Is the 1% rule always applicable?

Question

I found a great looking property to house hack in Tempe, AZ. It's a turn key 4plex walking distance from a major University (ASU) and definitely a nice place for me and my wife and toddler to live in. The only problem is that it's priced much higher than the 1% rule would allow. According to all the advice I shouldn't even consider a place that is below the 1% threshold. Here are my questions:

Can I take on a higher purchase price if all of the uniters were remodeled and would therefore require little to no repairs or maintenance?

Can I justify a higher purchase price if I am loving in one unit and therefore do not need to pay my own mortgage?

Can I justify a higher purchase price when it's close to a major University so I would likely never have an issue finding tenants?

Mike D'Arrigo · Answer

@Andrew Martherus personally, I think it's a meaningless metric. It says nothing about the bottom line and gives a distored  picture when comparing returns across different markets since operating expenses can vary greatly by market. For instance, property taxes are nearly 3% in TX whereas they are only 1% in Kansas City and less than 1% in Birmingham. The only way to do a meaningful evaluation is to a projection of the full income and expenses and look at what the bottom line cash flow and CoC return is.

Jonathan Bombaci · Answer

As stated before the 1% rule is just a rule of thumb. In my market I need a 2% -3% rule for it to make sense due  to higher property taxes and heating cost. If you like the property you need to run the numbers and see if it makes sense.

At a high level, if $1200 -$1500 is the market rent then I think the price is just to high.

At $720k if you put 5% down you’re looking at at least $4500 probably closer to $5000 a month for mortgage, taxes and insurance. If you rent 3 apartments for $1500 each and have no vacancies, no repairs, and every tenant pad on time forever (which is I mpossible).. then that’s $4500 a month in rent. So to live One unit you’d have to pay about $500 a month to cover the gap. But then you’ll have to come out if pocket to pay water, sewer, house electric,  and do the landscaping and maintenance yourself.

So basically the best case scenario is you give the bank $40,000 (5% down payment) so you can pay $1500 month to live in an apartment (which is market rent) while exposing yourself to a lot of liability, work, and potential to lose some money. And that’s pie in the sky absolute best case scenario.

Love the idea and househackimg is an awesome way to get started or to grow a portfolio. Just be patient and make sure to find the right property.

Wes Blackwell · Answer

@Andrew Martherus

No matter what market you're in, whether it's Tempe, Phoenix, Sacramento or anywhere else, all that matter is how your deal compares to the averages for the area.

The 1-2% is the bane most beginners on here lol, because it works in one market and people try to expand it to apply nationwide. I've probably made 20+ posts about it, no lie haha.

When you think about it, the median home price here is $270k, which would make 1% rule of $2,700... so why would anyone pay that when 5% down with a 5% interest rate would make for a mortgage of $1925 or so?

And the same thing applies to multifamily... just the numbers a little different (not as big a gap).

What I do for my clients is analyze what ALL the similar deals have offered in terms of ROI, and that way the investor can see what deals in that market are offering on average, and then truly compare this deal vs. what's normally available.

That's the only way to know if it's a deal or not, as some metric used in another state with different prices, rents and appreciation will be of no use here.

Ultimately, you have to ask yourself if the deal makes sense for you and your family. Calculate what your obligation to the monthly mortgage would be with your family living in one of the units, and if you're okay with that number then move forward.

One of the things about trying to house-hack a fourplex is that you have consider the numbers AND what works for your family. Sure, maybe you could find a better investment somewhere else in town... but does your wife also want to live there? Are you ok with the school districts for your daughter? Way more to consider than what your ROI is.

If you want help analyzing the actual specifics of the property just send me a message with the address and I'll let you know what I think.

Ann North · Answer

The only two cents I would like to add to this excellent thread is what if something goes wrong, say construction or it's summer and you suddenly can't find tenants since most college students are gone in the summer?

Can you cover $5000 a month yourself?

This can happen and once you cannot cover it ---  it can snowball real quick.

It is 10x more stressful to be living in a property, with your family, that may have issues now or in the future. Where will you live if something goes wrong?

Not trying to scare you but give you reality to think about so you can have peace of mind. It is also a good idea to look at schools in area, etc., because time flies a lot quicker than you realize.

Also, don't simply rely on a certain popular school ranking site (not sure if I can reference it here) because it's based on reviews and they can be skewed by parent reviews. Best to try to get a real understanding of the schools and only use that as an estimate.

It sounds like a good deal but taxes and hidden expenses can really add up! The more expensive the place, the more leveraged you are (right word?) and the higher risk. Good luck!

Dan H. · Answer

1% is a guideline.  You could have a 2% RE in a war zone and lose money.  You could also have a less than 1% RE in a high rent area and have decent cash flow.

However, at those rents in AZ, the rent to cost ratio is close to 1% at low down payments (95% LTV of owner occupied with PMI) for cash flow in B areas over the long term (amortizing expected maintenance/cap expense evenly across all months of ownership).

Using $1200/month for the 1 BR and $1500/month for the 2 BR gives a rent projection of $5400.  $5400/$720000 = 0.75%.  Without appreciation, this RE will be cash flow negative using my maintenance/cap ex numbers over the long term (up to $1800/month long term).  But 1) there is likely to be long term rent and market appreciation 2) you will have equity pay down.  3) If there was a good rehab done, many of the bigger cap ex items will be years from now (new or like new kitchens, baths, windows, HVAC, flooring, paint, etc.).  By the time the large cost maintenance/cap ex items hit, the appreciation could have this RE with significant cash flow.  4) (and the most important) It is a nice place for you and your family.

It does not calculate out to be a good financial investment, but providing a nice home for your family with an OK investment may make this a "good" investment for your family.  You have a different criteria than those of us that are not house hacking with a young family.  We prioritize the financials.  For you, I would prioritize the good home for your family and the financials are the bonus.

Good luck

Nick Giulioni · Answer

It's not a rule. It's a rule of thumb - a shortcut to quickly estimate how effective a deal is.

I would actually say that house hacks are largely the exception to the rule because you would be offsetting your own living expenses.

Do you have numbers?  Would need:

• Acquisition price
• Cost of repairs
• Estimated ARV
• Your current rent payment
• Estimated rent per unit

Nick Giulioni · Answer

100% agreed!

Nick Giulioni · Answer

@Edward Liu House hack refers to you living in the property, not value add proposition.

@Andrew Martherus Figure out how much you are spending in rent every month. If your total out of pocket post-repairs and Capex is less in the house hack, why wouldn't you do it?

Dustin P. · Answer

Lots of good information here already. As said the 1% rule is way too arbitrary to be used. I don't see the point of even using it as a rule of thumb. You're going to analyze every deal individually so why would you use the 1% rule to shortcut anything? In Phoenix your chances of buying a house that meets the 1% rule is almost non-existent, yet many investors are still buying here.

Michael S. · Answer

A/B neighborhoods in Huntsville AL and Madison AL are at about 0.7 right now - 1% here is not obtainable unless you get a great off market deal or you go notably farther from downtown and lose significant appreciation potential

Is the 1% rule always applicable?

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