investment property Archives - Lazy Man and Money

Can You Rely on Real Estate Investing’s 1% Rule

October 19, 2021 by Lazy Man 4 Comments

You’d think that after 15 years of being a landlord and reading about personal finance, I’d know all the rules of thumb. However, I recently came across the 1% rule of real estate investing and had to look up the definition. Perhaps I knew in the past and just forgot about it. We’re accidental landlords, our rentals are homes that we already lived in. The exception was an investment property that was insanely cheap. It was in great condition – no repairs necessary. We didn’t have to do a single calculation on it, because we already had a condo in the same complex. We knew everything about the neighborhood already.

I love rules of thumb because they help me verify that I’m on track. So…

What is the 1% Rule in Real Estate Investing?

It’s a quick estimation of whether you are getting value when you buy a rental property. The monthly rent should be 1% of the purchase price plus any necessary repairs. For example, a $200,000 home (with no repairs) should rent at $2000 (or more) to cover the mortgage payments.

Similarly, you could do the reverse and multiple an expected rent by 100 to figure out how much you should pay for a property.

When to Use the One Percent Rule

The best time to use the rule is early in the search as a prescreening tool. That’s what the experts say at least.

I was looking at the properties we have and I thought, “What if we sold them to another investor?” Or if I were an investor today, would I buy the rentals all over again?

Property 1

Our oldest property currently has a Zillow estimate of $200,000. That makes figuring out the 1% rule very easy because we just finished that example. Zillow’s Rent Zestimate is a little less than $1800. The rent we’re making is $1350. We’ve kept it low for a long time because our tenant is an elderly widow living there on a fixed income and we don’t have to do anything. Keeping the vacancies minimal is also important to us.

We’re losing money on the property as condo fees keep going up. It’s starting to be an older property and the expenses will go up to maintain it.

It wasn’t bought to be a rental in the first place. However, if someone bought it now and got a tenant in it, perhaps it would be close to 1%.

Property 2

My old condo is worth $358,000 now according to Zillow. However, the rent Zestimate is a little less than $2300. For it to follow the 1% rule, we should be collecting $3,580 a month in rent. Zillow says we couldn’t get close to that. It’s true, we have it rented for only $1900. We’ll look to raise this rent too because the condo association has had a couple of fires and the insurance has gone up.

Fortunately, we bought the condo a long time ago, so the mortgage is lower. Unfortunately, that’s not enough to generate positive cash flow.

So far no investor should buy either of our properties.

Property 3

Our newest property was bought in 2013 and it was a great deal at $95,000. We sold it for nearly double at the end of 2019. We did a 1031 Exchange, which allows us to roll the money into a new property without paying taxes on the sale. We did all this because it is easier to manage property closer to where we live.

We paid about $200,000 for the new property and it jumped to $265,000 as prices have skyrocketed in the last year. We’ve only been able to get $1600 in rent though. Zillow says that we may have been able to get $1800, but the $1600 was fair for the market. In the last couple of months, Zillow has jumped the rent estimate to $2500.

If an investor about the property from us for $265,000 and tried to rent it out to someone new, I doubt it would get $2,500, much less $2,650.

Property 4

This is actually our primary residence instead of a rental property. However, it used to be rental property. We lived in California, but in 2011 we bought a house in Rhode Island. The real estate market was still down and we figured we could get a price and rent it out to a military family until we retire in it. We only rented it for one year.

We bought it for $400,000 and we were able to rent it for $2,600. That’s not near 1% either. Zillow says it is worth nearly $700,000 now, but the rent would be a little more than $3,400. That’s only about 0.05% – very far from 1%.

Throw out the 1% Rule?

I think our area of New England makes the 1% rule very difficult to do. There might be some properties that are 1%, but it’s very hard. Perhaps if we bought a 3-family house, we could get enough rent.

Another “problem” is that the housing market has exploded in the last year. Rents have gone up too, but it seems like that they haven’t gone up fast enough to make hitting the 1% rule easier.

One way to get to the 1% rule is to wait. Rents go up over time, but your mortgage should stay the same. Let’s review the first property again. The purchase price of the property was around $140,000, so the current rent of $1350 is very close. If we charged a market rate, we’d finally have over the 1% rule.

What’s better than the 1% Rule?

Many real estate investors prefer to use the rent multiplier over the 1% rule. It’s very similar, but rather than just giving you a decision to move forward or not, it can be used to quantify how good or how bad a deal is. You simply divide the price of the property by the rent. So, we can use the very first example above with the $200,000 price and $2000 rent to come out with a rent multiplier of 100. That means it will take 100 months of rent to break even. Of course, you wouldn’t really break even because there are other expenses such as property taxes and repair costs. It’s just a good guideline to compare properties.

If you have another property that costs $100,000 and the rent is $1,500 that’s a much better deal as it would pay off in 66 months or five and a half years. Again, it’s important to note that about half the rent will go to other things over the long term.

Even though both properties pass the 1% rule, you can see how much better the second property is. Or, in the case of my property examples above how much worse they are.

Some people use the Gross Rent Multiplier (GRM), which just means that it uses the gross rents or the rent for a whole year. The math isn’t different, it’s only a matter of whether you want the answer in terms of months or years.

Final Thoughts

The 1% rule works to show you if a property is a good investment. It isn’t perfect though. Some locations are expensive and the 1% rate may not be possible. When that happens you may have to look at investing in another location, which can create its own set of management headaches. Or, you may decide to get as close as you can by minimizing the GRM and counting on appreciation to add value.

For us, the toothpaste is already out of the tube. We’re far enough along where we may be able to pay off the mortgages soon and have a real monthly cash flow. If we can raise the rental rates to be a little competitive it will certainly help. However, this is a tough time due to COVID, so staying with lower rents for a while longer may make the most sense.

Should I Put My Investment Property in an LLC?

November 5, 2020 by Lazy Man 5 Comments

That’s a question I asked myself years ago. I wish I was wise enough to answer it…

… NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO, NO!!!

Or as Al Bundy from Married… with Children once said, “Run hard, run now, run silent, run deep, run like Mexican water through a first-time tourist, but the key word here is ‘run!'”

I could go on about how I feel, and I will, but before I go any further I need to pause and stress something. Much of this is an account of my situation and how I personally feel. Your situation may be different… and your answer may be different. Perhaps you’ll be smarter than I was and get professional advice before jumping in.* In any case, I wish this was one of the 1.31 million personal finance articles I’ve read over the last 15 years or so.

I was going to suggest that no one should put their investment property in an LLC, but I talked with a few people and it seems like there may be some valid reasons to do it. Let’s cover a few of those reasons first.

Why Put Your Investment Properties in an LLC?

My wife and I were looking to simplify our finances. Whenever we needed money for repairs it would come from our checking account or a credit card. Since I love to rack up credit card bonuses, I put the expenses on a few different cards. We’re not the most organized people when it comes to having receipts. Come tax time, it’s a nightmare to put together all the numbers.

It turns out that organizing your finances is NOT a good reason to put your investment properties in an LLC. It can work well for internet publishing like Lazy Man and Money, but real estate is unique. I’ll explain why in the next section.

One reason why people may put investment properties into an LLC is that it can afford some legal protection in the event of a lawsuit. What kind of lawsuit? I’m not sure, but I’ve read that it can be someone visiting the property falls over a deck railing and gets injured. (Presumably, if it is someone living at the property, they have their own insurance and you have landlord insurance.) Because this involves lawyers and specifics of the law, I’m going to defer to your legal counsel to help you with how this can work. The people I know simply get umbrella insurance. One more thing that I’m looking into is protection from liability claims.

While I like legal protection and insurance as much as the next person, I have a limited budget for it. Umbrella insurance is fairly cheap and that’s about where my budget is.

Another reason to put investment properties in an LLC is that you can give some of it away in pieces. Maybe somewhere down the line, we’ll give the properties to our kids. I think we could give away a little at a time, so they wouldn’t have to deal with a big estate tax bill. That’s something that we’d have to tackle with our financial advisor(s). Once against see the “*” citation below. For now, we’re not interested in this. Our 6-year-old lacks the maturity to manage real estate… and probably will for at least the foreseeable future.

Finally, if you are investing in some commercial properties it may be easier if you are a corporation. (We’re not interested in this.)

Why Not to Put Your Investment Properties in an LLC?

I never figured there would be a negative to putting real estate in an LLC. Lazy Man and Money essentially works the same if it is in an LLC or not. My earnings are the same. My hosting costs are the same. I have two additional costs. At tax time, I have to pay more to the tax preparer. I also have to pay the state filing fee. I have a lawyer who automates most of this (at additional cost) and it’s about $1000 a year more than when it was a sole proprietorship. That’s not insignificant, but I’ve learned to live with it.

Real estate investing is different than internet publishing. It often depends on lenders and banks. Banks and lenders complicate things. For example, we’re in the middle of buying a new property, the first since we put it in the LLC, and it is a mess. I couldn’t work with the typical bank lenders because I need to use the “corporate division.” That process is a lot more difficult. It’s harder to track down the lender. They want incorporation documents. It’s a lot more hoops to jump through (which is significant because getting a mortgage is already a hoop-jumping intensive process.)

The first surprise was when we got our lending term sheet. Mortgage rates for 15-year-fixed loans can be as low as 2% now. We know that as investors we going to have to pay an extra 0.75% more. That’s just how it works with investing. What we didn’t know is that the LLC triggering the corporate loan adds another 1%. The rate jumps up to 4%. It’s still decent, but the “LLC tax” that doesn’t give us any real benefit is starting to get costly. In addition to that higher rate, the loan is not fixed. It readjusts every 5 years. What does the lending market look like in 5 or 10 years? I don’t know, maybe the rate will be 6% or 8%. We are very fortunate that we aren’t borrowing much money and can hopefully pay it down quickly.

The LLC nightmare gets worse. We registered our LLC in Massachusetts even though we live in Rhode Island. That may sound odd, but all the properties are located there and my lawyer practices there. We’re trying to manage properties closer to Rhode Island, so we are selling them off there and buying here when it makes sense. Our Rhode Island bank at the last minute decided that we need to register with Rhode Island which is an additional annual filing fee. It also almost caused the deal to collapse.

Finally, it’s looking like we’ll have to pay our tax preparer to file in two states now doubling the tax preparation fees. The annual fees to states and tax preparation are going to be around $2000, I believe. We used to pay a nominal fee when it was included as part of our normal taxes.

Some people may say that $2000 isn’t a big deal, but I’m a person who celebrates finding chicken at $0.69 a pound. I save up for years to buy a $1300 television. It’s significant especially with the potential of more expensive loan terms.

Lesson learned: a real estate LLC can cost you.

* Whenever I try to get professional advice it doesn’t go well. I’ve spent the last month trying to get a CPA who can help with some advanced future tax-planning questions. Most seem to want to manage all your finances at a cost of hundreds of dollars a month. I had a few ask about my investable assets because taking over that aspect is part of the core of what they do. Maybe I just haven’t found the right people.

Further reading: Bigger Pockets – Why You Should Skip the LLC When You’re House Hacking

Our Early Retirement Plan: Where We Are Now (Part 1)

November 1, 2008 by Lazy Man 10 Comments

If you are just starting this, I suggest you start at The Introduction – Part 0

You can’t figure out where you are going if you don’t know where you are…

My wife and I are each 32 years old. To some degree our finances are separate – we never felt the need to combine them other than opening up a join savings account. I have around $200,000 in assets. My wife has about the same. My money is mostly in a retirement accounts (things like 401Ks, IRAs) and equity in my old home (now an investment property that just about breaks even). Her money is invested in much the same way, but more in mutual funds and money markets than equity (though she does have some equity in the property she had before she met me).

Our Current Income

My Wife’s Income – She’s a pharmacist working with the military. She gets a tax-free housing stipend, which for San Francisco is quite healthy.
My Wife’s Extras – She is required to travel from time for work. When she does travel she gets money for meals. Rather than a reimbursement system, they simply just give her the cash. If she’s frugal with her meals that extra money adds up. She also gets the standard 58.5 cents a mile for her driving. For 20 miles, they’ll pay her $11.70. Since that’s about a gallon a gas, it’s $8.70 to cover maintenance costs. I think we make out well with this.
My Income – I make some money from my websites. What I like about this income is that I can do it from anywhere that has an Internet connection. I can also write it at any time. For instance, by the time you read this, it’ll be at least a week since I’ve written it. In addition to this, the start-up business that me and my business partner have is making us each around $2,000 at this point. For a company that’s about 5 months old, we are quite happy with it.

Our Current Necessary Expenses

Home – We rent our current place. It currently doesn’t pay to own in our area. Rents are proportionally cheap. We spend $2075 a month on rent, which may sound like a lot, but it’s San Francisco. For the year that’s roughly $25,000.
Transportation – My wife and I each own our cars outright. My wife gets a free bus pass from her work. I work from home. This makes our gas expenditures extremely cheap. We still have to pay for maintenance and insurance. I would estimate that this is around $5,000 a year, and that might be on the high side.
Food – We save a lot of money shopping at military commissaries. I wish this were an option for everyone but it simply isn’t. I think we typically spend about $125 every two weeks. That rounds up to about $3,500 a year
Utilities – Our Internet and cable prices are pretty standard. We have intro deals with Comcast and save a little money that way. Our cell phone plans are around $40 each for almost everything Sprint has to offer. Our heat and electricity expenses are very minimal – the weather in Silicon Valley is fantastic requiring no air condition and very little heat. Our phone service is a $15 plan with Vonage. Adding all this up, it looks like it’s around $3,500 a year (again rounding up)
Insurance – We have standard insurance – home, rental. We don’t currently pay for any extra life insurance as we don’t have any dependents. However, our insurance company, USAA wins awards each year for it’s great rates and customer services. It’s another military benefit that I wish I could share with the rest of you. The cost for this is insurance is around $2,000 or less for the year. I have to admit that I don’t have the actual numbers on this and I’m too Lazy to look it up.
Additional Stuff – There’s always going to other costs to factor in. I’m probably forgetting more than a few things here already. I’ll build in another $6,000 for these miscellaneous things.

That’s a rough outlook. I intention didn’t want to get too bogged down in the details at this stage. It looks like we spend around $45,000 a year. Our income covers this and leaves us with enough money to build up significant savings.

Is Now the Time to Take Advantage of the Housing Crisis?

June 25, 2008 by Lazy Man 3 Comments

The following is a guest post from Rich Credit Debt Loan. The site focuses on mostly on topics of wealth building, a pretty rare trait amongst personal finance blogs. I encourage you to sign up for his RSS feed.

Right now, the news is filled with images of foreclosed properties, falling home values and pretty much bad news all around for the housing industry. Does that mean that now is the best time to take advantage of the housing crisis? Yes and no! Is investing in real estate a good idea? Yes and no! While there is no perfect solution for making money, there are many opportunities out there right now that could make a difference in your financial future. However, you’re going to have to tread carefully before you jump in with both feet.

For the first time in many years, it is a buyer’s market in real estate. Homeowners are desperate to unload their properties before they foreclose and auction sales are continually moving property for pennies on the dollar. Technically, this is a great time to pick up some really cheap property to turn into an income stream.

The main problem right now is that banks are often too shaky to offer you a loan that you can leverage to make that extra income. Unless you have perfect credit, you may find that it is almost impossible to get a loan right now. For those of us that prefer to leverage debt instead of sinking our own money into an investment property, it is a very stressful period. There are all of these properties out there, and it’s difficult to take advantage of them.

This doesn’t mean that you have to give up however. There are still plenty of ways that you can start leveraging debt to make more money. The good news is with so many foreclosures the renters market is incredibly strong. If you can find a property in good shape, that has not been trashed by the previous owners that foreclosed, you can start making money right now.

The key is finding those properties that are in decent shape. Not everyone that goes through a foreclosure trashes their home, but it is pretty common. Before you even think about buying a property at auction or from the bank, you’re going to need to make sure that it is completely inspected. It is a great idea to go to the property yourself just to make sure.

If it is in good condition, it may be the right time to snap up that bargain and rent it out. Otherwise, you may find that you’ll have to hold onto that property for a few years before you can sell it at a profit.

Now, let’s talk about some alternative financing for the down payment (an example of good debt) since getting a loan from a bank is a little tough right now. Peer to peer lending is a great alternative to a traditional bank loan and you have the added benefit of getting a little more control over the interest rates you’ll be paying. Many people are leveraging debt by using p2p loans at low interest rates with great terms. It’s a lot easier to make extra money on a rental property when you’re not paying high interest rates to the bank.

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