Author Topic: In search of a deeper understanding of the 1% Rule  (Read 8209 times)

DavidInDc

  • 5 O'Clock Shadow
  • *
  • Posts: 5
In search of a deeper understanding of the 1% Rule
« on: June 11, 2014, 11:47:20 AM »
Need a little clarification:
I understand the 1% rule when evaluating new properties as a great go/no go filter to find likely profitable rentals.

Where I would like a little more discussion is on how you use it to evaluate existingly held rental properties.

So for a case study I have a rental in a now swank part of washington DC (Not so swank when we bought it) that was our primary residence, and now a rental.

So based on different numbers I get a very different answers:
Purchased for 137k (15 years ago), currently mortgaged for 290k (refinanced with cash out 310k 10 years ago when I took money out to buy my current residence so I could keep this one) and a reasonable selling price would be almost 600k, so 310k in equity.  Rents are 3850 a month.

So applying the 1% rule to these different numbers gives me:
Sale Price: 0.64%
Equity: 1.24%
Original Purchase:10.27%

If I turn it around a new investor looking to by based on that rent would be looking to pay 385000 (which is probably why there are not so many rentals in the neighborhood).  If I sold it and cleared 300k I could buy 3 1% properties for cash and make 3000 in rents (but probably have higher cashflow without and interest expense)

Probably not looking to sell as it is 5 doors down, super easy to rent (vacant 4 weeks in 6 years), and cash flows about 17k per year (+6k year in paying down mortgage)  after mortgage/expenses.  Just wanted a lesson on the finer points of real estate valuation.

Thanks in advance
David

Edited to make the refinance clearer.
« Last Edit: June 11, 2014, 12:56:25 PM by DavidInDc »

okashira

  • Bristles
  • ***
  • Posts: 416
Re: In search of a deeper understanding of the 1% Rule
« Reply #1 on: June 11, 2014, 12:08:17 PM »
I would apply the "rule" to the value of the home. Equity, purchase price are not important if you already own it.

If you can sell the home and gross after transaction fees $300,000, then I wouldn't rent it for less then 3,000/mo.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #2 on: June 11, 2014, 12:31:14 PM »
I would apply the "rule" to the value of the home. Equity, purchase price are not important if you already own it.

If you can sell the home and gross after transaction fees $300,000, then I wouldn't rent it for less then 3,000/mo.

Interesting, I was thinking of it the other way and was going to suggest he needs to evaluate it based on his original purchase price (although I'll admit I'm completely confused by the "currently mortgaged for $290k" part...was this a 2nd mortgage on the home?). 

I see okashira's point though of thinking of it this way as a tool to help set your current rent. 

Also, kudos for snagging a place for $137k that now rents for $3,850 per month!

waltworks

  • Magnum Stache
  • ******
  • Posts: 3276
Re: In search of a deeper understanding of the 1% Rule
« Reply #3 on: June 11, 2014, 01:25:05 PM »
I use it in exactly the same way for existing properties as I would for considering a property to purchase: how hard is my money/equity going to work if it's tied up in this pile of sticks and patch of dirt? Of course, there are some transaction costs associated with selling real estate so I factor that in to some extent as well.

If this is a roundabout way of asking if the 1% rule applies to your property, the answer is yes, and it applies at it's current market value. So it's a crap rental. But if you're happy keeping it, by all means keep it.

To put it another way: let's say you buy a stock for $10. It returns a 10%/$1 dividend every year, without fail. Great investment. Now the price of the stock rises to $100 - but the dividend is still $1. Do you sell the stock, since you are only earning 1% (let's say for the sake of argument that it'll stay at $100/$1 *forever* now, just to take the speculative aspect out of it)? Or do you base your decision on the original purchase price and keep it? As much as it might make you feel good that your $10 investment is returning 10%, the reality is that you now have $100 tied up in getting a 1% return, which sucks. Same story with a house that has appreciated a lot.

-W
« Last Edit: June 11, 2014, 01:30:27 PM by waltworks »

okashira

  • Bristles
  • ***
  • Posts: 416
Re: In search of a deeper understanding of the 1% Rule
« Reply #4 on: June 11, 2014, 03:01:07 PM »
I would apply the "rule" to the value of the home. Equity, purchase price are not important if you already own it.

If you can sell the home and gross after transaction fees $300,000, then I wouldn't rent it for less then 3,000/mo.

Interesting, I was thinking of it the other way and was going to suggest he needs to evaluate it based on his original purchase price (although I'll admit I'm completely confused by the "currently mortgaged for $290k" part...was this a 2nd mortgage on the home?). 

I see okashira's point though of thinking of it this way as a tool to help set your current rent. 

Also, kudos for snagging a place for $137k that now rents for $3,850 per month!

The idea is that if the property doesn't meet the 1% (or 50% or whatever) rule, then you'd be better off selling and investing elsewhere.
Be sure to include transaction costs if you already own the property.

Even if you bought the property for 100k, and it rents for $3000/mo now, if it's worth $550,000 now, better to take that $550,000 in cash for other investments then keep renting at $3,000.

okashira

  • Bristles
  • ***
  • Posts: 416
Re: In search of a deeper understanding of the 1% Rule
« Reply #5 on: June 11, 2014, 03:05:37 PM »
One more thing,
I believe that the 1% rule can be stretched a *tiny bit* for more expensive properties:

-typically maintenance costs will be a lower % of the value of the home when compared to a cheaper property
-same applies for insurance
-same applies for taxes
-there is also a labor/sanity advantage for the owner. It's just easier to manage one $500,000 property then it is to manage five $100,000 properties.

Don't forget the added risk of "putting all your eggs in one basket..." though.

SDREMNGR

  • Bristles
  • ***
  • Posts: 324
Re: In search of a deeper understanding of the 1% Rule
« Reply #6 on: June 11, 2014, 06:49:15 PM »
The correct application of the rule would be based on today's value.  So in today's numbers your rental is not a "good investment" per the 1% rule.

It will be extremely difficult to find properties that meet it in DC area and it would require a very good auction purchase in cash to achieve it.  You can forget about finding it on MLS deals.  But that doesn't mean you won't make money on real estate deals as you have shown.  Appreciation can be a huge money maker if you buy at right time.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #7 on: June 11, 2014, 07:50:24 PM »
The idea is that if the property doesn't meet the 1% (or 50% or whatever) rule, then you'd be better off selling and investing elsewhere.
Be sure to include transaction costs if you already own the property.

Even if you bought the property for 100k, and it rents for $3000/mo now, if it's worth $550,000 now, better to take that $550,000 in cash for other investments then keep renting at $3,000.

Okay, this is a fair point that I had not considered in the least.  My next thought though is that DC is a "non-typical" market in the U.S. and if he bought this place at $137k which is now fetching $3,800 in rent per month, he's sitting on an absolute cash cow that is unlikely to exist (rather be very very difficult to come by) elsewhere in D.C. 

I'd still like some clarification on the "currently mortgaged for $290k" part though, that would make a big difference in my thought process if I'm misunderstanding the purchase price of $137k. 

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #8 on: June 11, 2014, 08:09:06 PM »
Okay, this is a fair point that I had not considered in the least.  My next thought though is that DC is a "non-typical" market in the U.S. and if he bought this place at $137k which is now fetching $3,800 in rent per month, he's sitting on an absolute cash cow that is unlikely to exist (rather be very very difficult to come by) elsewhere in D.C. 

(Emphasis added.)

Sure, but if he could take 550k, for example, and buy two properties that met the 1% rule, say for 225k each and rented for 2250/mo each, you're now looking at 5500 gross rent per month instead of 3800.

Or if he could invest it closer to 1.5-2%, he could be getting a gross rent of 8-10k+ instead of 3800.  Not likely in DC, but available in some markets.

Now he wouldn't be able to cash out 550k due to mortgage, selling costs, taxes, depreciation recapture, etc. etc., but we're just talking theoretical - if he bought for 137k and it was rented for 3800/mo and worth 550k, it's irrelevant what he paid - it's relevant what he could cash out now and do with it versus that 3800 gross (and actually more important, obviously, is the net rental income).

I'd still like some clarification on the "currently mortgaged for $290k" part though, that would make a big difference in my thought process if I'm misunderstanding the purchase price of $137k.

Edited into the OP was the following info:  refinanced with cash out 310k 10 years ago
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #9 on: June 11, 2014, 08:19:39 PM »
I'd still like some clarification on the "currently mortgaged for $290k" part though, that would make a big difference in my thought process if I'm misunderstanding the purchase price of $137k.

Edited into the OP was the following info:  refinanced with cash out 310k 10 years ago

Ever have one of those moments where you feel like you should totally be able to understand something but for some reason it's just not quite clear and you feel like a total moron?  Yeah, that's me right now. 

So he bought the house at $137k, 5 years later, after the house appreciated substantially, he refinanced the home at $310k to pull out the the $170k in "equity" to purchase another place...is this the gist of it? 

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #10 on: June 11, 2014, 08:29:54 PM »
So he bought the house at $137k, 5 years later, after the house appreciated substantially, he refinanced the home at $310k to pull out the the $170k in "equity" to purchase another place...is this the gist of it?

Yes, sounds like they bought their (current) primary residence with those funds.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #11 on: June 12, 2014, 08:35:43 AM »
So he bought the house at $137k, 5 years later, after the house appreciated substantially, he refinanced the home at $310k to pull out the the $170k in "equity" to purchase another place...is this the gist of it?

Yes, sounds like they bought their (current) primary residence with those funds.

I guess I don't really get it then.  Isn't that essentially rebuying the same house, just paying more for it?  Seems like an odd strategy to me. 

waltworks

  • Magnum Stache
  • ******
  • Posts: 3276
Re: In search of a deeper understanding of the 1% Rule
« Reply #12 on: June 12, 2014, 09:36:01 AM »
No, it's just a home equity loan/withdrawal (I think?) That can make sense in a variety of situations if you want to use the equity (or some of it) in the house but not actually sell it.

If I had been the OP, I would probably have just sold the property to buy my new place and kept things simple but that's just me.

-Walt

So he bought the house at $137k, 5 years later, after the house appreciated substantially, he refinanced the home at $310k to pull out the the $170k in "equity" to purchase another place...is this the gist of it?

Yes, sounds like they bought their (current) primary residence with those funds.

I guess I don't really get it then.  Isn't that essentially rebuying the same house, just paying more for it?  Seems like an odd strategy to me.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #13 on: June 12, 2014, 10:32:03 AM »
No, it's just a home equity loan/withdrawal (I think?) That can make sense in a variety of situations if you want to use the equity (or some of it) in the house but not actually sell it.

If I had been the OP, I would probably have just sold the property to buy my new place and kept things simple but that's just me.

-Walt

Right, but it's still a loan that needs to be repaid, and the new loan is now double what the original purchase price on the house was so you've got the original principal of $137k and now the additional $170k (or whatever the amount was) as HELOC, meaning you owe ~$300k on the house you originally purchased for $137k. 

It definitely changes my perspective on the initial post and puts me in the "sell" aka take your money and run category if the OP is unable to substantially increase the rent.  You could do a lot of other things with an extra $300k in your pocket*.

*(Probably best not to keep that much money in your actual pocket)

DavidInDc

  • 5 O'Clock Shadow
  • *
  • Posts: 5
Re: In search of a deeper understanding of the 1% Rule
« Reply #14 on: June 12, 2014, 07:00:29 PM »
I am the OP. Just to satisfy everybodys curiosity. I bought the place for 137 15 years ago. Refinanced about 6 years later to buy a house 5 doors down (and pay off student loan debt) that was better sized for a growing family. So my outstanding mortgage on the property now is 289 and if I sold I think I could take out 260 in equity and maybe 50 more if I did a 1031 exchange.

In terns of appreciation taking that money out has done well by me with the value of my primary doubling as all since I bought it but if I had found MMM earlier I would have done better :)

Thanks for all the clarifications on 1%.  I guess to summerize you evaluate an exiating property by yhe opportunity cost of what else you can do with the money.

I am looking to purchase a additional rental in a different market. Where it should be easier to find  then in DC.





arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #15 on: June 12, 2014, 07:06:51 PM »
It definitely changes my perspective on the initial post and puts me in the "sell" aka take your money and run category if the OP is unable to substantially increase the rent.  You could do a lot of other things with an extra $300k in your pocket*.

*(Probably best not to keep that much money in your actual pocket)

I'm still not sure you're understanding - a higher mortgage now means less in your pocket.

Regardless, initial purchase price doesn't matter.  What matters is: what can you cash out now (after paying off liens, selling costs, taxes, etc.)?  Compare the opportunity cost of that money (what you could get on that if you invested that cashed out funds elsewhere) to your net return keeping the property (counting cash on cash after expenses, principal reduction, appreciation, etc.).
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Blindsquirrel

  • Pencil Stache
  • ****
  • Posts: 656
  • Age: 1
  • Location: Flyover country
Re: In search of a deeper understanding of the 1% Rule
« Reply #16 on: June 12, 2014, 08:03:31 PM »
 I actually target 1.5-2% rule for our houses, best performer is close to 3% rule house.  Obtainable in the Midwest, on the coasts your are out of luck as the prices are high but the appreciation on the coasts is way, way higher. Many folks have become millionaires on cash flow poor RE out there.  Arebelspy is spot on on the way to calculate it, I normally go by what I have in the place after repairs and not the value. I am after giant buckets of passive income every month though and the passive income yield on what I have in a place drives my buy/sell/flip/rent decisions.That can give some interesting dilemmas, rent a house I have 60k in for 11-1200 a month or sell for 120K after a 2 mo rehab? Kinda torn on that one as $1200 a mo with no payments and low prop tax is a pretty good lick of change every month.

123flip

  • 5 O'Clock Shadow
  • *
  • Posts: 14
    • 123Flip
Re: In search of a deeper understanding of the 1% Rule
« Reply #17 on: June 16, 2014, 08:12:48 PM »
You need to be clear on what you're trying to determine in order to get clarity on the determination...  :)

If I were you, the question I'd be asking myself is:

Is it a better financial decision to hold the current property as a rental or is it a better financial decision to do something else?


In this case, the "something else" is likely going to be selling the property and reinvesting somewhere else.  So, let's do this analysis...

You don't give enough information to do a full analysis of your options, but I'm going to make some guesses, and you can tweak the numbers using whatever the real numbers are...

OPTION #1:  KEEP THE PROPERTY:

You owe about $300K and are generating about $3850/month in gross income
I'm going to assume your mortgage is 30 years at about 5.5% (the low back in 2004) -- or about $1700/month
I'm going to assume you do your own property management, so your expense ratio is about 40% (long-term, not necessarily any given year)
That means you're monthly NOI is about $3850 * .6 = $2310 and your cash flow is about $2310 - $1700 = $610
That puts your annual cash flow at about $7320

Now, we could use this information to determine any number of ratios (ROI, COC, IRR, ROE, etc), but just sticking with cash flow should work for this analysis.

OPTION #2:  SELL THE PROPERTY/ALTERNATE INVESTMENT

EDIT:  NOTE THAT I SCREWED UP THIS ANALYSIS...SEE MY REVISION POST BELOW!

Let's see what happens if you sell the property...
You say the property is worth about $600K.  After commissions, fees, closing costs, concessions, etc., let's say you'd walk with 90% of that ($540K)
In order to achieve the return you're getting in Option #1, your cash-on-cash return would need to be at least $7320 / $540,000 = 1.35%
So, if you can achieve a better return than 1.35% on the $540K, your best short-term financial option is to sell and use an alternate investment vehicle

I'm not an investing genius, but I'm pretty sure I can think of a few investments that would return more than 1.4% with even less risk than a rental property in DC.

Now, there are some inflection points worth considering as well -- for example, the biggest being that you'll have the loan on the DC property paid off in 20 years.  Let's look at that one...

In 20 years, your cash flow increases to about $2300/month (ignoring inflation of expenses/income).  That would put your cash flow at about $28,000/year.
Even if your $540,000 sat in a 0% return investment for the next 20 years, you'd still only need to earn about 5% at that point to outpace the rental property with no mortgage payments.
And, if you grew the $540K at about 3% for the next 20 years, you'd have about $1M, so you'd only need to keep growing it at 3% to outpace the $28K annual cash flow.
You can do that with a long-term CD these days...and in a few years, you'll be able to do that with a savings account again.

In other words, unless there are non-financial considerations that you haven't mentioned, I can't imagine a situation where the best financial decision would be to continue to hold the rental property...

Just my $.02 though...
« Last Edit: June 17, 2014, 11:30:45 AM by 123flip »

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #18 on: June 16, 2014, 08:40:44 PM »
Thanks for putting some numbers on what I was trying to say earlier.

I completely agree with your analysis, save this:
In other words, unless there are non-financial considerations that you haven't mentioned, I can't imagine a situation where the best financial decision would be to continue to hold the rental property...

The only situation I can come up with is if there's some crazy appreciation.  I'm not one to count on that, and none of the smart investors I know do, but if that magically happened, that could (though luck) make it the best financial decision in hindsight.

Barring an appreciation crystal ball, the best financial decision right now is most likely to sell.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

brandino29

  • Bristles
  • ***
  • Posts: 318
Re: In search of a deeper understanding of the 1% Rule
« Reply #19 on: June 17, 2014, 09:02:05 AM »
[/i]
Just my $.02 though...

Thanks for that analysis 123, I've never really considered our rental in a context like that.  A couple of aspects I don't believe you addressed though that I'd be interested to see your input:  the fact that he'd have to pay off the existing mortgage still and the taxes that he'd have to pay on the profit of the sale. 

waltworks

  • Magnum Stache
  • ******
  • Posts: 3276
Re: In search of a deeper understanding of the 1% Rule
« Reply #20 on: June 17, 2014, 09:17:13 AM »
The comparison (I think) assumes equal leverage (ie you'd borrow money to invest elsewhere,  just as you're borrowing money to own the house).

The capital gains taxes (on something like $400k of profit after commissions and expenses) will drop the net below the assumed $540k but it won't change the basic conclusion. And if the OP has lived in the home recently he can get $250/500k tax free depending on marital status.

-W

[/i]
Just my $.02 though...

Thanks for that analysis 123, I've never really considered our rental in a context like that.  A couple of aspects I don't believe you addressed though that I'd be interested to see your input:  the fact that he'd have to pay off the existing mortgage still and the taxes that he'd have to pay on the profit of the sale.

123flip

  • 5 O'Clock Shadow
  • *
  • Posts: 14
    • 123Flip
Re: In search of a deeper understanding of the 1% Rule
« Reply #21 on: June 17, 2014, 11:27:30 AM »
A couple of aspects I don't believe you addressed though that I'd be interested to see your input:  the fact that he'd have to pay off the existing mortgage still and the taxes that he'd have to pay on the profit of the sale.

Wow, I completely screwed that up, didn't I...  :)

That pretty much nullifies my conclusions from above...honestly not sure what I was thinking...

Let me try again:

OPTION #2:  SELL THE PROPERTY/ALTERNATE INVESTMENT

Let's see what happens if you sell the property...
You say the property is worth about $600K.  After commissions, fees, closing costs, concessions, etc., let's say you'd walk with 90% of that ($540K) MINUS the mortgage payoff and taxes.  Mortgage payoff is $290K, taking you to $250K.  I have no idea what your tax burden would be, and this could change the equation a LOT.  Let's assume you owe $80K in taxes (estimate out of thin air), so you walk with about $170K.
In order to achieve the return you're getting in Option #1, your cash-on-cash return would need to be at least $7320 / $170,000 = 4.3%
So, if you can achieve a better return than 4.3% on the $540K, your best short-term financial option is to sell and use an alternate investment vehicle

Now 4.3% isn't as easy as the 1.35% I *thought* the analysis showed above, but even unleveraged investments in relatively passive real estate should be able to achieve that these days.  If you add some leverage, getting 8-12% isn't tough in many markets (for example, leave DC and head to PG county or even Anne Arundel County in Maryland).

So, while it's not as clear cut as I made it seem above, I still think selling is the better financial decision (though again, there may be non-financial factors as well that play a role).

Also, I apologize for the ridiculous oversight above...thanks Brandino for the correction...
« Last Edit: June 17, 2014, 11:29:35 AM by 123flip »

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: In search of a deeper understanding of the 1% Rule
« Reply #22 on: June 17, 2014, 11:58:38 AM »
The only situation I can come up with is if there's some crazy appreciation.  I'm not one to count on that, and none of the smart investors I know do, but if that magically happened, that could (though luck) make it the best financial decision in hindsight.

Barring an appreciation crystal ball, the best financial decision right now is most likely to sell.

Appreciation doesn't happen through magic or luck.  It's the result of economics for a given market and reasonable projections can be made.  Using the Case Shiller data for DC it looks like the historical rate of appreciation is a 4.4% compounded annual growth rate since 1987.  If you assume this historical rate holds true next year, then appreciation on 600,000 would be 26,400.  Of course prices can go up, sideways, or down in a given year, but over the long run DC has averaged out to 4.4%.  Assuming that conservative rate of appreciation next year, the leveraged return would be 26,400 / 250,000 = 10.6%.  (Note that the current YoY appreciation in DC is 8.5% according to Case Shiller, so this is a conservative estimate.)

Now I don't know the economics of DC intimately, but it seems like some of the strongest wage growth in the country is occurring due to all the high paid government jobs that reside there and continue to be created.  Just today, I was reading that the CFPB is hiring for an investigative bureaucrat position that pays between $98,000 - $149,000 with 49 days of PTO.  Not bad.

http://www.housingwire.com/articles/30333-do-you-have-what-it-takes-to-investigate-for-the-cfpb

Not only that but some neighborhoods are rapidly gentrifying which may lead to appreciation that exceeds historical rates, if it continues.  At the very least, it seems safe to assume a conservative historical rate of appreciation though.

Those are my 2 cents.  I think DC is probably one of the best markets in the country to hold property.
« Last Edit: June 17, 2014, 12:07:21 PM by Poorman »

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #23 on: June 17, 2014, 12:18:28 PM »
The only situation I can come up with is if there's some crazy appreciation.  I'm not one to count on that, and none of the smart investors I know do, but if that magically happened, that could (though luck) make it the best financial decision in hindsight.

Barring an appreciation crystal ball, the best financial decision right now is most likely to sell.

Appreciation doesn't happen through magic or luck.  It's the result of economics for a given market and reasonable projections can be made.  Using the Case Shiller data for DC it looks like the historical rate of appreciation is a 4.4% compounded annual growth rate since 1987.  If you assume this historical rate holds true next year, then appreciation on 600,000 would be 26,400.  Of course prices can go up, sideways, or down in a given year, but over the long run DC has averaged out to 4.4%.  Assuming that conservative rate of appreciation next year, the leveraged return would be 26,400 / 250,000 = 10.6%.  (Note that the current YoY appreciation in DC is 8.5% according to Case Shiller, so this is a conservative estimate.)

Now I don't know the economics of DC intimately, but it seems like some of the strongest wage growth in the country is occurring due to all the high paid government jobs that reside there and continue to be created.  Just today, I was reading that the CFPB is hiring for an investigative bureaucrat position that pays between $98,000 - $149,000 with 49 days of PTO.  Not bad.

http://www.housingwire.com/articles/30333-do-you-have-what-it-takes-to-investigate-for-the-cfpb

Not only that but some neighborhoods are rapidly gentrifying which may lead to appreciation that exceeds historical rates, if it continues.  At the very least, it seems safe to assume a conservative historical rate of appreciation though.

Those are my 2 cents.  I think DC is probably one of the best markets in the country to hold property.

I understand all that, but my opinion of someone thinking they know where the next hot appreciating market is, or which places will under- or over-perform is the same as I hold on someone trying to buy the next hot stock. 

Make of that what you will.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: In search of a deeper understanding of the 1% Rule
« Reply #24 on: June 17, 2014, 12:30:15 PM »
I understand all that, but my opinion of someone thinking they know where the next hot appreciating market is, or which places will under- or over-perform is the same as I hold on someone trying to buy the next hot stock. 

Make of that what you will.

This to me is closer to index investing.  We know what the historical returns are, and the OP has benefited from strong fundamentals that seem likely to continue into the future.  The "1%-ers" are really more like bond investors, completely focused on cashflow to the exclusion of everything else.  There's nothing wrong with that, but most people like the appreciation that stocks and real estate have to offer.

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #25 on: June 17, 2014, 01:31:13 PM »
I understand all that, but my opinion of someone thinking they know where the next hot appreciating market is, or which places will under- or over-perform is the same as I hold on someone trying to buy the next hot stock. 

Make of that what you will.

This to me is closer to index investing.  We know what the historical returns are, and the OP has benefited from strong fundamentals that seem likely to continue into the future.  The "1%-ers" are really more like bond investors, completely focused on cashflow to the exclusion of everything else.  There's nothing wrong with that, but most people like the appreciation that stocks and real estate have to offer.

I disagree.

It's not cash flow to the exclusion of all else - it's before. They'll still get the appreciation, they just aren't banking on it, or trying to guess where they'll get more appreciation and sacrificing cash flow on the assumption that their guess is right.  The person seeking appreciation sacrificing cash flow is guaranteeing no cash flow, and hoping for appreciation.  The person seeking cash flow will get that, and then get the appreciation that happens naturally.

Trying to pick a hot market for appreciation and not caring about cash flow is like trying to pick a hot stock, IMO.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Bobberth

  • Bristles
  • ***
  • Posts: 311
Re: In search of a deeper understanding of the 1% Rule
« Reply #26 on: June 17, 2014, 01:45:38 PM »
I agree that the financial decision leans towards selling the property.  I just want to point out a couple of the non-financial aspects you may want to consider.  A rental 5 doors down from where you live is different than having one across town and much different than one across the country.  Do you want to take that step up in involvement?  Do you want to sell this one property, and one tenant, to manage 3-5+ tenants even if it comes with a higher return?  If you did an exchange to defer taxes, you would probably be looking into a multi-family property out of your area.  After 6 years of only 4 weeks of vacancy,  are you willing to step into what is most likely a higher vacancy rate and more tenant issues to deal with?  Do you want to deal with 8 people paying $500/month, 4 people paying $1000/month or one person paying $3800/month?  There are BIG differences in those types of tenants and properties.  Are you able to find and manage a property manager so you don't have the management headaches?  Can you tell if the PM is less than honest?  Can you insure that you don't get ripped off if you do purchase out of your area?  Lots of things to think about with this decision, not just the numbers. 

While you would be able to make more money selling and investing in other properties, I would be tempted to stay with the current property and its ease of management.  That is unless you really wanted to get more actively involved in real estate investing.

Poorman

  • Bristles
  • ***
  • Posts: 260
  • Age: 41
  • Location: Orange County, CA
Re: In search of a deeper understanding of the 1% Rule
« Reply #27 on: June 17, 2014, 02:29:24 PM »
The person seeking appreciation sacrificing cash flow is guaranteeing no cash flow, and hoping for appreciation. 

Personally, I think the best investors consider both, not one to the exclusion of the other.  This property has a cash-on-cash return of 4.3% so it has the guaranteed cashflow plus solid fundamentals for growth in the future.  If anybody is "hoping" for appreciation then they aren't doing a very good job of looking at the economics that drive appreciation in their market.  Are wages/jobs growing, flat, or declining?  The same fundamentals that drive growth also lead to lower turnover/vacancy costs and lower headache tenants in many cases, plus rents that will increase faster than the rate of inflation.  It's certainly possible to beat 4.3% CoC plus 10.5% growth by going into really depressed areas, but it might be more hassle than it's worth.  Unless the OP's cashflow needs are imminent, I think those of you advising to sell based on the cashflow alone are painting an incomplete picture.

waltworks

  • Magnum Stache
  • ******
  • Posts: 3276
Re: In search of a deeper understanding of the 1% Rule
« Reply #28 on: June 17, 2014, 03:06:58 PM »
I don't know, historically real estate doesn't appreciate very much as far as I know (I'm aware that there are different ways of looking at that, and that the really old historical Schiller data is mediocre). And outside of certain markets, until the 90s or so the whole idea of speculative real estate buying was practically nonexistent because houses just don't usually behave like stocks and have a ton of volatility. So most real estate investors, myself/Arebelspy included, don't tend to want to count on appreciation for *anything*. If it happens, cool. If not, I want to know that I'm not going to lose my shirt because I've got a property leveraged at 3 or 4 to 1.

-W

arebelspy

  • Administrator
  • Senior Mustachian
  • *****
  • Posts: 27911
  • Age: -999
  • Location: Traveling the World
Re: In search of a deeper understanding of the 1% Rule
« Reply #29 on: June 17, 2014, 06:04:38 PM »
I don't know, historically real estate doesn't appreciate very much as far as I know (I'm aware that there are different ways of looking at that, and that the really old historical Schiller data is mediocre). And outside of certain markets, until the 90s or so the whole idea of speculative real estate buying was practically nonexistent because houses just don't usually behave like stocks and have a ton of volatility. So most real estate investors, myself/Arebelspy included, don't tend to want to count on appreciation for *anything*. If it happens, cool. If not, I want to know that I'm not going to lose my shirt because I've got a property leveraged at 3 or 4 to 1.

Over the long run, it should match inflation.

Every market is local, of course.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.