Author Topic: 1% rule. 1% of what???  (Read 10341 times)

Villanelle

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1% rule. 1% of what???
« on: April 07, 2015, 08:59:25 AM »
When evaluating an existing rental and trying to determine if it is better to hold or sale, how does the 1% rule work?  1% of the purchase price?  Of what I could sell it for now (which would be a loss)?  Of what we owe on it (less than what we could sell it for, thankfully)?

We kept our home when we moved overseas in part because we thought we might return there, and in part because we were at a terrible point in the market (down about $125k from when we bought 4 years earlier for $550k) and we didn't want to lock in those losses.  There were a few other reasons.  It has turned out to be a good decision as the place has recovered and now would "only" be a ~$50k loss, since I think it could realistically sell for about $500k.  (We are not even close to underwater so we could sell and still walk away with almost $100k, I think ).  After all expenses (except figuring in what we save on our income taxes with all the deductions), we do make a small amount of money each month, even considering future maintenance.  But not much.  Of course with the growth we've had in the value, our "return" has been amazing--$!5k/yr plus the small profit-- but I certainly won't bank on that continuing, or even not reversing. 

We just renewed our tenant's lease so we are about 10 months out from having to make a decision.  I'm looking at a ton of different ways of weighing this decision, and the 1% rule is one of them, but I'm not sure what number to use on an existing rental, as opposed to a new purchase where it is obviously 1% of the purchase price. 

If it matters, both times we've had the property listed, is has gone within days. And it is a 1900sqft townhouse that isn't upgraded, so middle market as both a rental and a sale.   Very high COL area in SoCal.   

theoverlook

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Re: 1% rule. 1% of what???
« Reply #1 on: April 07, 2015, 09:29:48 AM »
Keeping in mind that the 1% rule is just a rule of thumb for evaluating a property and isn't the end all be all of analysis (that would be taking all expenses and deducting them from income, like you've already done), in your situation I would say the 1% rule would apply to what you could sell it for.

Ricky

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Re: 1% rule. 1% of what???
« Reply #2 on: April 07, 2015, 10:10:22 AM »
The 1% rule states that you should look for homes that would rent for 1% of the purchase price monthly. My guess is you're no where near the 1% rule, but that doesn't matter. The "rule" is only a quick and dirty way of crossing certain investment choices off the list. It means if you're not getting a minimum of a 12% return before accounting for expenses and opportunity costs, it's not worth your time. This varies across markets and investors.

For instance (A) - house is in a bad neighborhood, no growth prospects, doesn't even hit the 1% rule, immediately cross it out. Another (B) - house is in a decent neighborhood but not great, overall metro is growing, neighborhood could be up and coming, doesn't quite hit the 1% rule yet but prospects look good. (C) - condo is well above the 1% rule but upon further investigation you find out the HOA is almost doubling their monthly fee to pick up slack for all of the delinquent payments. Based on the three choices, I'd mark off (A) and (C) and consider (B), but also look at other options since it isn't immediately where I'd want it to be.

Some investors look and demand for 2%. It just depends on your level of risk tolerance. An investor obviously demands a higher return in real estate since there is more work involved.

The 1% rule has nothing to do with your situation until you sell and start to look for other properties (or not).

At this point, you need to calculate your returns and compare them to other options. Subtract PMI/taxes/avg. maintenance costs up until now from your gross rents and divide that by how much money you put down. If it's low, like less than 3% low, then you're better off looking for other avenues (pun intended) in my opinion.

dragoncar

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Re: 1% rule. 1% of what???
« Reply #3 on: April 07, 2015, 10:10:41 AM »
He who has top 1% of wealth makes the rules.

clarkfan1979

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Re: 1% rule. 1% of what???
« Reply #4 on: April 13, 2015, 08:54:21 PM »
It's a rule, but not a law. So Cal is a different ball game and is not going to come close to the 1% rule, but you could score some appreciation, or depreciation.

When I was in college my landlord bought a bunch of property in the late 1980's in San Diego before it got real expensive. I doubt that he achieved the 1% rule when he bought. 

Villanelle

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Re: 1% rule. 1% of what???
« Reply #5 on: April 14, 2015, 04:45:52 AM »
This year's taxes actually presented a much better picture that we'd assumed (based on last year). Wee had a lot more expenses on the house this year.  Basically, we actually spent almost the amount generally use for running the numbers, knowing that while we've had a lot of cheaper years, big things would eventually come up.  So maintenance was way up.  But We've aggressively paid down the HELOC (30k paid off last year over the course of the year) and we are another year into our 18 year mortgage, which is enough to see a meaningful difference in the interest paid. 

So we made about $320 per month.  Still not sure we won't sell it next year come lease-end time, but it's nice that it is finally a truly profitable venture, above and beyond the appreciation. Without the appreciation, I should certainly be able to expect to do better than $3800/yr on that money, but with the appreciation, I'm well ahead of the market for the last few years.  (Yes, I know I can't guarantee those returns will continue, as evidenced by the fact that it is still worth less than we paid.)   So it's a judgement call, but 2014's expenses/rent picture was better than 2013, and 2015 will likely continue that trend. 

waltworks

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Re: 1% rule. 1% of what???
« Reply #6 on: April 14, 2015, 08:32:18 AM »
Assuming you are correct about your cashflow - that's ~$4k on $100k worth of your money. Not good.

By all  means keep it if you think it'll appreciate, though.

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Villanelle

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Re: 1% rule. 1% of what???
« Reply #7 on: April 14, 2015, 11:14:46 AM »
Assuming you are correct about your cashflow - that's ~$4k on $100k worth of your money. Not good.

By all  means keep it if you think it'll appreciate, though.

-W

It's more than $100k of my money, actually.  We have about $200k in equity.  So it's even worse than that.

But the appreciation picture is the big question.  It's unanswerable how much appreciation we'll see, of course.  We've gotten about $75k in about 4.5 years, after losing $150k  in the few years prior to that.

There's also the fact that we are hesitant to leave the American real estate market entirely.  And considering we hope to end up on SoCal again in the future, staying in that market in particular has appeal. 

mathew1659

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Re: 1% rule. 1% of what???
« Reply #8 on: April 14, 2015, 01:33:36 PM »
1% rule is a sure fire way to lose money with rentals. 2% of property value is what you should get per month. 50k investment property should net around 2k per month in rents.

here are the expenses you should be accounting for and the "typical" amounts used by experienced real estate investors:

Historical data - as a percentage of gross rents, these are the expenses you should be using on a rental property:
these are for a A or B class property, percentages change slightly depending on the property class
 
10% Capital Expenses - driveways, roofs, furnaces, items that last longer then 5 years
5% Maintenance - appliances, carpet, paint, items that last less then 5 years
5% Vacancy - people move, die, lose their job, etc. this is assuming a A or B class property, C&D's should be 10%
7% - 15% Property Taxes - depends on where you live
10% - Property Management - you can do it yourself, but you should still account for the cost, time isnt free for anyone in reality
5% - 10% - insurance
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50% - average expenses for a rental property not including principle & interest payments ( mortgage ), or of course the other main thing that most of us do this for: PROFIT.
* remember, multi's & apartment buildings are going to have higher expenses because there is typically some landlord paid utilities such as water and trash, along with yard care and snow removal.

everyone has these expenses, but because they dont occur monthly most people dont realize they are actually losing money.
so the above example, a house that market rents for $700/month will have $350/month in expenses (current or anticipated), if you have a $225 loan payment that means you profit (true PROFIT) about $125/month. Principle paydown is not accounted for, it is simply icing on top, the reason for this is because you cant utilize the paid down principle to go pay your employees or buy yourself something without taking out another loan or adjusting the one you have, its locked money therefore experienced investors do not account for it in a cashflow analysis. - research it.

Research the 2% rule and the 50% rule. Experienced real estate investors know what these are and why they should be understood.
there is no arguing of why use a percentage of gross rents to calculate expenses, research it, its the correct way.
Personally I find it hard to hit the 50% rule, my expenses are closer to 55% because of taxes.



 






« Last Edit: April 14, 2015, 01:43:05 PM by mathew1659 »

Villanelle

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Re: 1% rule. 1% of what???
« Reply #9 on: April 14, 2015, 02:14:30 PM »
I don't have to estimate those costs since I have actuals.  For example, my property manager takes only 5%, since I live in a high COL/rent area.  I also know my property tax rate, exact insurance costs, etc.  So I don't need to use a % of gross rents, because, since I already have they actuals, I can use those.   So while I acknowledge your repeated "research it" advice, much of what you posted doesn't quite apply to my situation.  We bought this house to live in it, not as an investment. When our circumstances changed, we decided to rent it because prices were so very low and we thought it was a good bet they would recover at least somewhat, and we knew we'd likely be moving back in 3 years (we didn't).  Now, we are reevaluating. 

I was mostly just trying to evaluate whether we want to continue to hold this property.  Since I know the 1% rule is a semi-standard for evaluating before purchase, I figured it might help me figure everything out after a purchase as well, which is why i started this thread--so I could figure out how I might apply that metric to an already purchased price. 

bruce88

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Re: 1% rule. 1% of what???
« Reply #10 on: April 19, 2015, 02:40:28 PM »
Don't know if I am too late to this party, but....

Looking at your equity and the recent movement in prices only works if you bought well before the market fired up, before crashing in 2007ish.   Your outlook will be totally different if you bought in 2003, and saw your property double, then crash.  If you bought in 2006, near the top, your home may not recover for a decade or longer. 

For evaluation purposes, you need to go back at least 10 years from today, and compare prices to see where you are.  If you can sell today, for near 2004 prices, that is most likely a good thing and you should consider getting out.  If you cannot, the problem may be worse than you think, and you STILL need to get out, and cut your losses.  OR, consider your home a long term rental and make the most of it.

We went through a similar situation with a FL condo.  We purchased in 2002, saw the market go crazy, then crash.  We sold in 2010 after a slight improvement in the economy.  We still made money, though.  If we had purchased in 2006, we would still be waiting for the market to "come back", and we would have lost tens of thousands of dollars in holding costs since.
 

clarkfan1979

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Re: 1% rule. 1% of what???
« Reply #11 on: April 23, 2015, 05:44:36 AM »

10% Capital Expenses - driveways, roofs, furnaces, items that last longer then 5 years
5% Maintenance - appliances, carpet, paint, items that last less then 5 years
5% Vacancy - people move, die, lose their job, etc. this is assuming a A or B class property, C&D's should be 10%
7% - 15% Property Taxes - depends on where you live
10% - Property Management - you can do it yourself, but you should still account for the cost, time isnt free for anyone in reality
5% - 10% - insurance
__________________

Thank you for posting some categories. Are these categories from a book or did you come up with them?

I have a 4 bed/2 bath that now rents for $1900. I purchased a 4 bed/2 bath rental house in May 2007, for 182K. I did 10K in improvements which included a new furnace, flooring, tons of paint, new plumbing which I paid for. Built a wall for the 4th bedroom. If I divide $10,000 by 96 months I get $105 a month 5.5% to date. I did the original rehab to the house myself, but paid for labor for most repairs after the purchase.

Principle and interest is $760. I put 20% down on a purchase price of 182K. Original rate was 6% and refi-ed in 2009 for 4.75%. 

If I was to rent out the whole house in 2007, it would have been around 1300. However, I lived there and rented out 3 individual rooms for $325/room each. The rent 8 years later is now 1900/month.

10% Capital Expenses - driveways, roofs, furnaces, items that last longer then 5 years

Original Rehab of House: $10,000. Divided by 96 months is $105/month or 5.5%.

Water heater in 2008 ($800) and I paid to have a new a/c system installed in 2010 for $2100. A new roof was installed in 2002, so I don't have to worry about that in a while.

$2900 divided by 96 months = $30/month or 1.5%, not including original rehab.

5.5% + 1.5% = 7% for this category if I consider the total rehab.


5% Maintenance - appliances, carpet, paint, items that last less then 5 years

New washer ($325), dryer repair ($250), new dishwasher ($600), water damage in basement ($1200), new shower unit in basement ($2400), hail damage to shed ($150), electrical fixes ($250), plumber to snake the drain ($150), touch-up paint ($250), & microwave ($300) and cleaning supplies at $125. 

Total is $6000, divided by 96 months is 63/month or 3.3%

5% Vacancy - people move, die, lose their job, etc. this is assuming a A or B class property, C&D's should be 10%


Over the last 8 years, my vacancy rate has been 0%.


It is a college town and I typically show the property 4-5 months before it is available. I usually have over 10 applications of people who want it.

7% - 15% Property Taxes - depends on where you live

The property taxes are 1530/year, so this is 128/month or 6.7%

10% - Property Management - you can do it yourself, but you should still account for the cost, time isnt free for anyone in reality

I manage the property myself. I think arebelspy has said that he averages about 1 hour/month per rental unit. I would have to agree with this. My time is worth $35/hour, so I am averaging 1 hour/month that is $35/month or 1.8%.

5% - 10% - insurance

With a 5,000 deductible, my yearly rate is $675. This is $56/month or 3%.




My total is 21.8% including total rehab. I'm not saying that it would be 21.8% forever, but if I sold tomorrow it would be after 8 years.

trobertson79

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Re: 1% rule. 1% of what???
« Reply #12 on: April 28, 2015, 03:00:41 PM »
1% rule is a sure fire way to lose money with rentals. 2% of property value is what you should get per month. 50k investment property should net around 2k per month in rents.

I have a feeling that this 2% thing applies to lower end properties.  I own 7 units that are in low cost areas (substantially cheaper than nearby areas because of the issues with the neighboorhood/tenants) income and the overhead relative to rent is much higher (higher turnover, utilties vs meger rent, higher property management %, ...) though the rent to value is around 1.5-2%.  In the end I make maybe 7-9% a year on them.  Meanwhile on a property that's closer to 1% but in a much higher cost of living area I make closer to 15% a year after everything (it was a particularly good buy).

iamlindoro

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Re: 1% rule. 1% of what???
« Reply #13 on: April 28, 2015, 03:23:42 PM »
1% rule is a sure fire way to lose money with rentals. 2% of property value is what you should get per month. 50k investment property should net around 2k per month in rents.

I have a feeling that this 2% thing applies to lower end properties.  I own 7 units that are in low cost areas (substantially cheaper than nearby areas because of the issues with the neighboorhood/tenants) income and the overhead relative to rent is much higher (higher turnover, utilties vs meger rent, higher property management %, ...) though the rent to value is around 1.5-2%.  In the end I make maybe 7-9% a year on them.  Meanwhile on a property that's closer to 1% but in a much higher cost of living area I make closer to 15% a year after everything (it was a particularly good buy).

Ignoring the fact that the quoted post actually suggests a 4% rule, 2% is not impossible to find in modest or middle class neighborhoods.  Sure, 2% is easier to find at retail price in blue collar neighborhoods (but not lower end by any means), but you can also hit 2% by buying below retail in A/B neighborhoods, too.  Buy distressed properties, find someone with a problem and help them solve it, take on something unsightly but which you can fix at low cost, etc.

Simply put, you don't have to accept a worse property, you also have the option to pay a lower purchase price.
« Last Edit: April 28, 2015, 03:25:13 PM by iamlindoro »

trobertson79

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Re: 1% rule. 1% of what???
« Reply #14 on: April 28, 2015, 03:31:57 PM »
Ignoring the fact that the quoted post actually suggests a 4% rule, 2% is not impossible to find in modest or middle class neighborhoods.  Sure, 2% is easier to find at retail price in blue collar neighborhoods (but not lower end by any means), but you can also hit 2% by buying below retail in A/B neighborhoods, too.  Buy distressed properties, find someone with a problem and help them solve it, take on something unsightly but which you can fix at low cost, etc.

Simply put, you don't have to accept a worse property, you also have the option to pay a lower purchase price.

I don't doubt you as you seem to know what you're talking about, but I've not seen returns like that before so now I'm interested.  Do you have any listings (zillow or whatnot) of properties that might have this kind of return?  Are they rare or common?  Maybe my searching methodology is all screwed.

Do you maybe have examples of properties you've bought that have had 2% or higher rent/price ratios?

iamlindoro

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Re: 1% rule. 1% of what???
« Reply #15 on: April 28, 2015, 10:38:46 PM »
I don't doubt you as you seem to know what you're talking about, but I've not seen returns like that before so now I'm interested.  Do you have any listings (zillow or whatnot) of properties that might have this kind of return?  Are they rare or common?  Maybe my searching methodology is all screwed.

Do you maybe have examples of properties you've bought that have had 2% or higher rent/price ratios?

Neither of these is my property, but both passed through my email in the past two weeks:

Decent Duplex in a moderate area for $44,900 *retail*, pre-negotiation, currently rented for $1075 total per month:

https://www.redfin.com/OH/Cleveland/3329-W-99th-St-44102/home/70740494

SFH in a decent area, $29,900, rented for $700 to a tenant who has been there for two years and wants to stay:

https://www.redfin.com/OH/Cleveland/11802-Erwin-Ave-44135/home/70744684

2% is pretty common in the right markets.  The key is having a partner who can tell you which areas are warzones and which are decent if you don't already live in one of them.

Again, these are retail so even these decent deals could be bettered by finding something off-market or being willing to do some renovation.
« Last Edit: April 28, 2015, 10:42:45 PM by iamlindoro »

arebelspy

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Re: 1% rule. 1% of what???
« Reply #16 on: April 29, 2015, 11:22:12 AM »
I am a former teacher who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and am now settled with three kids.
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phillyvalue

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Re: 1% rule. 1% of what???
« Reply #17 on: May 03, 2015, 02:47:33 PM »
At the end of the day a general discussion about these percentages or ratios is not going to help anyone. Like any asset, the return you require on your investment is going to vary substantially depending on risk, expected growth, etc. The ROI you expect from a property in a market where building new properties is easy, vacancy is high, etc could be many times the return you'd expect from a property in a coastal city where there is usually very little net new inventory coming online, vacancy is close to zero, and strong fundamentals in the market are mostly assured.

So you have people discussing 24% ROI here where in NYC a 4% unlevered cap rate would be exciting for a good property.

It would be no different than if in the investing ideas forum we had a topic on the rule of what P/E ratio to pay for a stock.

clarkfan1979

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Re: 1% rule. 1% of what???
« Reply #18 on: May 13, 2015, 06:35:11 PM »
At the end of the day a general discussion about these percentages or ratios is not going to help anyone. Like any asset, the return you require on your investment is going to vary substantially depending on risk, expected growth, etc. The ROI you expect from a property in a market where building new properties is easy, vacancy is high, etc could be many times the return you'd expect from a property in a coastal city where there is usually very little net new inventory coming online, vacancy is close to zero, and strong fundamentals in the market are mostly assured.

So you have people discussing 24% ROI here where in NYC a 4% unlevered cap rate would be exciting for a good property.

It would be no different than if in the investing ideas forum we had a topic on the rule of what P/E ratio to pay for a stock.

I like the P/E ratio analogy. Variability will also exist within a single property. The neighborhood could have different demand levels over different decades.

trialbyFIRE

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Re: 1% rule. 1% of what???
« Reply #19 on: March 28, 2016, 01:52:51 PM »
At the end of the day a general discussion about these percentages or ratios is not going to help anyone. Like any asset, the return you require on your investment is going to vary substantially depending on risk, expected growth, etc. The ROI you expect from a property in a market where building new properties is easy, vacancy is high, etc could be many times the return you'd expect from a property in a coastal city where there is usually very little net new inventory coming online, vacancy is close to zero, and strong fundamentals in the market are mostly assured.

So you have people discussing 24% ROI here where in NYC a 4% unlevered cap rate would be exciting for a good property.

It would be no different than if in the investing ideas forum we had a topic on the rule of what P/E ratio to pay for a stock.

hello! resurrecting this old thread instead of starting another.

Have been doing a lot of reading on this forum specifically around the rent versus buy question. Based on all the info so far, I'm having a hard time wrapping my head around the 1 or 2% rule.

For example, I am currently debating renting or buying in Jersey City in the near future. A 2-bedroom rental goes for ~3500/month, while the sale price is at least $650k (if not more). Based on the rules, it makes absolutely no sense to even consider purchasing, is that correct?

iamlindoro

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Re: 1% rule. 1% of what???
« Reply #20 on: March 28, 2016, 01:58:16 PM »
For example, I am currently debating renting or buying in Jersey City in the near future. A 2-bedroom rental goes for ~3500/month, while the sale price is at least $650k (if not more). Based on the rules, it makes absolutely no sense to even consider purchasing, is that correct?

Correct, and it sounds like you effectively understand it.  1% of a $650K purchase price is $6500/month, meaning as a general rule of thumb that would be the minimum rent you'd want to make ti make sense for cash flow purposes.  Likewise, 2% would be $13,000/month.  Remember that these are rules of thumb, but generally speaking it is much more difficult to achieve these returns in high cost of living cities, as the coasts generally are.  This means that many of us living in such areas need to invest out of area to find those returns.

arebelspy

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Re: 1% rule. 1% of what???
« Reply #21 on: March 28, 2016, 01:59:04 PM »
Yeah.

Rules of thumb are general guidelines to go off the cuff and see if you should dig deeper.  In that case, I'd start with a hard "pass" without having to dig deeper.

If you do a full analysis, I think you'll see why (rate of return around what CDs give you, with WAY more risk, liability, and work involved).  And that's based on average numbers..I'm betting the property taxes on it make it even worse, based on the location.
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trialbyFIRE

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Re: 1% rule. 1% of what???
« Reply #22 on: March 28, 2016, 02:10:28 PM »
Thanks for the quick replies!

JLR

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Re: 1% rule. 1% of what???
« Reply #23 on: March 29, 2016, 06:06:34 PM »
Wow! If I understand this 1% rule, we are getting an even better deal where we are renting than I thought. This house would sell for $400 000 and we pay $350pw. And we just found out that the landlord likes our gardening skills so much he is going to cover our water bills.

arebelspy

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Re: 1% rule. 1% of what???
« Reply #24 on: March 31, 2016, 08:35:34 AM »
Wow! If I understand this 1% rule, we are getting an even better deal where we are renting than I thought. This house would sell for $400 000 and we pay $350pw. And we just found out that the landlord likes our gardening skills so much he is going to cover our water bills.

Yeah, many landlords in expensive places don't follow rules like this, or care about making a positive ROI though cash flow, but they speculate on appreciation making them money.

In those real estate environments, it is much better to rent than own (mathematically, ignoring emotions and potential quality of life/stability).
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brooklynguy

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Re: 1% rule. 1% of what???
« Reply #25 on: March 31, 2016, 09:56:57 AM »
Wow! If I understand this 1% rule, we are getting an even better deal where we are renting than I thought. This house would sell for $400 000 and we pay $350pw. And we just found out that the landlord likes our gardening skills so much he is going to cover our water bills.

Yeah, many landlords in expensive places don't follow rules like this, or care about making a positive ROI though cash flow, but they speculate on appreciation making them money.

Right, and because of this, JLR, it doesn't really make sense to use the 1% rule (or other real estate investing rules of thumb) to evaluate whether you are getting a good deal as a renter.  Your rent could be above-market for your area and still look like a screaming deal if you're comparing it to the alternative of purchasing (instead of renting) a comparable place.

JLR

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Re: 1% rule. 1% of what???
« Reply #26 on: March 31, 2016, 08:11:46 PM »
Wow! If I understand this 1% rule, we are getting an even better deal where we are renting than I thought. This house would sell for $400 000 and we pay $350pw. And we just found out that the landlord likes our gardening skills so much he is going to cover our water bills.

Yeah, many landlords in expensive places don't follow rules like this, or care about making a positive ROI though cash flow, but they speculate on appreciation making them money.

In those real estate environments, it is much better to rent than own (mathematically, ignoring emotions and potential quality of life/stability).

Yes. I wonder if it might be our landlord's emotions that are helping us to get such a good deal here. Apparently this used to be their family home and he wasn't keen to move away, but his wife was. And now they are renting it to us cheap. It is about $45-$50 a week below market rent for the area.

He is a banker, so surely has done all the sums and it still works out well for them, perhaps one of the ways you mention, arebelspy.