Calculating 1% Rule

[Charlotte Wilson]

Maybe I am overthinking this but when I look at properties to purchase that I plan to rent out, how do I make sure I am including all the potential additional “cost” besides the mortgage and property taxes? Is there a quick way to estimate what those other costs will be monthly to make sure my calculations are accurate? This will be my first investment property and My fear is that I will estimate my cash flow incorrectly and end up losing each month. Any advice or thoughts are appreciated. 

[Drew Sygit]

@Charlotte Wilson please understand this about the "1% Rule" - it's ONLY a tool!

Like any tool, you have to know how to use it correctly or you could get, "injured".

We use it to quickly sift through multiple options - and that's about it.

BP has a Rental Calculator that includeds everything you are asking about: mortgage P&I, property taqxes, home insurance and percentage for maintenance & vacancy.

It also includes Cap-Ex percentage, but in our experience it's a waste of time to worry about this. It's more important on 5+ unit acquisitions.

What we don't like about the BP Rental Calculator is its one-size fits all approach. It assumes the property is Class A - which not a lot of investors are acquiring these days.

Here's some copy & paste info about property classes:

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Recommend you first figure out the property Class you want to invest in, THEN figure out the corresponding location to invest in.

Property Class will typically dictate the Class of tenant you get, which greatly IMPACTS rental income stability and property maintenance/damage by tenants.

If you apply Class A assumptions to a Class B or C purchase, your expectations won’t be met and it may be a financial disaster.

If you buy/renovate a property in Class D area to Class A standards, what quality of tenant will you get?

Similarly, if you put several Class D tenants in a Class A 4-plex, what do you think will happen to the property?

So, when investing in areas they don’t really know, investors should research the different property Class submarkets.

Here’s our OPINION for the Metro Detroit market (use as a template for your target area!) that we’ve learned in our 24 years, managing almost 700 doors across the Metro Detroit area, including almost 100 S8 leases:

Class A Properties:
Cashflow vs Appreciation: Typically, 3-5 years for positive cashflow, but you get highest relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% the more recent norm.
Tenant Pool: Majority will have FICO scores of 680+ (roughly 5% probability of default), zero evictions in last 7 years.
Section 8: Rents are too high for the program and cash paying tenants are better overall.

Class B Properties:
Cashflow vs Appreciation: Typically, decent amount of relative rent & value appreciation.
Vacancy Est: Historically 10%, 5% should be applied only if proper research done to support.
Tenant Pool: Majority will have FICO scores of 620-680 (around 10% probability of default), some blemishes, but should have no evictions in last 5 years
Section 8: Rents are usually too high for the program.

Class C Properties:
Cashflow vs Appreciation: Typically, high cashflow and at the lower end of relative rent & value appreciation. Can try to reposition to Class B, but neighborhood may impede these efforts.
Vacancy Est: Historically 10%, but 15-20% should be used to also cover tenant nonpayment, eviction costs & damages.
Tenant Pool: majority will have FICO scores of 560-620 (approaching 22% probability of default), many blemishes, but should have no evictions in last 2 years. Verifying last 2 years of rental history very important! Also, focus on 2 years of job/income stability.
Section 8: This is the Property Class S8 was designed for. Still need to screen S8 prospects though.

Class D Properties:
Cashflow vs Appreciation: Typically, all cashflow with little, maybe even negative, relative rent & value appreciation
Vacancy Est: 20%+ should be used to cover nonpayment, evictions & damages.
Tenant Pool: majority will have FICO scores under 560 (almost 30% probability of default), little to no good tradelines, lots of collections & chargeoffs, recent evictions. Verifying last 2 years of rental history and income extremely important to find the “best of the worst”.
Section 8: All the S8 “gurus” promote putting S8 tenants into this Class of cheap properties to “get rich”. If only it was that easy!

Make sure you understand the Class of properties you are looking at and the corresponding results to expect.