Author Topic: Do you calculate 1% based on purchase price or current value?  (Read 2965 times)

aspiring

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Do you calculate 1% based on purchase price or current value?
« on: January 26, 2015, 12:00:56 PM »
Hello wise MMM forum-

I'm new here and have learned of the 1% rule by reading these forums. In considering to sell or rent a property do you look at the purchase price (we bought 10 years ago) or the current value (in a hot market)? Here's my info:

Market Value: 280K
Original Purchase price: 200k
Original Mortgage Amount: 160k
Interest Rate: 3.65
Mortgage Term: 30 years
Term remaining: 27 (we refi-ed)
Amount remaining on mortgage: 138k
Gross Rents: 2250
Principal and Interest (the P&I of your PITI - should match with the above info): 660
Taxes and Insurance (the T&I of your PITI): 200
HOA costs: 200 (water and maintenance)
Deferred maintenance notes: about 15k which will need to happen in 1-3 years

If I calculate 1% using the purchase price of 200k, the $2250 rent qualifies. If I look at the market value of the home 280k, it does not meet the 1% rule. I also wonder about the opportunity cost of having so much money (142k) tied up in my home. But then the income is nice....

What say you forum? Rent or sell?






ioseftavi

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #1 on: January 26, 2015, 12:10:02 PM »
I'm sure walt or ARebelSpywill chime in here in a moment (and that's a good thing), but from what I've read, you evaluate property based on the rent to current value.  That goes for buying, selling, and holding.  Low rent-to-price ratios are usually an indicator of markets that are much hotter, where owners are focused on the possibility of appreciation.

For what it's worth, there was a biggerPockets.com podcast wherein an owner said that below 1% rent-to-price, he considers selling much more seriously.  At 0.5%, he puts the house on the market no matter what, because there will be better opportunities elsewhere.

You're barely at 0.8%.  It's not a slam dunk, but I'd consider selling.  Particularly if you can roll the proceeds into a better, higher-yielding investment.  I'm sure that some of the others here will be able to give you some more specific advice, too.

sammybiker

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #2 on: January 26, 2015, 01:29:40 PM »
I take the opposite view...my properties are in the 2% rent vs purchase price.

So when I buy, I should be buying at a price that provides that 2% ratio after all costs including renovation.  And if I'm buying correctly, I will have equity/the property will be worth far more than I purchased it for.  This is a good thing!

As I'm concerned with cash flow & cash on cash returns, I don't care about value vs rent price.  If I'm buying correctly, my value vs rent will never be 2% - likely closer to 1%.  But that's okay.  I'll utilize that equity to leverage further and go buy more.

iamlindoro

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #3 on: January 26, 2015, 01:34:57 PM »
I'm sure walt or ARebelSpywill chime in here in a moment (and that's a good thing), but from what I've read, you evaluate property based on the rent to current value.  That goes for buying, selling, and holding.  Low rent-to-price ratios are usually an indicator of markets that are much hotter, where owners are focused on the possibility of appreciation.

1%/2% rule is based on purchase price, not current value. Thus, it's calculated by:

(Gross annual rents after expected vacancy/12)/Total Cost including closing costs and improvements

Edit to add:  I agree with the above, too-- you shouldn't be "aiming" for 1%, since the original rule is 2%.  1% is just something someone made up to justify accepting less than the general rule of thumb.  Thus, you'll hear people refer to "1% rule" and "1.5% rule" and other stuff, but each person really has their own threshold for what's acceptable.  For me, 1% is cutting it a little too thin and asking for a major repair or extended vacancy to wipe you out.

« Last Edit: January 26, 2015, 01:40:31 PM by iamlindoro »

waltworks

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #4 on: January 26, 2015, 03:03:32 PM »
It depends on what your goals are. If you are going to purchase a property, you would use the price you'll pay for it. If you are thinking about selling, it's the market value minus whatever transaction costs/taxes you'll incur.

I mean, if I buy a $100k house (for cash, to make it simple) that rents for $2k/mo, awesome. If that house is now worth $1m, though, and the rent is still $2k, not so awesome. I'd probably want to sell it and invest the equity in something else. It's possible, of course, that there are no other good investments available to me, or I expect it to appreciate even more, or that for some reason it will cost me a fortune to sell the place, or whatever, so all that has to be taken into account as well.

-W

aspiring

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #5 on: January 26, 2015, 04:14:47 PM »
Thanks for all the great info everyone. It helps me in thinking about what the best course is....

arebelspy

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Re: Do you calculate 1% based on purchase price or current value?
« Reply #6 on: January 27, 2015, 10:34:40 AM »
Good answers.  The only reason it matters is opportunity cost.  The lower your return (versus current value), the better the chance taking that current value and investing it elsewhere can net you a higher return.

Look at what your opportunity costs are at all times.
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