The 1% Solution to Real Estate Investing
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When I first began looking into real estate investing, I spent a lot of time trying to figure out what criteria I would use in selecting which property to buy. I have built many Excel spreadsheets with mind-numbing calculations and data, all geared to finding that perfect investment property. Having now purchased four rental properties over two years, I’ve developed a much easier way to evaluate whether a property will generate positive cash flow or not. I call it the 1 percent solution, and it works like this–
Will the property generate monthly gross rent equal to at least 1 percent of the total cost of the property?
The total cost of the property includes four things: (1) purchase price of the property; (2) fix-up costs; (3) financing costs; and (4) carrying costs from the time of purchase until the first tenant moves in. Of course, this requires making a reasonable estimate of what the rent will be and the cost to fix-up the properties. With enough experience and research, I’ve found that these estimates can be made with good accuracy. On estimated rent, for example, I usually estimate within a range of $100 and calculate the 1 percent using the mid-range of this estimate. Because my investment properties are all in the same area, I’ve got a very good idea of how much rental income a given property will generate.
A note of caution. In many areas of the U.S., finding a property that meets the 1 percent rule is next to impossible. I invest in the mid-west, and given the high rate of foreclosures, have been able to find properties that generate rents at or near 1 percent of total cost. I am able to finance nearly 100% of the total cost on a 30-year fixed rate mortgage that enables me to generate positive cash flow immediately, even after factoring in an allowance for repairs and vacancy.
I’d be interested in hearing if anybody else uses this or another guide to evaluate potential real estate investments. But I’ve found the 1% solution to be a great way to make money.
4 Comments, Comment or Ping
Q at $1 Million to My Name
I would not use that as a property searching tool. My 4-family doesn’t meet the criteria. It is true that if I had purchased in a seedier part of town, I could have bought an 8-family and set myself up for greater potential monthly cash flow.
But I bought this building as a long-term, low-headache investment. It’s in a great neighborhood - in fact, it’s in my neighborhood, right across the alley from my house. Houses in my neighborhood range from $200,000 up to $500,000, and I’m in the Midwest. So it’s a very decent neighborhood. I’ll trade a little less cashflow for a beautiful solid building that will be a great long-term asset for my family.
Jun 6th, 2007
DR
Q, you make a good point. I’v found, generally speaking, that the better the neighborhood and nicer the home, the lower the cashflow. On the upside, not only is the property generally less of a management headache, but appreciation is generally better. That said, I’m surprised that a 4-unit property doesn’t generate combined rents equal to or greater than 1% of the cost of the property. Multi-unit properties generally generate higher cashflows.
Jun 7th, 2007
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