex/4 plex and there is nothing close and yet everything is selling. Now is it because the1% applies more to single family? Also perhaps they're coming in lower than asking but with how fast the properties are going I doubt the seller isn't getting asking price. Please help I'm just curious to know what you think. Thank you and Merry Christmas

Oren K. · Answer

Ross - I think you have to first define what you mean by profitable (not rhetorical). Profits can be had in two basic forms; appreciation and cash flow.

A property can be cash flow negative (you have to support it with additional funds each year) but is appreciating so quickly that when you exit / sell , you have an overall 'profit'.

A property can be very high cash flow positive (you take fund each year) but has virtually no (or even negative!) appreciation. Each year you are taking the 'profit' but when you sell you basically get your purchase funds back (ignoring inflation).

As well, both examples are affected by any leverage you may take out on the property; All-Cash ties up the capital but insulates you from interest changes while highly leveraged may allow you to purchase more but has interest rate risk (it also eventually ties up capital as the loan is being paid).

These two 'extremes' are why many investors look at the Internal Rate of Return (IRR) and other financial metrics and not just CAP Rate or Cash-On-Cash. Also any metric that require forecasts into the future (e.g. Rent increases, Exit Price) are an additional 'risk'.

There are markets like SoCal and NY where appreciation is going strong. Prices are high and you need either deep pockets or syndication / partners. Alternatively there are markets like the Midwest where you can find and buy low price value-add properties that once stabilized  (which has its own risk profile) generate cash flow in the teens if not higher on an all-in basis.

Defining what kind of profits you want  (or the balance between them) will help you figure out what markets / properties are right for you.

Oren

David Ivy · Answer

@Ross Ellington

In the current market, you're highly unlikely to find a single family or residential multifamily property in Austin fitting the 1% rule. However, as Account Closed said, a quick rule-of-thumb, like the 1% rule, is just a tool among many others that investors can use to quickly determine whether a deal is worth researching further.

Kenneth Reimer · Answer

@Ross Ellington Hi Ross, great question. In regards to expenses, one of the common assumptions that most people don't realize they're making with the 1% rule and the 50% rule, which devalues the relevance of the metric, is the age of the building. If you have a quad built in the 50s or 60s, the routine expenses to make sure their is no deferred maintenance will be much different than for newer (not necessarily new) construction. So I would say, along with Account Closed, that the rule is only a good starting point.

Also, the rents that a property is achieving may be under market. It's the same conversation with cap rates on multifamily deals. An investor may be buying a building at sub 5% cap rates on actuals, which seems very rich, but the achievable pro forma after increasing rents and efficiently running expenses could be a 7% cap in a great area.

Lastly, I see many BP members running a deal on the listed price. Depending on the deal and area, what they fail to do is run the numbers to find out the price at which the deal would make sense to them. It's all too common for the members to run the numbers on actuals and walk away from it due to the numbers not making sense. The analysis should be to find at what price the deal does make sense.

Again, great question!

Kenny Reimer

Account Closed · Answer

Absolutely.  All of those "rules" are just guidelines people use to analyze deals quickly before digging into the details.

Account Closed · Answer

@Ross Ellington

I think that @David Ivy and Oren K. both make good points. The metrics in the Austin market are a little bit funky. You might find something that meets the 1% rule in the Austin MMA, but it will most likely be on the outskirts and it will have to be bought "as is". A lot of Austin investors are might be forecasting potential appreciation into their returns, but, like Oren said, the margin for error ("risk") goes up with long term speculation.

I think that Austin is slowing down a bit, but it's definitely still hot, and people are willing to adjust their own investment criteria in hopes of the capitalizing on appreciation further down the line.

It's a bit of a weird market, but there are still deals to be found! Feel free to reach out if you have any questions!

Lance Adams · Answer

Oren K. did a good job describing why the 1% monthly income rule is sometimes ignored, as it currently is in Austin.  Folks here are betting on capital appreciation and/or the continued escalation in rents to make the investment attractive in the future.  It has paid off very well for them over the past few years but I think most would agree it is more risky than if the properties were significantly cash flow positive when purchased.  In fact, I would say that most of the duplexes in Austin are selling at prices that are cash flow negative when realistic numbers for repairs and capital reserves are put into the analysis.

Ross Ellington · Answer

Thank you guys so much for the responses. I've bought a single family already through the VA. Austin might be out of my price range for now just because I would need it to be a cash flow investment. But something down the line I'm def game for. Thanks again. Sorry for the late response. I'm full time student, work40  hours, 3kids a wife and I do the reserves. So if I'm late in responding I apologize but will anyways respond to you. Thank you everyone

Michael Lee · Answer

Hello and welcome to BP!  Just remember that the 1% rule is a rule of thumb that can tell you to take the project to the next level or look at the project more seriously.  There are a bunch of factors and ratios that can help you move to the next level.  I have heard that the prices of homes in Austin are high.  I have lived right out of Dallas Texas and I found BP about 18 months ago while medically recovering and looking for something to do that is more flexible and based on my experience and no-how.  Besides my construction business since age 17 and I held an active real estate broker license that was about 30 years old.  i am now 60 years old and quite opinionated about real estate action.

You might want to review stuff like NOI and positive cash flow as being more important.  But mainly look at all and determine if that project meets your goals.  There are some people that teach marketing sales on the internet called Paperless Agents in Austin.  Both of the hosts have about 20 years of experience based on digital marketing what is working well for those that have used that.  Their service products seem to be very modern.  Besides selecting your niche and market area there are several things that should be considered before you start investing.  One of those items is to form some type of corporation or a LLC.  You might also consider hiring a lawyer and/or a CPA to advise you on what to do.

Another thing you might do is to get your financer figured out and get a loan letter that you can use to help you get some deals by telling the seller that you can close.   Another thing you need to do is getting your location located that is convenient for you and has the fewest distractions.  You can locate your office in your place as long as you can close it off and does not have any distractions for you.  Just do what is average in that neighberhood.  Do not try to do everything yourself.  I am trying to keep this initial letter to you short.  I have more starting tips I could give you so contact me if you have any other questions.

Good luck to you!

Oren K. · Answer

Investments of virtually every kind are a trade off between risk and reward.

In a high appreciation / negative cash flow market you better have outside sources of capital to support the investment and you hope that the the market continues to appreciate; otherwise you have a money pit. IF your purchase timing was 'off' (i.e. at the top), you may not even get your initial purchase back if things move quickly (think 2008).

In a high cash flow / no appreciation market, your tenants and the building itself become the main 'risk' factors; turnover, damage, typically age of building / systems. If too much goes too  wrong too fast and not only are you not making any profit but you need to supply additional funds which can wipe out 'profits' for years down the road. Alternatively, if you do not support the investment, it can quickly spirals down to no value.

Knowing what you are buying, having realistic expectations, underwriting it correctly and setting up reserve funds goes a long way towards success.

Most people are looking for something between these extremes.

Jeff B. · Answer

Basically, ALL of California fails the 1% rule -- yet we have many investors and a fare share of the housing market in general.

1% of $1000 is worthless, but 1% of $100,000 is meaningful and 1% of $1,000,000 is just wonderful.  So look at the annual ROI to determine *IF* a particular property is worth your time and effort.

Can a market be profitable below the 1% rule? Austin Tx

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