Seattle / Tacoma Area, Does the 1% Rule still apply for rentals?

Question

Hello All, longtime reader first time poster ha ha.....My question is this, does the 1 or 2% rule apply here in the Seattle area? I dont see how it could, please read on.

So this past spring I had an epiphany and decided to liquidate half of my 401K (~100K) to purchase rental properties here, in the suburbs south of Seattle. Backstory...... I already own and rent out 1 house, a 300K, 4 bed 2.5 bath generating about 1900/mo @ $220 "profit" (nowhere near the 1% rule) - I rented this house purely as a means to purchase a better home, and as a necessity to forgo a contingency when buying.....Fast forward to now, with my 401K proceeds, this summer I bought 2 more homes, here is the breakdown;

Home #2 , a 1947 Puyallup home, 3bd/1ba nicely completely remodeled w a Olympic mtn view and close to everything , Paid 250K w 20% down, payment ~$1300 @ $1850/mo $550 profit (not 1%)

Home #3, A 1908 Tacoma House w peekaboo ocean view, 3bd, 1ba remodeled in a gentrifying area, paid 185K w 25% down - payment $950, rented @ $1750/mo $800 profit (not 1% either)

both houses were long term flips by the seller and I bought them turn key, The market here is red hot and I was lucky to get each house, most everything on my interest list sells within 1 to 5 days, I go in with the down payment and waive inspection to get the deal. I do my own maintenance and live locally so I can take care of most issues myself. I manage my own properties....

........ I rent my properties at the maximum possible, what am I doing wrong if anything...thoughts?

Ryland Taniguchi · Answer

There are definitely 1.5% rule deals here in the Seattle area and I am picking up 10 a year no money down. In my opinion, the "golden years" for turnkey properties was between 2009 and 2013. The turnkey deals stopped penciling for me in 2014 and I have been buying locally in Tacoma ever since.Between 2009 and 2013, I was picking up 24% cash-on-cash (better than 2% rule) properties using 20% down to calculate. Was buying properties between $80 k and $90 k turnkey (rehabbed and property managed) that today are now worth $280 k +. Rents also went up $500/month. In addition, we are very active as hard money lenders in the turnkey space and are the #1 non-recourse lender in the country, and so I have deep connections and intimate market knowledge of multiple areas.Surprisingly, you simply cannot beat the numbers that you can get local through BRRRR. The 1% rule and the 2% rule are good rule of thumb measures. I personally prefer to look at IRR in comparing different investments. A cap rate is your return with 100% cash paid. A cash-on-cash is higher than a cap rate of you use leverage. An IRR factors in initial cash out, cash flow and then your net proceeds upon sale. The problem with IRR on cash flow properties is that you need to know when you are going to sell and estimate roughly how much it will sell for. To calculate IRR, you have to factor in global trends and multiple economic factors.So let me go back and walk through why I bought turnkey properties between 2009 and 2013 to understand how I predicted future IRR. And then I would bring that up to date on my current analysis on BRRRR locally. Back on February 27, 2010 (easy for me to remember the exact date because it's my birthday LOL), Warren Buffett was on CNN saying that the best investment at that time was single family homes that you rent for the longhaul. Whenever SFR prices fall below the cost to build (replacement costs), it is the best time to buy and the deal of two decades. You go all in when SFR drop below replacement costs. In 2009, I was buying properties in Phoenix that were selling at $60 per sq ft while having builder friends who told me that they built the exact same house in Glendale for $85 per sq house. A historical opportunity. Back in 2009, I read an online article by Fred Foldvary at Berkley that was written in 1997 where he predicted the 2008 crash. Perhaps, the theory of the 18-year cycle is flawed but the predictive value from the guy who created the theory was spot on. Maybe a big coincidence or fluke but we shall see in the next cycle how well the predictive value is.So here is what I got out of it. Stock markets tend to crash every 5 to 8 years and when it goes beyond the 8 years then the crashes tend to be bigger. I noticed an interesting pattern where there would be two smaller stock market crashes before the real big one. Back in 2009, I based my assumption on how long to hold real estate based on this 18-year cycle theory. I ran my forecasts for IRR based on the year 2021 as my exit year. Add 18-years to 2007 and that would put the crash around 2025. Historically, US real estate crashes have occurred between 15 and 21 years. So I had 2022 as my early crash date. Now it must be pointed out that the Foldvary Theory says two events will throw off the 18-year cycle theory... World war and a currency crisis. There was no 18-year cycle according to Foldvary in 1945 because of World war II. There were two real estate market crashes in 1971 and 1979 due to the collapse of the Bretton Woods currency system.So long story short, I bought houses in 2009 from turnkey providers in Phoenix and based my IRR calculator on a 2021 exit. Basically, a twelve year hold. My plan was to create a hypothesis and then evaluate the markets every year. How does my 2009 analysis hold up today? I think it is still spot on. House prices will continue to rise but at decelerated rates of increase than the last four years. Still seeing a slowdown in 2017, a side market and then a last push up in price that still puts me between 2022 and 2030 for the next major crash. And the next major crash will be worse than 2008 and home prices will drop lower than 2008. I think buy and hold for the long haul is foolish. The Phoenix houses I bought for $80 k in 2009 I believe will pass the $400 k price range around 2021 and then I cash out. What to do with the cash out? That's the problem. You can't roll it over to anything as the entire asset class of real estate will crash. My plan in 2009 was to donate all my profits to a 501(3)c non-profit. In 2016, I now have the name and the Cause.. Start With America. Start With America is a people's hedge fund that mirrors the actual hedge funds that I run now but the profits are allocated to improving the financial IQ of the inner city through financial IQ after school and early education programs and a TV show called Start With America.So why cash out around 2021? Because the house selling for over $400 k will drop back down to $80 k whenever the next crash happens.Why do I think that? The dominoes are already set for the next big crash. England and Germany were th strong economic pillars of the European Union. Brexit did two things. It first removed one of the two economic pillars of the EU. Second it set a precedent for Portugal Italy Ireland Greece Spain to also leave the EU. These five countries are bankrupt. It is just a matter of time before one of them leaves the EU to devalue their currency. This will be the catalyst that brings down China from a twenty year bull market. Global trade breaks down. Banks that lend globally will shut down. The crash will be longer and worse than the 2008. Still want to buy and hold forever?So what's going on in the economy today and what needs to happen before the next major economic crash? A couple of sign posts.1) Watch affordability ratio comparing medium home prices to medium income.2) Watch the California market trends and California tends to proceed Seattle by at least a year. Lucky for us here in Seattle. In California, the luxury market is starting to slow down which tends to be the peak of the upward trajectory tend. In 2017 or 2018, expect the luxury market to slow down in Seattle.3) A stock market crash is now overdue. If this crash leads to a currency crisis, anything can happen. I am betting with 4-to-1 odds that the next stock market crash will be more like 2000. What will be interesting is watching which sectors of the next stock market crash get hit and how that correlates to jobs in each sector. If the tech sector gets hit, it will directly cause Seattle home prices to dip.4) Watch cap rates compress.5) Real estate will keep going up due to low interest rates. And I posted this several times before but the US government cannot afford 20% interest rates on an $18 trillion deficit ($3.6 trillion payment exceeds our tax revenues). Interest rates going up is not likely until we jump off the cliff in a dollar crisis and hit hyperinflation. As a side note, taxes will have to triple.6) Currently, there is no oversupply of housing. Unless we experience a currency crisis, it is likely that the next crash won't be the big one. Again 4-to-1 odds.In any case, figure out how to calculate IRR. You can get 18% IRR on turnkey properties out of state. Just buy in class B areas. 2% rule is deceptive out of state because you don't want to buy turnkey in class C and Class D areas. For example, in Memphis you don't want to buy in the Loop or in Fraysier. If you buy in class C and class D, in five years you will have to re-rehab the properties.I am getting 1.5% rule in Tacoma through BRRRR but more importantly getting 65% IRR to 75% IRR. Interestingly, it is roughly the same return I was getting 2009 to 2013 from turnkey providers. But it is a lot more work. On the other hand, I don't think I could outperform the 2009 to 2013 turnkey with today's BRRRR. After the next crash, I will go a step further and do BRRRR in Phoenix first, then Memphis, then Kansas City and then Birmingham. The only way to outperform my 2009 to 2013 turnkey numbers would be to set up my own operations in those markets. Half of the BRRRR deals today are development deals where I subdivide a lot to get the land for free. Then use Reality Homes or True Built to put up an affordable house. I am looking now in Mt Vernon, Arlington, Sedro Wooley, Oak Harbor, Chehalis, Vancouver, Longview, Kelso, and around Portland for more BRRRR markets using my marketing systems. Then I will let everyone know what I am finding. Oh ya and I do full gut out rehabs on my BRRRR so that reduces my capex.

Alex Chin · Answer

@Jason Fox - first things first, 1%/2% "rules" should never be considered a lock in any way. You can lose money on a 3% house, and make money on a 0.5% house; a savvy investor has to dig a heck of a lot deeper than comparing rents to purchase price.I think the thing that stands out to me is that you have zero reserve expense built into your numbers, it looks like you consider anything that isn't PITI to be straight profit.Unless you intend to sell the properties within the next 5yrs. or so, at some point you WILL have cap-ex, maintenance expenses, etc. For example: say you have a new composition roof. That's only going to last you 15-20yrs. (we'll say 20) and will cost about $15,000 to replace. Thus you should have a Roof, Cap-Ex expense of $62.50 that you pull out every month for when you do eventually need to replace it. Take these items into account and take another look at your "profit" to see if the cash-flow still meets your requirements, what's your ROI on the down payment investments?.

Jacqueline Cliff · Answer

In my opinion, you are correct in regards to the Seattle market. Although the rental market is hot, the prices are also much higher than many areas of the country. Every investor has their own criteria as to what is acceptable cash flow per door. As long as your flow matches your required minimums or higher, I think you are doing well. Just be sure to not allow yourself to purchase something that doesn't meet your requirements and make sure you have included ALL expenses when analyzing your numbers prior to purchase.

Jarvis Smith · Answer

@Ryland Taniguchi as a new investor I learn from your posts everyday. Thanks for sharing!

Jared Carpenter · Answer

@Ryland Taniguchi fascinating post, thank you for this information and advice.

Thomas S. · Answer

You need to take a much closer look at your numbers and how you operate your business. SFH rentals will consistently have 40-50% expenses long term. Based on your numbers all your properties are, in the case of long term hold, negative cash flow investments. Turn key is fine but you must realise that these properties can not be held long term and at a certain point in time will be very difficult to sell as rentals to a serious investor due to the negative projected cash flow situation.These are not a good strategy for investment and I would strongly advise selling as soon as you can make a profit on equity appreciation.

Jason Fox · Answer

Alex C, Thank you for the insight , I will factor the cap-ex into my planning starting now. As for the ROI on the down payment, I just figured that as the cost of doing business and consider that money as seed money to the appreciation of the property, its from my 401K after all, and I feel this Seattle area housing market is a much better bet than stocks going forward. In the future, I am going to have to figure out how to purchase my next property, im tapped out on down payment cash, but have lots of equity in my rentals, and decent cashflow so far. Jared- While Id love to get into properties closer to, or in Seattle (rents are considerably higher), at this point, the investors and sharks have taken over, and for a little guy like me, frankly, I am priced out. In Seattle (and the immediate communities), There are deals to be had, but most are turds that have been sitting and are finally becoming attractive due to sheer demand, or properties that are basically tear downs. I am finding the best deals down south, Tacoma, Puyallup, Bonney Lake and Olympia. Anything within 40 minutes commute to Seattle is fair game and popular. There is a TON of inventory in Tacoma, and the market has softened considerably as summer has ended. I think that right NOW is the time, by March or April next year, we will see values and pricing shoot up like never before, more records broken, etc etc. Working a regular job in the area, watching, and seeing, I feel the frenzy and see the influx of new people and jobs. This area is on fire.......my tenants are happy to have a place, my prospective tenants seem desperate to find a place, ESPECIALLY if you accept pets. I think being pet friendly is a big key to getting higher rent with average houses. My two cents. Thanks for the great replies, keep them coming!

Jared Carpenter · Answer

@Lane Kawaoka where do you focus your attention now?

Lane Kawaoka · Answer

I stopped investing in 2012 in Seattle because I a did not have the ability to source deals.