Hey there fellow REIer, Cam Dunlap here…
I was recently asked a question by one of my insider colleagues that spotlighted a couple investing principles that I feel very strongly about. Here’s the Q:
“When purchasing rental units, the idea is to have the rent at 1% of the investment price. Does that apply to condos? And if the rent-to-value ratio is good, is paying market price or slightly higher when wholesaling acceptable to an investor who is looking for cash flow and appreciation?”
I’m going to tackle one question at a time…
Ok, first: Yes — it applies to condos.
Second: The old rule was what we called the rent-to-value ratio.
So, to keep the numbers really simple, a desired 1% rent-to-value ratio of a $100,000 house should rent for $1,000 a month. Easy math.
Lemme say it another way: The $1,000 rent is 1% of your purchase price — or your basis of $100,000. What does that last part mean?
Let’s say you buy the place for $80k, and you’ve got to put $20k in it to make it right. Well, your basis is $100k. That’s the number.
And, you probably have more leeway with condos. Why? Think about it… the occupant of the condominium has no responsibility to mow the lawn or paint the exterior or do the landscaping and stuff like that.
That’s part of what people pay for in their monthly condominium dues. So, they have fewer direct expenses, but they actually pay them in the monthly condo fees.
But with a single-family rental house, then the tenant is certainly responsible for mowing the lawn and shoveling the driveway and sidewalk and all that.
But the leeway there is that debt is so cheap right now! If you’re getting $1,000 a month in rent, you’d be safe paying $120k for that house and still be in a good place because debt is so cheap.
Look, I’ve got private lenders who I’m paying 3.5%–4%, and they’re thrilled.
See, the 1% ratio was developed back in the ‘80s…
In the late ‘80s, a typical mortgage was 8.5%–9.5%, and in the early ‘80s, mortgages were upwards of 14%–18%. So debt service had a much bigger impact on monthly numbers than it does now, because debt is so cheap, so you can go over that and still make it work.
Appreciation vs. Cash Flow: Does 1% still apply today?
So, the second part of the question…
If you’re going to buy a property in good condition from a wholesaler, and they’re expecting you to pay at or near retail — and the numbers work for you: taxes, insurance, maintenance, property manager — I might be willing to pay more for that house.
But only if other circumstances are right too… if there’s an underlying incentive or some concession that’s built into the deal, like seller financing at zero interest.
Pro Tip: Do NOT manage your own properties yourself. Ever.
Now, here’s the thing….
I adopted a philosophy 28 years ago — and I will never, ever change. And, I’m going to strongly suggest, in fact, borderline insist that you adopt this philosophy too.
Here it is: When you invest in long-term buy-&-hold properties — only ever look at appreciation as a bonus. We don’t ever buy for appreciation, we buy for cash flow. Then, if and when the property appreciates, that’s a nice bonus.
Make sure you roll that into the decision-making process. Do NOT say: “I’m pretty sure this is going to appreciate, so I’m going to be willing to push the numbers and pay a little more or go a little thinner on cash flow.
Don’t do it!
Don’t let the prospect of future appreciation influence your buying decision in any way, shape or form. EVER. Only look at it as a potential bonus.
Ok, I think I made that clear. 🙂
So, lots of good, actionable info for your next deal. Go get it.