1% Rule in New Jersey HOT Market

[Alexandra Preziosi]

Hello!

I am a real estate agent in the Northern New Jersey area in a seller's market (like most of the country at this time). I am looking for investment properties for myself as well as my clients, and there is little inventory that would satisfy the 1% rule of thumb. For example, in a good rental town, it is average for a multi-family with 2 units, 2BR per unit to rent for $1,800/ mo / side; or $3,600/ mo total. 

It is common for a home like this to be priced at $450,000 or $500,000 and prompt a bidding war, where the final purchase price can be $25K - $75K over ask! (sometimes even more)

In not considering the 1% rule, a home purchased at this price and generating this amount of rental income might appear to come out with a positive return each month (not considering cap-ex, vacancy, and other expenses), but will assume all separate utilities for tenants. 

To take this example, say the potential rental income of this property is $3,600/ mo and it is purchased at $500,000. (assume $12,000 taxes, $1,200 insurance, 20% down).

Mo. Payment (mortage, ins, taxes): $2,896/mo

Rental income: $3,600

Net: $704/ mo = $8448 / yr 

$8448/ $100,000 (down payment) =  8% return 

My question is, what should I do to help advise my clients on their purchase if they really love an investment property and want cash flow if the 1% rule is so hard to come by in our market. My goal is to do right by my client, of course, and also get them the property they want, in addition to helping their investment goals. Is it enough to consider the difference between the monthly mortgage payment (incl. taxes and ins) and monthly rental income to consider a particular investment to be a "good" investment (if utilities are also all separate)? 

I greatly appreciate the insight. Thank you. 

[Stephanie P.]

Originally posted by @Alexandra Preziosi:

Hello!

I am a real estate agent in the Northern New Jersey area in a seller's market (like most of the country at this time). I am looking for investment properties for myself as well as my clients, and there is little inventory that would satisfy the 1% rule of thumb. For example, in a good rental town, it is average for a multi-family with 2 units, 2BR per unit to rent for $1,800/ mo / side; or $3,600/ mo total. 

It is common for a home like this to be priced at $450,000 or $500,000 and prompt a bidding war, where the final purchase price can be $25K - $75K over ask! (sometimes even more)

In not considering the 1% rule, a home purchased at this price and generating this amount of rental income might appear to come out with a positive return each month (not considering cap-ex, vacancy, and other expenses), but will assume all separate utilities for tenants. 

To take this example, say the potential rental income of this property is $3,600/ mo and it is purchased at $500,000. (assume $12,000 taxes, $1,200 insurance, 20% down).

Mo. Payment (mortage, ins, taxes): $2,896/mo

Rental income: $3,600

Net: $704/ mo = $8448 / yr 

$8448/ $100,000 (down payment) =  8% return 

My question is, what should I do to help advise my clients on their purchase if they really love an investment property and want cash flow if the 1% rule is so hard to come by in our market. My goal is to do right by my client, of course, and also get them the property they want, in addition to helping their investment goals. Is it enough to consider the difference between the monthly mortgage payment (incl. taxes and ins) and monthly rental income to consider a particular investment to be a "good" investment (if utilities are also all separate)? 

I greatly appreciate the insight. Thank you. 

Here's my insight.  Sorry it's so long, but I was intrigued with your post for some reason.

If I were sitting with your client and they asked me if it's a good deal, I would tell them this.  I only know what I'd say because I've said it hundreds if not thousands of times with numbers specific to each day of course.

1.  "It's a math problem that only you can solve.  If owning this property and cash flowing more than $700 per month is right for you, then do it.  If not, then don't." Then slide the offer sheet across the table for them to sign. If they sign it, you're off to the races.   

2.  I may also say "You can't sneeze at 8K per year, but many would, especially in the higher cost rentals.  In truth, you have to be comfortable with the profit you're going to make because the numbers are what they are."

I learned a long time ago that putting your financial concerns about a client on them is fruitless.  It's better to present the numbers and if they qualify, don't get in their way.  I blew a sale, almost 40 years ago, and my boss and I were rehashing the presentation.  He said "They wanted to buy.  Why didn't you let them."  I'll never forget that quick lesson.  Well worth the blown sale and the $250 or so in commission I lost out on.

The dominant buying motive is the strongest motivating factor in sales.  It's "The Why".  Once you find it, the sale isn't just a sale, but the fulfilling of a need.  The person may not be looking at the $704 monthly profit as terrible, but a way to show his/her Dad/Mom/Wife/Husband that this real estate thing can be profitable.  It may be more than their grandparents made in a whole year and a validation for a whole family or it could be the beginning of a journey they've been dying to take since they read "Nothing Down" or some other real estate book many years ago.

Once you find out why they're there and you've found them the opportunity to fulfill the need, present the numbers honestly and get out of the way.  If they want to go in a different direction or they feel it's not right for them, then probe a little more to pinpoint what was missing and keep looking.  If they are being unrealistic, you can't take on that burden yourself.  Again, they're numbers and if they work, they work and if they don't they don't.  

Hope that helps

Stephanie