True story!
More than twenty years ago, I was sitting down on a Sunday evening reading the paper. (For you millennials, a newspaper is like a website you can hold in your hands.) In the real estate section, there was a student condo listed for sale near the University of Texas.
I turned to my wife and said, “I’m buying this tomorrow.” She looked at me like I was crazy and asked how I could be so sure if I had never seen the property.
What she didn’t know was that I had a trick.
Well, it’s not actually a trick. It’s a simple rule of thumb that gave me confidence that this could be a good deal. Of course, I was going to look at the place first. However, unless there were big structural problems, or mold covering the entire unit, I knew this was a good price.
The rule of thumb that I was using is called the 1% Rule. The basic assumption is this: if the rent equals roughly 1% of the purchase price, the property will typically produce positive cash flow.
This is not a true “rule”, nor is it foolproof. Every submarket has different metrics and those need to be taken into consideration when you do your formal underwriting. The value of the 1% Rule is it gives you confidence to give a quick yes or no to a property on your first look.
Have you ever heard about the 100/10/1 ratio? This assumes you must evaluate 100 properties to make offers on 10, which will hopefully result in one purchase. Real estate is popular today and it takes a lot of looking to find a good deal. Wouldn’t it be nice if you spent as little time as possible on the 99 before you found the one!
The utility of the 1% Rule is that you can quickly evaluate small properties, thus saving you tons of time underwriting each deal. If the numbers are close, and you like the asset, then you can proceed with formal due diligence.
One final note. You might find that properties in your submarket will adequately cash flow if the ratio is .08% or 1.2%. If that’s the case, use those ratios and you can quickly evaluate a lot of offers.
I’ve put together a short video explaining the 1% Rule, with a fun twist on location. Click the link below to see how it can be used anywhere.
To complete the story, I bought the unit. It has been cash flow positive since day one and I still own it today!
Click Here to See the 1% Rule on Video
Until next time!
Tom
