In evaluating deals, when to consider which rule?

Question

Hey BP,

I've recently made an account (yesterday) and have been reading articles, the e-book that BP is so kind to publish and I've been looking at different real estate deals in my area (San Diego) and I've noticed that although I typically never find properties that do better than 1% rent over price, there are some properties given that the down payment is high enough, that I am able to "beat" so to say, the 50% rule. My current thinking is that if I am able to beat the 50% rule and given if the property is not a junker and doesn't seem like there will be significant difficulties getting it rent ready, it seems like I could cash flow even while "ignoring" the 1% rule. Does this logic make sense or am I not seeing something? Appreciate you all reading this and guiding a new BP onto the straight and narrow.

- Eugene

Jay Hinrichs · Answer

@Eugene Lee  those rules were spawned out of the Great GFC... not germane to todays markets in most areas.

you can though still buy in areas were there is more housing than people to use the housing and find those rules apply and even more.. those are what we call cash flow markets that's all they are all they will ever be ( in most likelihood) so if your going to invest there only reason to do it is to hit those 2% or better metrics

where we reside on the West coast we generally look for break even and make our big bucks on having our tenants pay down our debts and of course appreciation...

you have most folks that live in the non appreciating markets and their mantra is  ( cash flow cash flow appreciation is only luck its not investing  LOL)  and you have those that have gotten stupid wealthy buying west coast assets that double or tripled in value in a 10 year time frame.. take your pick..

Its a long game though.. and in many instances if its just cash flow you want.. real estate is not always the best thing anyway you may be better plunking down 100 to 200k and buying some subway sandwich franchises make you far more cash flow than any rentals.  that type of thing

Bill Gulley · Answer

Well, the only thing I agree with Joe about here is that those rules are pretty much for the lazy.

The problem really is that new investors (and many old ones) didn't learn real estate, the simple economics of real estate, it all boils down to what makes real estate valuable or more valuable.

Anyone can offer 60% of the value, you might get 1 out of a hundred offers, maybe none. It's also a more predatory approach if all you can do is make your money by taking equity out of a seller's pocket.

Profits come from adding value over what you paid. If all you do is take money, you're not really an investor.

So, your analysis begins with "what CAN I do with a property"? Is there any "value add" to this property ?

Cash flow is important, but it appears on BP it's the only goal (might be because everyone is broke today and needs to eat LOL).

Is the property at its highest and best use? Can you serve niche tenants, like some organization, that reduces vacancies or pays premium rents for special amenities or location?

What about building equity long term, increasing your net worth, gain a position to leverage future financing, do you even have a public relations aspect to your business?

A good deal is one that doesn't eat any hay! It pays for itself at whatever the value might be.  :)

Kevin Fox · Answer

Hey @Eugene Lee

As a few others have said, you can go ahead and throw all those rules of thumb right out the window.

While I'm sure they're applicable in some markets, I can tell you first hand that most, if not all, of the "% rules" you'll see mentioned on this site simply do not work in San Diego.

What kind of property are you looking to purchase?

Justin R. · Answer

@Eugene Lee You'll be able to find a property that throws off yearly free cash flow here locally, even if it doesn't meet the 1% threshold you mentioned.  None of my properties do, and the capital tied up in them continues to perform just fine.

That said, it's more difficult to find a property locally where the free cash flow is better than, say, the dividend income thrown off by investing in a Blue Chip dividend mutual fund.

If you're looking at small Multifamily properties locally and want a first pass "rule," I suggest using a GRM target of 12-14 as a first screen, assuming you're looking for a property that will throw off free cash flow with a 70% leveraged mortgage.

If you want to more than basic long term buy it and hold it, you can do it.  As @Bill Gulley said, though, if you continue on you'll want to throw this rule stuff out and focus instead on finding ways to add real value to properties and neighborhoods.

David Faulkner · Answer

The answer is simple. Ignore ALL of those rules, they are garbage and will get you into all kinds of trouble. As others have mentioned, learn the fundamentals and analyze each property individually. If you are too lazy or not knowledgeable enough to do this, then don't invest in Real Estate until that changes.

Brent Coombs · Answer

The "hotter" the market, the less those normal investment rules are likely to work.

The larger your down payment, the easier it is to "cheat", so that it LOOKS like the rules will work!

If you want to ignore the "rules", you'd better pray that future appreciation doesn't fail you!...

Patrick Liska · Answer

Agree with @Brent Coombs and @Joe Villeneuve, easy to manipulate those numbers and those rules are really just a for a fast analysis of a property. you are better off doing your due diligence and running all your numbers. after researching the area market and running the numbers, the main area i like to focus on is the COC return. the COC will tell you how much you will earn based on how much you invest in the property, just like any other investment vehicle out there but with Real Estate you can earn money in different ways, not just not like an interest bearing account or stock market where you hope the stock will rise in value.

Oren K. · Answer

I really don't understand both the hyping and bad mouthing of the 'rules' that are commonly discussed on BP.

Soap Box ON

Over time, most activities (e.g. businesses, sports, personal relationships, etc.) where judgement is involved, develop 'rules of thumb', 'short cuts', 'approximations', etc. which allow you to make 'quicker' decisions at the expense of less certainty; they will be wrong some of the time. Even in very exacting jobs (e.g. space craft design), where even a small mistake is literally a mission critical life & death issue, they use 'rules' to avoid over-engineering (or to use another phrase 'analysis paralysis').

The 'rules' for real estate investing are not intended to be exact or fully comprehensive. They do NOT capture the reality of every market condition, every strategy option, every goal objective. They DO allow you to use very little information to make an complex decision that covers many market conditions, many strategy options and many goal objectives.

One thing we all have in common is limited time and how we choose to spend it. As each opportunity crosses your path, you can choose to do a deep dive, get a lot of information, do a full analysis and then determine how you will move forward (i.e. invest or pass) . Alternatively, based on just a few simple pieces of information that are readily available, make a quick decision to move on to the next opportunity or gather more information for a more detailed analysis.

To put it in different context that I think a lot of people on the West coast can relate to. If you have ever been a technology hiring manager (and many other hiring managers as well) in the last couple of decades, you have probably experienced the incoming 'stack' of resumes when a position is posted. There is simply not enough time to do a detailed review (much less analysis) of each resume, interview the candidate and then come to a considered decision. Instead, you put the 'stack' through various filters that at times have nothing to do with the applicants ability (e.g. formatting). You are looking for reasons to say NO so you can move on to the next resume. You need to quickly turn the 'stack' into a hand full of resumes that you can look at more closely. If you don't do this quickly, by the time you are ready, the people you want are probably no longer available. In doing this quick filtering process, might you miss out on the next Einstein, Jobs, Pasteur or Rembrandt ( you really should know these names without looking them up ;)... Sure. In the mean time, you have missed out on many other excellent applicants.

The 'rules' are a temporary substitute for judgement which develop over time. Over time, as you get exposed to more circumstances and situations your judgement should improve and you should rely less on the 'rules'. This does not mean you never use the 'rules', rather your experience allows you to know when they can be applied and when they can not be applied and when they should simply be ignored.

Soap Box OFF

Eugene Lee · Answer

hey BP

Thank you so much for the response. To be honest, I was beginning to become a little discouraged in my search for potential opportunities in San Diego because of the low rent to price ratios. It's encouraging as a newer investor that even those that have already invested seem to have properties that do not necessarily (strictly) meet the rules. Perhaps I was putting too much stock in them. Thank you so much for the input.

@kevinfox I have been looking mainly at single family in the range of 300k and 500k, primarily in the UTC area but also as far down as national city. The goal is cash flows with appreciation being a cherry on top.

In evaluating deals, when to consider which rule?

Most Popular Reply