I am a big fan of utilizing “rules of thumb” for the mere simple fact that I am analyzing dozens of deals every week and this allows me to determine if we are even in the ballpark before spending hours determining if a deal is worth taking to the next step of underwriting.
Here is a rule of thumb that Nationwide is becoming almost extinct at this point:
The 1% rule.
What is the 1% rule?
The 1% rule measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price.
For example, you are looking at buying a property for $200,000. The gross rental amount should be no less than $2,000 a month or 1% of the purchase price.
So with this in mind, think about where you live. Most people live in areas where real estate has increased dramatically over the last 3 years especially…So the 1% rule is literally impossible to find if you are looking on the MLS.
I currently live in the Phoenix area. The average median home price is almost $475,000. However, the rents have not kept pace with the equity appreciation that we have seen so the average rental amount is closer to $3,000. Well below the 1% rule.
What does this mean for investors in these markets like Phoenix, San Diego, Seattle, Washington DC, etc? This means that if you are looking to buy a long term rental property in these markets…You will most likely see a return of less than 4%…YIKES.
Many investors have had to become much more creative by pivoting to STR (short-term rental) strategies such as AIRBNB’s or Padsplit (rent by the room) in order to still get a return that is closer to 8% or greater…However, you are stuck with one investment strategy to make money and let’s say regulations come in for that particular city and restrict the use of STR’s…(They recently just passed a law in Chattanooga that does not allow any future Airbnb permits)…This can leave you in a pickle.
Thankfully, you can still find investments out there that are close to the 1% rule where we have been focusing our buying in markets such as northern GA and the SW market of TN. Keep in mind we are finding properties that on average we are purchasing for the 1% rule and once repairs are completed the properties are selling for just under the 1% rule which is impressive in and itself but taken one step further, property taxes in these areas are very low and most homes that we purchase do not reside in an HOA that often kills your cash flow. Combine that with lower than average property management fees and you will see returns in year 1 of over 7% and by year 5 cash on cash returns or ROI are well over 10% on average.
While most investors are struggling to find properties that have positive cash flow day one, we have been fortunate to put a team in place in the Chattanooga area that are consistently able to find properties near that 1% rule which in turn makes for some happy & more importantly repeat investors!
If you are looking to add to your portfolio of rental properties or if you are looking for your first investment property, we may be able to help.