Evaluating rental - 1% rule; cashflow; stable income stream

[Jacinle]

Hi

To prepare for my RE, I have always wanted to diversify and add a stable income on tops of my classic 7/3 Equity and Bond portfolio.

Now with property price rising and interest rates rise, it seems the basic rules for evaluation good rental, e.g. the 1% rule and cashflow/ROI, all fail in today market situation.

For example, in my area, a 3 bed single family home

Purchase Price   800000   750000
      
Rent           2300           1800
Yearly   27600   21600
Net Yield   3.45%   2.88%
5 years fixed mortgage rates references - 3.14%

Cashflow would be just break even or slightly negative.

This is net yield even before considering expenses, void etc

Should we be pouring cash in stock markets?  Thoughts?

J

[Telecaster]

The 1% rule houses have been hard to find lately.   But if the property doesn't make financial sense, it is best to skip it and move onto something else. 

[Dee_the_third]

1% is easy to find in some markets, impossible in others. The balance is usually in the equity on the house, but that's nonliquid. Up to you if it's worth the risk, in your specific market, for your specific situation. 

I, personally, would not do it, especially with today's interest rates, unless there are extenuating circumstances -i.e. you want to live in this house eventually, and you are snapping it up for a discount price right now. You haven't factored in capital expenses, maintenance etc. or the value of your time.

[clarkfan1979]

Hi

To prepare for my RE, I have always wanted to diversify and add a stable income on tops of my classic 7/3 Equity and Bond portfolio.

Now with property price rising and interest rates rise, it seems the basic rules for evaluation good rental, e.g. the 1% rule and cashflow/ROI, all fail in today market situation.

For example, in my area, a 3 bed single family home

Purchase Price   800000   750000
      
Rent           2300           1800
Yearly   27600   21600
Net Yield   3.45%   2.88%

Cashflow would be just break even or slightly negative.

This is net yield even before considering expenses, void etc

Should we be pouring cash in stock markets?  Thoughts?

J

I did a re-fi on a rental in December 2020 and got 3.5% on an investment property. Today the rate would be 6.5%. At 3.5%, it's not close to the 1% rule, but the cash flow is good and principle pay down is good.

Because of the recent interest rate increase, sales price will need to come down for it to make sense. Motivated sellers will eventually come down on price, but it will take some time (at least 6 months).

[Jacinle]

I did a re-fi on a rental in December 2020 and got 3.5% on an investment property. Today the rate would be 6.5%. At 3.5%, it's not close to the 1% rule, but the cash flow is good and principle pay down is good.

Because of the recent interest rate increase, sales price will need to come down for it to make sense. Motivated sellers will eventually come down on price, but it will take some time (at least 6 months).

I added back the mortgage rates, I am in UK
Last summer when I started looking, I was given a rates of 1.2%, then 1.6%, then around 2% at the beginning of the year and now 3.14% ...

[WGH]

The ROI IMHO is heavily dependent on if you are buying a distressed/foreclosure property at a discount, putting in some sweat equity and increasing it's value.

If you are buying a turnkey property for market value even at 1% the ROI won't beat the stock market if there isn't significant appreciation.

[daverobev]

All real estate is local, but the UK and US don't compare - in the US it is the owner that pays property taxes vs the tenant paying council tax, for example.

Landlord's insurance in the UK costs a pittance vs what it costs in the US (YMMV by state).

So - the 2% rule (yes it's supposed to be 2% of purchase price, ideally...) and 50% rule (half of your gross rents 'going away') don't follow for the UK.

Also the British government has done all sorts of silly things making it much better to have a Ltd holding your real estate, if you have a mortgage etc. Just... because, I guess.

Now, here's my perspective. If something is too expensive, don't buy it. I've been pondering buying a little place somewhere in the UK for years now, but the time hasn't seemed right. There were bargains in Liverpool, say, a few years ago - so it seemed to me - but of course there are reasons for things to be cheap.

IMHO people who buy when things are expensive are a) just driving the prices up b) getting a bad return and c) can't really be called investors because they may well be losing money. "Oh but I only care about the capital gain"... yeah, well, that's up to you. But effectively you're subsidising your tenant if the place isn't cashflowing after all expenses (inc. tax, maintenance fund).

So then, risk vs reward. Put it into a Ltd and you have accounting expenses. Keep it out and you can't deduct interest on your mortgage (I believe). In a Ltd if the house explodes due to (whatever event that insurance won't cover), the Ltd can go bankrupt and your losses are at least limited - especially if the Ltd has the mortgage. Risk = however much you put in less however much you take out. Outside, same scenario, you can be on the hook for a lot - and your primary residence and other assets are at risk. Is it worth it for £50, 100 a month? Sure you get a house free and clear in 25 years but does that matter to you?

Lots to think about, work through, type out and evaluate. I'm not saying don't do it, I'm saying make sure you've really thought through all cases as much as you can.

[ChpBstrd]

Cashflow would be just break even or slightly negative.

If your model says break even, expect negative.

With interest rates rising fast, on the heels of a massive property bubble, why not just wait 12 months to lock in 7-8% yields on bonds? I know the consensus is that we're not heading in that direction, but I think the consensus is probably wrong.

[clarkfan1979]

Cashflow would be just break even or slightly negative.

If your model says break even, expect negative.

With interest rates rising fast, on the heels of a massive property bubble, why not just wait 12 months to lock in 7-8% yields on bonds? I know the consensus is that we're not heading in that direction, but I think the consensus is probably wrong.

They said "cash flow" would be break even, not the entire return of the investment. With real estate you also have principle pay down and tax advantages, which are both guaranteed. Lastly, you have appreciation, which is not guaranteed, but is the biggest reason why we all do real estate.

[Sandi_k]

I wouldn't be buying at that price. I'd be looking for markets that allow purchases for lower investment amounts, such as $150-$200k.

Leverage is your friend...until it isn't.

[Telecaster]

They said "cash flow" would be break even, not the entire return of the investment. With real estate you also have principle pay down and tax advantages, which are both guaranteed. Lastly, you have appreciation, which is not guaranteed, but is the biggest reason why we all do real estate.

Those things are all real.  Still though, the principle pay down is just you getting to keep your own money.   We've all experienced a long period of rapid real estate appreciation, but historically RE appreciation by itself isn't very good.  For purposes of valuing the investment, I think you have to assume a historical rate of appreciation.   In that context if it isn't flowing cash it probably isn't a good idea.   

[ChpBstrd]

They said "cash flow" would be break even, not the entire return of the investment. With real estate you also have principle pay down and tax advantages, which are both guaranteed. Lastly, you have appreciation, which is not guaranteed, but is the biggest reason why we all do real estate.

Those things are all real.  Still though, the principle pay down is just you getting to keep your own money.   We've all experienced a long period of rapid real estate appreciation, but historically RE appreciation by itself isn't very good.  For purposes of valuing the investment, I think you have to assume a historical rate of appreciation.   In that context if it isn't flowing cash it probably isn't a good idea.

Yea when I think of positive cash flow RE, I think about all the people who bought Las Vegas real estate with near-zero cash flows in 2006 or 2007 as a wager on appreciation, and suddenly watched the rents for those properties evaporate.

Then they were in the horrible position of deciding whether to make the payments and pay the bills for multiple underwater houses themselves and to potentially lose everything invested in the end anyway, or to abandon their properties to foreclosure.

Positive cash flow properties tended not to end up in this position in the first place, because they were in non-bubble geographic regions. Negative CFs were a sign of the housing bubble in hindsight, and the easiest red flag for a RE investment.