1% rule

[warrenv]

Hi All



I am not sure why I read this could of been here or somewhere else, or maybe I got this totally wrong.



I was under the impression to consider a potential property it had to fit the 1% rule, for example a property that sells for $150,000 should be able to rent for $1500.00 month gross.



I have looked in Winnipeg, Red Deer, and Hamilton.

Nothing even comes close, I have looked at MLS, kijii



Not sure if I am doing something wrong or got the equation wrong or looking in the wrong place



Warren

 

[Rickson9]

Don't worry about it. The 1% rule doesn't work anyway. Let me clarify, the 1% rule doesn't work if you like money. My properties are closer to a 1.5% (houses) to 2% (condos) rule. That works much (much) better for me.

 

[markl]

Hi Warren,



The 1% rule where gross monthly rents equates to 1% of the purchase price are very rare especially in better neighbourhoods where you would actually want your rental.



Most investors with the lower rates look in a 8 - 10% of yearly gross income range.



That being said you can still get 1% you just have to move quickly and ally yourself with some one on the ground who is familiar with these types of properties. As when they come up in Hamilton there is usually a lot of interest.



These tools are just a factor of interest rates and your trying to get a high spread on what you can borrow at and what you earn on it.



Rickson are you investing in the states? What type of mortgages if any are you getting down there?

 

[Rickson9]

Hi Mark, I'm investing in Phoenix, AZ although I have also briefly looked into Detroit, Miami, Ft. Lauderdale and Atlanta. I bought with cash. No mortgage since prices in decent areas were $40 to $50 per square foot.



In my opinion it's a mistake to invest in a property that can't offer significantly more than 1% of the purchase price in monthly gross rent.



Edit: It's a mistake, UNLESS you don't like money. Otherwise it's amazing.

 

[Thomas Beyer]

[quote user=warrenv]I was under the impression to consider a potential property it had to fit the 1% rule, for example a property that sells for $150,000 should be able to rent for $1500.00 month gross.
That does not exist in healthy (job creating, in-migration, diversified, low taxation) cities in Canada .. only in sick ones. Look for 6-8% of property value as a target for annual gross income, which nets to be 3-5% after operating expenses for single family houses or 4-7% for multi-family buildings.



It exists in isolated pockets of select healthy US cities, but that needs careful research as light and shadow is often only blocks apart.

 

[invst4profit]

If you can't find a property that fits the 1% rule expect to lose money for about 5 years. Once you have paid down the mortgage far enough with your money from your tenants you will then likely begin to see positive cash flow. Assuming you don't factor in the lost income on the cash you have tied up in the mortgage.

Imagine receiving a whopping 5% return (if your lucky).



The fact is many investors hold out for the day their tenants have paid off the property and then benefit from the sale. It's like owning your own home-forced savings. As long as you don't get too many bad tenants or extended vacancies you simply try to keep your head above water till the big pay day. The problem is that even one bad tenant tends to spoil the dream when you aren't making a profit.

 

[Rickson9]

Strongly agree. Great quotes from Greg.

 

[KevinMatwichuk]

Yes. I'm with Rickson. I only buy properties that meet the 1.5 to 2% rule as well. Yes they are in the US (Georgia, Arizona, and Florida). My cash on cash return is between 9% and 15%. The oldest house I own is 1998. Beside the great returns I enjoy almost zero vacancy on my portfolio and best of all no mortgage payments which is a great feeling!

I do own a portfolio in Alberta as well but the performance is lacking in comparison to my US properties.

Buying houses in the US at 1/3 of reconstruction price with high Cashflow is a win-win situation in my books! Congrats Rickson for investing when most others were scared.

The big problem with US housing in going to be the housing shortage which is going to occur in the future. The population there is growing rapidly and there are virtually no new construction.

 

[markl]

Hi Thomas,



I disagree you still see the 1% rule happening in Hamilton which has all of the key factors and is the #1 town in Ontario. This is of course getting harder and harder to find though.



These are in good areas as well not in the north end of the city.

 

[MarkTorgerson]

The 1% rule is a great rule of thumb. I use it all the time for doing a quick analysis in my head.

For those saying the math doesn't work....simply run it through. A $150,000 property at 80% financing at 3.5% for 25 years is roughly $600/month. Take the monthly revenue of $1,500 (1% of $150,000) deduct taxes, maintenance, insurance, .. etc and it still cash flows VERY well.



The key part is making sure it is in a strong economic center. As Thomas points out ones that are job creating, in-migration, diversified, low tax....etc.



You will do great with the monthly cash flow and principal pay down.....the plumb will be in the appreciation of the property.



They are difficult to find, but they are still out there.

 

[Darr]

The real returns generated by Canada 10Year Bonds are negative by .25%. A property that is sold at a price that yields a gross monthly income of 1% (approximately equaling a cap rate of 10%) can only be deemed distressed. This cap rate is a 10 1/4% spread over CDN Treasuries.That would be some deal or it has major hidden or differed maintenance.

 

[Darr]

IMHO, I think Thomas`s numbers are very accurate and conservative from a buyer`s perspective.



Notwithstanding, I find the $150,000 property example an interesting challenge to find. After all, it`s not what you`ve paid for the property that counts but mostly the total cost of having it in good order. As you know, Free Cash Flow is equal to CFO minus Capx. Searching for a property with no differed capx led me to this site:



http://www.barnpros.com/products/american/index.html



Everyone has different tastes but I prefer the `Haymaker`. It comes with six stalls, a wash bay and a tack room with a window. If you lean on these guys, you might take it home unassembled for 75K. This leaves you with the remaining 75K to buy the land and build your foundation, etc. Since tenants need running water and your new building may not have indoor plumbing means you need to find a waterfront lot. In Hamilton, that empty parcel of land was most likely owned by Stelco adjacent to the bay and the refineries. The bonus however is that each time the young fillys take a bath, they come out with a Miss Clairol shine. At $250 per month each, it should work.

 

[Thomas Beyer]

Properties that cost $60,000 and rent for $1200 or 2% exist where in the US with no or little value depreciation risk ? Propertirs that cost $100,000 and rent for $1000/month or 1% exist where in Canada ?

 

[Darr]

Exactly!. You cannot buy anything income generating with boatloads of leverage anymore. Comparable yields in real terms and risk adjusted are much too low. Every dollar of leverage reduces your ROE. Once distressed sellers have been taken out because they no longer have access to credit to upgrade their deferred maintenance, it`s game over. Hard asset prices will spike upwards as a result of more deficit spending causing currency dilution and a loss of purchasing power. This is the largest scale transfer of wealth from the `have-not" to the "have's` in the history of humanity.

 

[MarkTorgerson]

I have sourced multi unit properties in northern Alberta / BC at 80k per door that generate $800 per month in revenue. They could use upgrades but I wouldn't consider them distressed.

The 1% rule is much more difficult to find for residential but I will consider a property that even comes close to that rule of thumb. This would obviously require a much deeper level of due diligence before an investing decision is made.

 

[Darr]

Consequently if it needs an upgrade then it's not generating 1%.



I`m not going to get into a semantic discussion about what constitutes distressed. As far as I`m concerned it`s a seller that`s forced to sell. However, let`s look at this from another angle:



Given that alternative real returns are dismal, why sell such a high yielding investment if not distressed?

 

[Rickson9]

[quote user=MarkTorgerson] The 1% rule is a great rule of thumb. I use it all the time for doing a quick analysis in my head. For those saying the math doesn't work....simply run it through. A $150,000 property at 80% financing at 3.5% for 25 years is roughly $600/month. Take the monthly revenue of $1,500 (1% of $150,000) deduct taxes, maintenance, insurance, .. etc and it still cash flows VERY well.


I think this depends on an individual's definition of "very well". 80% financing on a $150k property is $120k mortgage and $30k equity. Monthly revenue of $1,500 deducting expenses leaves $750 per month; deducting $600/month in financing leaves $150 per month or $1800 per year. This is a cash-on-cash return of 6% ($1800/$30k) which, in my opinion only, is very bad considering the amount of leverage used. Also, any "hiccup" during the year can easily wipe out a large portion of the $1800.



Although a 6% yield isn't common, it isn't terribly difficult to achieve. One wouldn't need to use such large amounts of leverage to get it either.



[quote user=Darr]Every dollar of leverage reduces your ROE.


Actually, every dollar of leverage increases returns on equity.



[quote user=ThomasBeyer]Properties that cost $60,000 and rent for
$1200 or 2% exist where in the US with no or little value depreciation
risk ? Propertirs that cost $100,000 and rent for $1000/month or 1%
exist where in Canada ?


I can't speak for others and I can't speak for Canada. However, looking at my investments in the city of Phoenix, AZ they range from 1.5% to 2.1% "rule".



The 1.5% (worst) is from a detached 3 bed 2 bath home I purchased for $55k and rents for $850 per month and the 2.1% (best) is from a 2 bed 2 bath condo I purchased for $35k and rents for $750 per month.



On average, for better or worse, with regards to the "1% rule", I'm executing at a 1.7% to 1.8% rule.



I'm currently negotiating with the owner of a 16 unit multi-unit in Phoenix, AZ that has 3 vacant units and currently brings in $76k in gross rents ("pro forma" with the all units rented is around $96k). Separately metered. The price we're dancing around is $450k. That's a 1.7% rule. He is offering 80% VTB with terrible terms, but we'll see how that turns out over the next few days.



To say that a 1% rule is difficult to find is kind of true, but most people who say it aren't really looking hard enough or in the right places.



Again, I may be biased, but I don't believe that the 1% rule works. Either way, I don't use it because I actually enjoy making money.

 

[Darr]

Leverage increases your debt service and thus reduces your net income. In a low yielding /low cap rate environment leverage becomes a real large drag on your ROE.

 

[markl]

Hi Thomas,



We still see them in small multi family 2 - 4 units in the core of Hamilton. If you look hard enough you will find a very select few on the Mountain in Hamilton as well.



Regards,

 

[Darr]

Mark - Are you including the cost of the deferred maintenance in your total purchase price when calculating your 1% return?