The "1% rule" discussion inside. (my calc look right?)

Over the course of the last few months I have read about 30-40 REI books. Several of the cash flow oriented books preach the 1% rule in that if you can charge rent equal to 1% of the purchase price of a home then you have a good chance to create positive cash flow. Unless you’re blowing like 20-30% as a down payment the numbers just don’t work. Paying more up front to get positive cash flow is just silly to me. I don’t want this to sound like a negative thread because it isn’t; I am looking for opinions to debunk my method calculating cash flow in hopes I am missing something somewhere.

Let’s take a typical property and apply the 1% rule. My property taxes are .91% (based off of KY taxes).

Purchase Price \$58,000.00

Total Cost \$58,000.00
Down Payment \$0

Finance Amount \$58,000.00
Mortgage \$409.00 (100% LTV @ 7.5% Int)
Insurance \$40.00 (Estimate)
Rent \$580.00 / month (per 1% rule)
Vacancy (5%) \$29.00 / month
Management (10%) \$58.00 / month
Property Taxes (.91%) \$43.98 / month
Water \$55.00
Maintenance (10%) \$58.00 / month
Total Cost \$750.98
Monthly Cash Flow

``````   \$(170.98)   /month cash flow  - Negative
``````

Ack I am a moron…I think I should have posted this in the Beginners forum

Gmtmaster,

I use the 1% rule as a screening tool. In other words, if the rent isn’t greater than 1% of the purchase price, then I won’t even look at a house as a possible purchase. Obviously, you can’t use the 1% rule to determine if a house will cash flow or not. You have to do exactly what you have done in your post, which is to run the numbers. Once you’ve done several deals, you’ll know what you can pay for a house in your area and have it cash flow properly.

I see that you’re in Kentucky. Your numbers appear to be almost exactly like my numbers here in Ohio. What we see from your example is that you need to be buying houses in the \$30K range or lower in order for them to cash flow properly with the rents you can get. These deals are out there - you just need to look for them.

Also, I would not include water in my calculation because I am not paying the water (the tenants pay all utilities). Also, I manage all my properties, so I don’t have any management expense.

Let’s look at the same example, except assume that you bought the house for \$30,000.

Market Value \$58,000
Purchase Price \$30,000
Rent \$580
P & I \$210
Insurance \$40
Vacancy \$29
Taxes \$44
Maintenance \$58

Total Expenses \$381

Positive Cash Flow \$199

So, you see that the key is buying the property at a discount! I have found that you can’t normally pay retail for a property and have it cash flow. You must buy at a discount.

Also, I believe that it is critically important to have the positive cash flow be AT LEAST 1/3 of the mortgage payment (1/2 is a lot better). This is necessary to have a business model that is sustainable in the long run!

Good Luck,

Mike

Thank you so much for the reply, this is exactly what I was looking for. I was able to get several houses at the 30k mark but they of course didn’t come easy. I have one that is \$37k and is renting \$425 per side. I was pondering through my local REI club listings and of course the MLS and it is really hard to buy cash flow properties at the listed prices (which are 90% of the time equal to the exact appraised value). Like you said it looks like the goal is using the 1% rule as an initial screen and then see if there is room to haggle to obtain good cash flow. I guess it is all in the motivation of the seller.

Thanks again.

gmt,

A couple of things are cutting into your cashflow:

(1) Your interest rate is high (7.5% – I pay about 6 to 6.25% now)…partly because of the 0% down, I would guess…

(2) You insurance is high – I pay about \$240 - 270 a year for a ~\$60K properties.

(3) Your taxes are a bit higher than mine…

(4) I figure 7 or 8% for mangement ('cause that’s what the going rate is)

(5) My tenants pay their own utilities.

So, you should look like:

P&I = \$405.54
Insurance = \$22.50
Vacancy (5%)= \$29
Management (7%) = \$40.60
Taxes (.91%) = \$43.98
Maintenance = \$58

Total = \$599.62

Rent = \$580

Cashflow = (\$19.62)

A large part is interest rate driven by 0% down.

Are the KY tax rates based on full appraisal or a tax appraisal?

Still the 1% “SWAG” is within 20 bucks.

Keith

Keith…

The tax is based on the valued assessed by the county; I have seen instances where the taxes are assessed at 30k and the property is appraised at 45k, sold for 35k.

Thanks for the input, I was afraid I was a little high on the insurance but better to be high than low.

The reason I used water in the example is that it is rare (in my area) to find properties where the renters paid water. It seems like the norm but then again there is no rule stating that I can’t go against the wave. Also, the interest rate is because of the 100% non owner occ’ed loan.

Still trying to find management that will manage for under 10%. Property management companies believe it or not are pretty scarce in KY. I have 8 that I contact on a regular basis but they all charge 10% and half first months rent to place. I wish we had a little more competition here as far as that goes. They also have extremely weak areas of coverage, I am working with 3 different property managers in the city because some only go so far.