Author Topic: Should the 1% rule be indexed to interest rates?  (Read 412 times)

LPG

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Should the 1% rule be indexed to interest rates?
« on: July 01, 2019, 01:05:45 PM »
Hi everybody,

There's a question I've been thinking about for a long time, but haven't yet gotten around to investigating. Now that I'm considering buying my first home, with a plan to turn it into a rental when I eventually move out, I think it's time to ask. And the question is very simple: Should the 1% rule of smart real estate investments be indexed to interest rates?

This seems like an obvious yes to me because interest rates directly impact mortgage costs, which directly impacts profitability on real estate investments. For instance, let's say you're considering buying a $300,000 place with 20% down. The mortgage would be $240,000. At 4% interest that comes to $1,146/mo mortgage payments. This looks like a great deal with rental income of $3000 per month (Worse than these numbers suggest because of property tax, maintenance, vacancy, etc, but I think these numbers illustrate a concept). If interest rates increase to 15%, which certainly isn't the case today but my parents tell me was the case in the 80s, that same mortgage would cost $3,035 per month. That's a loss even before we add property taxes, maintenance, vacancy, etc!

How do you all think about this? Are there times when you'd accept properties not meeting the 1% rule because it's still attractive in a low interest rate environment like we currently have? Are there times when properties do meet it but you ignore them anyway because interest rates are too high and the place would be a net loss?

SwordGuy

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Re: Should the 1% rule be indexed to interest rates?
« Reply #1 on: July 01, 2019, 04:13:01 PM »
The 1% rule is not a rule.  It is a guideline.

Only real numbers matter, and those real numbers are always specific to the property and the price and terms.

Seadog

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Re: Should the 1% rule be indexed to interest rates?
« Reply #2 on: July 03, 2019, 08:08:29 AM »
Hi everybody,

There's a question I've been thinking about for a long time, but haven't yet gotten around to investigating. Now that I'm considering buying my first home, with a plan to turn it into a rental when I eventually move out, I think it's time to ask. And the question is very simple: Should the 1% rule of smart real estate investments be indexed to interest rates?

This seems like an obvious yes to me because interest rates directly impact mortgage costs, which directly impacts profitability on real estate investments. For instance, let's say you're considering buying a $300,000 place with 20% down. The mortgage would be $240,000. At 4% interest that comes to $1,146/mo mortgage payments. This looks like a great deal with rental income of $3000 per month (Worse than these numbers suggest because of property tax, maintenance, vacancy, etc, but I think these numbers illustrate a concept). If interest rates increase to 15%, which certainly isn't the case today but my parents tell me was the case in the 80s, that same mortgage would cost $3,035 per month. That's a loss even before we add property taxes, maintenance, vacancy, etc!

How do you all think about this? Are there times when you'd accept properties not meeting the 1% rule because it's still attractive in a low interest rate environment like we currently have? Are there times when properties do meet it but you ignore them anyway because interest rates are too high and the place would be a net loss?

I always thought that should kind of be the case. My thinking was that in effect, a home is like a bond with a non-cash coupon.

When you have a plummeting interest rate environment, money becomes easier to borrow, more ppl can out bid each other for the same homes, and prices go up - meanwhile what that home actually produces stays the same.

Too - when you're in a low interest rate environment, it's generally indicative that great returns can't be had in other places (ie if economy was so strong rates would be going higher). Due to that, you need to be satisfied with slightly lower returns on RE.