Guys, I’ve been buying real estate rental properties now for almost 10 years. I’m going to teach you a few things I look for when purchasing a property.
The 1% rule is the quickest metric you can look at and in fact I still screen properties by this rule today. What it means is that you will be able to rent a property out for 1% of the purchase price. This assures you are getting a decent cash-on-cash return.
Example: You see a house priced at 200,000. You will need to look at other rentals in the neighborhood and decide if you will be able to rent that house for 1% of the purchase price, or 2,000 a month.
After passing my quick 1% rule screen I then go into a deeper look at the property and determine what the cash-on-cash return will be. I look for a 10% cash-on-cash return. In higher growth areas I realize this isn’t possible. Since there’s not much growth here I’m getting good cash flow. It’s a tradeoff.
I have a spreadsheet that I made to enter these numbers in to calculate quickly for me. If anyone is interested I can add a link to it.
Cash-on-cash return = profit / cash costs
Here’s an example of a property I just looked at:
Cash Costs –These are the out-of-pocket cash expenses you will incur. These costs include closing costs, down payment, and any out-of-pocket repairs you need to make before renting. Depending on what state you live in, whether that be Houston, Texas, or Orlando, Florida, there will be different ways that closing costs will be calculated depending on a myriad of factors, so be aware. In this regard, it is wise to find out ahead of time what fees and charges you will need to pay at closing in order to plan your finances adequately. If you are purchasing a house in Arizona or a nearby area, for instance, you may be required to pay an underwriting fee, credit report fee, appraisal fee, and title insurance, among other expenses. Your real estate agent may, however, be able to negotiate some of the closing costs with the seller for you. In addition, there are several online resources like https://tubac.com/tubac-az-closing-costs/ that can help you learn more about how you can reduce your out-of-pocket costs.
Purchase Price – 170,000
Repairs – 500.00
Closing Costs – 5,100
Down Payment (25%) – 42,500
Total Cash Costs = $48,100
Financed Amount (25% down payment) – 127,500
Monthly Expenses – This one is self-explanatory , total monthly expenses
Interest Rate – 5.75% for this example
Monthly Taxes – 334.58
P&I Monthly – 744.06
Property Ins./mo. – 107.25
HOA Dues – n/a
Total Monthly Expenses w/o Maintenance – $1,185.89
Maintenance/Vacancy Costs – This one can be a little tricky. A lot of people like to estimate 20% here to be safe. Depending on the age of the property and location I make a determination here. I used 15% for this property. That means I allocate 15% of the monthly rent into an account to cover any future maintenance or vacancy expenses.
Maintenance/Vacancy (15%) – 270.00
Total Expenses after maintenance/vacancy costs = $1455.89
Expected Rent – 1800
Monthly Profit = $1800 – $1455.89 = $344.11 or $4129.32 yearly
To get your Cash-On-Cash return just take the $4,129.32 and divide by your total cash costs of $48,100.
Cash-on-Cash return – 8.58%
As you can see, this property passed the 1% rule of estimated rent above 1% of purchase price. However, the cash-on-cash return is just 8.58%. This was a property I looked at back near the end of last year when interest rates were higher.
At an interest rate of 5% instead of 5.75% , the Cash-on-Cash return boosts to 10.07%!
So basically I’m also watching interest rates to meet my criteria. If I can get this same property at a 5% rate then it meets my criteria of a 10% cash-on-cash return.
If this is helpful let me know, or if there is anything else I can explain let me know as well. So far this simple process has served me well.
Jasper Levi Stojanovski says
Thanks for sharing!
I have never heard of the 1% rule regarding real estate, or cash-on-cash returns!
Hopefully remembering this will serve me well in the future when I decide to buy.
Jasper Levi Stojanovski recently posted…How to Become a Millionaire – 8 Steps to Wealth
All About Interest says
It’s just a simple rule of thumb I use to quickly estimate if a property is worth looking into further.
Thanks for stopping by!