1% Rule in Practice Regionally

[Patrick Menefee]

Hello BP

I’m curious how members in different regions have tailored the 1% rule (especially charlotte, but anywhere really). Looking relative to some of the properties I’ve seen in the area, 1% seems difficult to attain and 2% seems nearly unfathomable.

I know this isn’t a hard and fast rule, and i know it varies by market. But how many of you abide by it or what variation works in your area?

Thanks!

[Quito Keutla]

@Patrick Menefee In my area Seattle the 1% rule is seems like a myth as prices here are crazy, that’s why I’m looking to invest out of state. Although we get great appreciation. Happy Investing!

[Dennis M.]

Originally posted by @John Woodrich:

Originally posted by @Dennis M.:

I guess I’m the oddball I would pass a deal if it was anything less than 2% . I invest in lower income areas in western pa. All of my stuff is atleast 3%

Your comment here makes your comment above seem a little skeptical.....   https://www.biggerpockets.com/forums/52/topics/681...

So you recommend people find at-least a 1% deal but you will only invest at a minimum of a 2% deal????  In PA???

Look I would only use the 1% rule as a minimum gage in general and I would want more for me personally . no ,I don’t need a bullet proof vest or ak47  to collect rent lol and yes You are certainly going to have more challenges and yes it’s going to be hands on management  to operate in these areas . That being said ,there’s many great deals to be had in the Midwest and near me that are far from war zones that are truly 2-3-4% deals out there . 

[Brad Larsen]

There are lots of other factors to consider other than the 1% rule.  It's an amazing gauge of value to rent for quick looks at a property, but there is so many other good factors.  The one that is difficult to tell because of each individual tax situation is depreciation.  "Losing" money on a home may make (save) you money in taxes.  Great point on the number one metric to look at though.  Take care!   

[Kyle Joseph]

I think the 1% rule is a good way to screen and filter deals, similar to how you might think about price per unit or micro-location, for example.  If you know market rents in that area, you can quickly determine if the property would be close or hits 1%.  If so, it may be worth digging in a bit more.   In the markets I look at, I find sometimes a property might pass a quick 1% test, but then I dig in and realize it would need XX in capex.  All of a sudden Gross Rent / Cost Basis is now much lower than 1%

[Stone Jin]

I'm sure there is some thread on here about the 1% rule trap.  People spend all their time searching for a 1% rule house and pass on all the good .95% houses that are in solid neighborhoods that will get appreciation. 

The other thing to be careful of when looking at 1% rule is that the market has priced the risk reward based on it.  Obviously 1% on average will have higher risk.

The thing to figure out is what metrics you want for your return. For us it is 10% Cash on Cash and $400 cashflow per month per SFH. I really don't care about what % rule anything follows as long as I can get what I want.

@Patrick Menefee

[Walt Bassett]

I found that as I evaluated deals, the 1% rule was very difficult to achieve.  I have investments in Massachusetts and North Carolina.  In MA my ratio was 0.6 %.  I focused on Raleigh, Durham & Chapel Hill and found several deals greater than 1%.  BUT, you have to look hard and negotiate.  It's almost impossible to find a single family rental with a 1% rent ratio, since sellers are using residential comps to price.  However, I was able to put together a deal in Chapel Hill with a rent ratio of 1.4% by finding a multi-unit rental.  I followed up a year later with a multi-single family deal (off-market) that will yield 1.6% out of the gate , raised to 2.0 once I raise rents to market value.

AND, the only way to achieve these numbers (IMO) you have to plan in the B, C class arena

Walt B 

[Brian Ploszay]

I've been in real estate a long time and I never really knew what the 1% rule was.  I just looked it up.

It is a performance gauge, but it leaves out expenses.  For deals, I create a spreadsheet with detailed expenses and I generally back into a cap rate.  I generally use "price per door" as an initial test of interest in a property.  

I tend to purchase value add foreclosures - properties that need deep repairs.  Buying distressed properties gives you some more equity once you finish them, but you do spend more time initially on the investment.  

[Christopher Lombardi]

@Patrick Menefee I find that it’s only useful in low tax jurisdictions and when flood insurance isn’t needed. The rule works for me in PA and south jersey but in north jersey with high taxes it makes no sense. With that said, the best way to analyze any investment is to do a discounted cash flow analysis. It’s detailed, provides for future rent and expense assumptions and allows you to make the best decision based on the expected performance of a property.

[Jimmy Deringer]

@Patrick Menefee

I’m having no problems finding the 1% rule on different markets. Sometimes the 1% rule isn’t even a good deal on these markets! You’ll have a real hard time finding this in cities with more price volatility right now.

[Adam Mitchell]

We see 1% rentals in the Dallas area but generally they are off market properties. 2% rentals are pretty hard to come by and if you find one it generally makes more sense to flip it with the profit potential in it.

[Adam Mitchell]

@Patrick Menefee

We see 1% rentals available in the Dallas area but they are generally off-market deals. 2% rentals are hard to come by and if you do find one it usually makes sense to flip it and take the profit.

[Erik W.]

2% or better in Springfield,MO is all I look for.  I MIGHT go a little lower (1.7%) if I really like the property and I think it has potential to be more valuable in the future (college rental by the bedroom or add a bed room after existing tenant moves out, etc).

These house don't appreciate much, but the cash flow is amazing.  These are solid "Class C", which I define as no frills but clean, safe, and functional.  

War zone?  No.  Do I carry a weapon?  No.  Are they going to ever make it on HGTV?  Not a chance.

[Dawn Anastasi]

1.5-2% is possible in my area. 2% used to be more common until the market got tougher. Now, it's more common to get around 1.5%, which is still pretty good cash flow wise.

[Steven McCutcheon]

@Patrick Menefee

For clients in NJ, I've seen it work best using the BRRRR method. Otherwise using turnkeys are too expensive with our high taxes. Finding value add properties usually gets the 1% rule to work!

[Account Closed]

@Patrick Menefee I just recently discussed the one percent rule in gory detail with a few other investors & the results even surprised me a bit when I crunched the numbers in my deal calculator. I've copied the post and pasted it below. There's a link to the deal calculator in there with all of the numbers. 

Note that the 1% rule in most cases will not meet a commercial lenders debt coverage requirements, which is telling

-----

The 1% rule is only a rule of thumb, and in most markets doesn't cash flow well enough either. I mocked up a 1% deal with some very reasonable expense numbers and you can see how good your cash flow is here. Let me know if you have any questions about that sheet :)

https://docs.google.com/spreadsheets/d/1MXdYGiA-qe...

[John Williams]

@Patrick Menefee

In places where I’ve lived, including Tennessee, Alabama, and Georgia the 1% rule is fairly easy to hit. It’s a trade off for appreciation in many cases though!

[Blaine Johnson]

I remember when this exact conversation religiously used 2%?

Anyone buying under that was considered a fool...

There are no rules.

Just use some common sense with what you want. If the numbers satisfy you, do it.

[Greg Fitch]

I've bought a few Class B/C townhouse apartments in the Triad recently and gross monthly rent seemed to price out at around 1.2% of sales price. Unless it's a marquee property and/or in a prime area in the Triad, I think the 1% rule still works in this market. There's a tradeoff with appreciation there but if cash flow is your top objective, this market still works.

[Bart H.]

Originally posted by @Patrick Menefee:

Hello BP

I’m curious how members in different regions have tailored the 1% rule (especially charlotte, but anywhere really). Looking relative to some of the properties I’ve seen in the area, 1% seems difficult to attain and 2% seems nearly unfathomable.

I know this isn’t a hard and fast rule, and i know it varies by market. But how many of you abide by it or what variation works in your area?

Thanks!

 I have said it before, the 1% rule, is really like discussing a PE ratio on a stock.  Growth stocks like Amazon are going to have super high PE ratios, value stocks like utilities will have fairly low PE ratios.

You buy amazon based on the stream of future potential earnings, because they are growing, you buy utilities for the cash flow of their current earnings being returned to you as dividends.

All other things being equal, a higher percent in the 1% rule indicates a lower expected long term value of price appreciation.  Ie in Detroit, or in war zones, I am sure I can find 2 or 3% deals till the cows come home.  In California a 1% gross rent is probably impossible to find.  

In my market (DFW), its more or less a 1% market depending on the class of the neighborhood.

Now I get it, there are investors who need the cash flow to pay the bills, its probably unwise for them to buy in say California.  

The rental income reduces the volatility, just like the dividend on a stock reduces a stocks volatility.  The 1% rule helps you evaluate those properties.

But real money is made on Amazon or Facebook from price appreciation, not on Consolidated Edison on dividends.  The dividends might help you eat without selling shares, but real money is made when the price of Amazon doubles or triples over time.

Now I believe a dividend helps support the price of a stock, so I wouldnt ignore it all together.  But at the same time there is something to figuring out where you can add value or pick areas of the country that will appreciate in price faster than the rest of the US economy.

[Marisa R.]

I am achieving this currently in the Detroit market... caveat...no war zones.

Appreciation is never a given, but if the horse has already bolted then you have a pretty good chance of also achieving this. 

I agree with others its not just about the cash flow, you also need to grow capital...… increase your net worth. If you have both you cant go too wrong.

[Scott D Burrows]

@Patrick Menefee

I hear you there, especially in this economy, with the housing market where it is at and in your community, it is definitely a challenge to overcome. 

Another thought... have you ever done a compound interest analysis of 20% down payments? If you do an NPV, comparing to the stock markets long term returns, you will more than likely find that the stock market outperforms (S&P index funds, etc)... Just use Excel to do these..Real estate does better if you can either far exceed the 1% rule (because although it can compound, it doesn't techniquely)...also those that get insanely rich off real estate generally are buying when the economy is in the toilet and time it perfectly (there are other aspects that I'll mention later, before anyone freaks out reading this :). 

My opinion is that if you can't either get significantly over 1% or can get houses in the $60-$80K range, or even less, with financing, you will become rich. Nothing to say it's impossible, but on average you'd do just as good (with index funds, etc) if you are in it for the long game-obviously if you are in it purely for the cash flow and immediacy of funds coming into bank account consistently- with a tax shield in place, then disregard. However, I think the majority of people on here, if they went to Excel and used a few analysis formulas, will realize quickly the reason that flipping is so prominent currently is due to the lack of scalability in the real estate market at a certain point (beyond $100,000 homes) the effort vs. reward becomes questionable (not a steadfast/absolute rule, but on average it becomes more questionable...sizable risk vs reward). 

Use the following in Excel and see if they help, =NPV (Net Present Value) put your down payment on the outside of the formula and make it NEGATIVE (cash flows go inside)...this will compare to another interest rate (i.e. stock market return compounded at an 8-10% rate)... if you are withdrawing this money consistently obviously this will be different, but both are considering that you are reinvesting and not taking the money and buying fancy Rolexes, cars, etc.... BTW, if it is negative, then you are better off with the stock market or alternative investment than what you are considering. (For example =NPV(.10,3500,3500,3500,3500,3500)-70000... if you increase by 3% every year, you can factor that in, etc

Another formula to checkout is the =IRR ( Internal Rate of Return)... this will tell you what kind of return you are getting if you were to reinvest all of your money at the interest rate of the return that you are getting from your houses... super useful formula.. again, if negative, look at something else... (this is just telling you if I keep buying houses at the same price point and get the same rents with the same down payments, using the same money, how am I doing).

Additionally, take a look at the =PV (Present Value) and =FV (Future Value) formulas... these formulas can show you, for example, if you are investing $40,000 into a down payment (i.e. on an $200,000 house) and not getting 1% (lets assume .08% of ARV) $1,333 a month in rent and about $900 is going to mortgage and taxes/insurance... you would be making ROUGHLY $200-$300 a month CF (Cash flow) after expenses/vacancies... or $2,400 a year... based on a $40,000 investment you are looking at a 6% return on your money... if you do that for ten years, it can tell you what that $40,000 is worth in ten years at 10% compounded vs. 6% (assuming you are taking the 6% and ENTIRELY reinvesting back into another house). (Use these formulas to help you look at $40,000 in ten years invested in housing or $40,000 in ten years invested in real estate.... even try 20 years).

Anyways, I know this wasn't directly answering your question, but it was more to show you another way of looking at why the 1% rule is a rule... if you aren't getting that and are playing for appreciation or debt paydown + cash flow.. just be careful. If you have another strategy, maybe if you are trying to reduce your taxable income by taking passive losses, while still getting principal paydown and equity build up through appreciation, that is a whole other topic... but from a purely basic investment standpoint, you want to at least get 1% if possible. 

Hope this helps. 

Sincerely, 

Scott

[Scott D Burrows]

@Patrick Menefee  

Another point to mention, make sure to include at least the following, when determining the total return: 

• Principal paydown (use an amortization table.. you can find a million on Google) or forced equity/appreciation of investment.
• Rent Cash Flow (CF) after payments/taxes/insurance.
• Tax Shield (if you are a higher income earner, this can also be something as well). 
•  Finally, I usually will consider about a .5% appreciation rate per year for overall appreciation (non-cash benefit, but can come in handy down the road), increases net worth slowly without taxes.

Hope this helps as well. 

Sincerely, 

Scott

[Brian Dickerson]

With management and proper vacancy/capex/repairs reserves, I'm still unsure how people make a profit on a 1% on SFH's (unless you're doing a BRRRR where you have little to no cash left in the deal after refi). 1% is attainable in central/northern FL. We won't look at a deal unless its 1.3% +

It can be misleading though if you aren't familiar with the area.  Our properties in NY are over 2% deals if you're only looking at purchase price and rent.  But wait til you see the property taxes up there!  

[Beau Fugitt]

Great post.  I'm not glad the deals seem hard to find for everyone, but glad I'm not the only one who can't seem to land them regularly.  I am re-reading @Brandon Turner's book on rental properties and felt like a total failure for not finding better deals.  I'm under contract on a 1% deal in central Arkansas, but they are hard to find.  

[Henry Lazerow]

The whole 1, 2, 3 % value really varies on size of deal due to cap/ex costs. A 1% deal that's $300k will out perform a $50k 2% deal all day in real life.

In Chicago you can hit .07-.08 in A/B and .09-1% in the C class areas,and over 1% in the C-/D class areas.