1% or 2% rule in Minnesota?

Question

I'm just getting started in real estate investing, with the intent of renting out either single family homes, multi-family or townhomes.   I know that one cannot go strictly by the 1% or 2% rule, and that more detailed analysis is required...however, at least for screening the hundreds of possibilities, I'd like to understand whether ANY properties in the Minnesota MSP/metro area meet even close to the 1% rule, let alone the 2% rule.  Everything I'm finding is more like .5% or .7% at best, and my banker, who has done investing himself, basically said the market is so high right now, it would be better to do nothing until prices comes down.  Any advice?

Justin Egge · Answer

Big disclaimer: I don't adhere to the 'rules' often preached on BP. I prefer the perspective of: a 'deal' is the transaction that fits your model (read: end-game), regardless of it's conformity or lack-thereof to a metric.

That said, I spent 7+ years trying to apply these rules in MSP and always struck out. When I did find a property that aligned, it was always in a rough part of town with a rental clientele I wasn't comfortable working with. Not to mention the time required to find the options. These metrics, in my opinion, are geared for mass growth acquisitions, scaling quickly, and likely dumping quickly when the sponge is dry.

My approach is different - buy and hold 4-5 SFR, pay them off, self manage, and retire from corporate 20 years early. No empires, planes, large employee staffs, etc. Just freedom, but I also have a family and am not willing to put in 80-hr weeks to do more. This means I always pay market-rates, but the homes are solid, take little to make rent-ready, and the clientele/renters are great (if vetted well).

As for 'do nothing until prices come down' - it's a 50/50. My last two purchased were in 2017 and 2019, and they've appreciated ~55K since. Both times I sat for two years waiting for the market to tank, got sick of waiting, and jumped in. You could sit on the sidelines or jump in - either have pros and cons. After all the waiting, I learned to put my money down. After a couple years the principal pay-down alone offsets most losses you'd see anyway. Two cents: always put 20% down to eliminate PMI and ensure you can survive downturns. Note: current politics and environmental factors (COVID, unemployment), make the gamble more risky today than last year. I'd wait until Feb 2021 myself.

Again, my approach appears to be different and may not suit you. Stating all this because it took years - and someone speaking this same message - for me to feel comfortable that my strategy was "acceptable", and maybe this statement will save you some headache. Envision the life you want, adopt a model that will support that life - then build it.
Best of luck!

Evan Kraljic · Answer

You will not be finding any 2% rule properties in the Twin Cities. 1% rule properties are also scarce, and don't expect to just find them sitting on the market unless if it's is in a rougher neighborhood. To give you a reference point, I had an appraisal done recently in South Mpls in what I would consider a C+/B- neighborhood, and the GRM used for the income approach to valuing my property was 121.48, which was an average found from maybe 40-50 rentals in the area. GRM is gross rent multiplier, essentially the inverse of the 1% rule. So while a 1% property would have a GRM of 100, this 121.48 results in a 0.82% property (1/121.48).

For advice, I would just say that while yes, MSP is a hot market right now, that doesn't mean you should just wait for it to cool down. There are deals to be found in any market, but it hot markets you need to make it a good deal, don't expect it to just fall into your lap.

Now for the logical follow-up, how does one make a deal good? Raise rents to improve your cash flow, which is either by finding a property with below market rents and/or renovating so the property can rent for more money. I'd be careful with the first one right now though due to the eviction moratorium which states that you can't end any tenants leases right now unless they are breaking laws, which will probably be in place through the winter here.

The most ban for your buck when it comes to increasing rents is by finishing more square footage (attic or basement) or converting a spare room to a bedroom. Also you said you're pretty handy so if you find a place with an outdated kitchen/bathroom you could DIY most of it to renovate it cheaply and raise rents that way. I did all of the above with my first duplex and while it has been a lot of work, the cash flow will be pretty good when all is said and done.

James Hamling · Answer

@John Hanson ALL my listing meet the 1% rule, or better.

That said, all my developed buys for investors are in MSP ancillary markets because NO their is 0 1%-2% properties in the Twin Cities market and IF you find one it without factoring the mountain of reno work it needs.

If your planning on waiting, lol, that will be measured in decades, literally.

If your not readily finding good investor buys in MN that only says that you need an investor agent who specializes in this because I have 0 shortage of good deals. Is it easy, nope, I am over 20 years professional in the industry with a epic reputation and I actually specialize in investment real estate and have been an investor almost 12 years. We are into a market where 95% will not be able to find good deals, it's a super seller market with 0 change on the horizon.

Twin Cities market is only going to work for rehabbers, with an emphasis on those capable of doing big scale renos and redevelopment, and equity investing. The cap rates are at stupid low levels.

There is the 1 x-factor to Twin Cities which is the extremely rare TC existing pro's, but it's less than 1% of investors so not worth discussing, they know who they are and generally know how rare their success is vs others.

And before anyone asks, hell no I absolutely will not share how I am doing it, that's asking the Col. for the secret recipe, not a chance. Anyone who says they will give you their secret is a liar plain and simple, no sane person is going to destroy their competitive advantage.

Justin Egge · Answer

@John Hanson Exactly, I've found .65 - .75 the working ratio for my model. Think of it in terms of buying a car:  slightly used car (less than 20K miles) vs. a well-used car. The well-used car is going to nickel and dime you month after month. In this analogy, the well-used car maps to the 1-2% rule properties. They sound great and often work well for large outfits that have support staff (repair-men, office admins, trade contractors, etc.) to manage the upkeep and tenants, but for smaller (1-man) shops, it represents a headache and consistent cash outlays. As others have mentioned, the capex and general expenses will be far higher and more frequent. The slightly used car maps closer to the model I'm representing. You're going to put out more cash up front to get it (down payment), but the capex and upkeep expenses will be fewer because the property is in a better area, in better repair-state, and will be better treated by residents. In these high-priced options, you also usually get longer-term residents; 2-4 years being typical. This increases your profit margin both from turn-over costs, as well as long-term tenants take better care of properties.It comes down to the type of life you want. Do you want to manage a lot of properties, and/or manage employee's? If so, the 1/2% rule might be your thing and you'll need to scrap it out with other investors competing here. If you want a simpler model that you can more easily self-run, and have far less investor-competition, you may have to reconsider. As an example, I interact with my tenants usually once a month. It's very low overhead, and that makes it worth it for me. Picking up higher-cashflow properties might make more money, but it brings a lot of calls/headache's/time I don't want to deal with. Once your SFR are paid off, 2K/month (less taxes + insurance + upkeep) is a good pay day when there's 4 of them.

Bruce Runn · Answer

It takes hard work and a lot of leg work.    I agree with @Evan Kraljic, we create our opportunities through reno's, increasing rents, and being a 1/2 step ahead of everyone else by being willing to take calculated risks.   Our adage is Patience, then Pounce and we are always ready to buy when a deal comes up.  No one is going to serve up an amazing deal on paper just so you grab the low hanging fruit.  You have to work at it and find the hidden gems.  You can't believe the books that preach you can get rich quick with little to no effort.

I bought a duplex last month in Uptown with lower than market rents.  During my walk through, I learned that 1 of the tenants wanted to get out of his lease  so I bought it and immediately let him out so he could move.  I raised the rent on that unit $250/month and had it filled in 1 day with 3 groups of people wanting to rent it-  The other unit comes up for renewal in Spring.  Want to guess the plan?  Suddenly an additional $500/month pushes the return on this buy through the roof.   I'm sharing this as it's not rocket science but these are the types of ways you can be consistently successful.   I go into a lot of properties since you can't buy off the MLS, you have to get into places to be able to know/learn what's good and what's not.  We also focus on a very focused area of South Minneapolis as it's very popular and what I consider A and B locations with older multi family buildings and almost all of our rentals are close by as we know the rents, costs, recent purchases ect.   We also get alerted sometimes to properties going onto the market.

John Hanson · Answer

Thanks a lot for the insight.  I'm much the same in that I don't want to deal with poor areas or heavy work to rehab/flip/rent...but most of the SFH's in decent areas are pushing $225,000 to $275,000, with maximum rents of about $1800 to $2000.

Ryan Luthi · Answer

@John Hanson great question(s)!  I completely agree with

@Bruce Runn and his comments above.  With interest rates this low, you just need to know to look for, where to look for it and be patient and persistent.  If we had too much inventory or other factors that showed that things will soften in the soon future I'd say wait, but nothing indicates that will happen and rental occupancy is at 99% currently with only luxury being built so it is and appears to remain a landlord's market in my opinion.  With the right guidance and focus you can stay within the 494/694 corridor and even in city limits (Mpls/StP) and find deals in the 1% range for sure.  One tip, you need to do the work as Bruce said, optimize the property in the first year, with the focus on the potential for after that, then you will find many gems. Happy to grab coffee if you'd like help or just to tell stories.  Good luck!

Michael Stutelberg · Answer

Why the MSP metro area? What about outside the metro area? Have you listened to Episode 402 of the BP podcast?

Michael Stutelberg · Answer

Depends on the area you are looking and distance you want to travel. But I have seen some >1% on paper deals listed on the MLS for MSP area. The broader you look in the area the better chance of finding a deal. Otherwise get involved in local meetings and begin looking for off market deals.

John Hanson · Answer

Thanks everyone for the great feedback.  Of course, I do need to figure out how to find off-market deals, but I won't ask this of people here, because it sounds like it would be offensive.  One question I have, however, is what the difference is between and investor's agent and a regular agent who has expertise in how to buy correctly for investment purposes?

1% or 2% rule in Minnesota?

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