0.5% Rule

Bay Area
1

When I first got started buying rentals, I did some research and stumbled onto the “1% Rule”. Basically it says you should collect every month at least 1% of the house price. So for example, if you pay $1M for a house, you should rent it for at least 10K a month.

I was looking for rentals in the North Bay at the time and I told my agent about this rule. He was polite but basically said “You are out of your mind”. It was 2011 and even then it was hard to find properties with the 1% Rule. If you go on sites like Biggerpocket many people still talk about the 1% Rule, but you can only find such deals in flyover states like Kansas.

So what’s the rule of thumb for us in major league areas like the Bay Area? I calculated for cash-flow neutral we can use the “0.5% Rule”. Let’s work out an example. I use 1M because it’s a nice round number. Math is the same regardless of price.

Purchase Price: $1,000,000
Down Payment 25%: $250,000
Financed Portion 75%: $750,000

For mortgage payment every month, use my rule of thumb: $500 per $100K financed. So mortgage payment = $750K / 100K * 500 = $3,750

Property tax is 1.2% per year, that’s 0.1% per month: $1,000

So the “PIT” part of PITI is $3,750 + 1,000 = $4,750. Now put in $250 per month for insurance and other expenses and it comes out to $5,000.

There you go: $5K = 0.5% x $1M.

Even there your cash flow will likely to be slightly negative because we didn’t account for repairs and vacancies. Also property taxes will most likely cost you more than 1.2% with all the parcel taxes. It’s a “rule of thumb”, not a detailed Excel model. But I like to buy houses on the edge of cashflow neutral anyway. That’s a good way to play offense while still have some degree of defense.

2

Errr…forget the long drawn out analysis…why not just buy multi unit buildings then? Should easily then be able to make it (cash flow) work, no, vs SFH buy???

3

Friends don’t let friends buy multi-fam in Bay Area.

Dude, 0.5% of purchase price is the easiest analysis you will ever do. Basically just divide the number by 2. How is it complicated?

4

It’s not (complicated)… but I don’t see how you cats can expect to buy SFHs (around here anyway) and think you will be cash positive. Not …gonna…happen. Multi units are where it is!!! The pros do it all the time.

5

Yeah some SFHs in the bay area are priced just slightly below multi-family units, so insane. I’d rather buy multi units even factoring in all the cons.

6

Personally, I look at Bay Area investment as building wealth. Not building cash flow. I am in the same boat with you regarding looking for neutral cash flow at least. Right now I am enjoying my day job and keeping it for next 5-10 years, so growth is more important to me. 0.5% rule works for me as long as I am picking out desirable area for my speculative appreciation. If you hold long enough, they will come.

But for longterm, I see myself taking those gains and doing multi-family syndication or joining those syndications outside of bay area.

1 Like
7

The .5% is based on assuming high appreciation. …Single family homes were not traditional engines of rental income…The current era is a new phenomena. …Seen by a few visionaries in 2009…Now we have the lowest homeownership rate in my lifetime…And a generation of lifetime renters…Mutli Family should be in your portfolio for the long term…As long as prop 13 is in effect owning muti family for multi generations is a solid wealth building plan…But multi family cap rates should be higher than sfhs…Still 10 caps available but not near the BA

8

According to my Austin property manager, he said 10 years ago before the boom, getting 12% gross rental yield is the norm but appreciation is only about 1-2% p.a. Things are very different now, Austin is appreciating at double digit since 2009, yield drops drastically. He said many who put down 20% or less downpayment struggles to have positive cash flow.

9

I see too many potential risks owning multi-family in the Bay Area. Well, I am not sure I will even touch multi-fam anywhere in California. When pols and mob look for targets multi-fam owners are the easiest of targets.

Like @myo I am in wealth building mode. As long as my portfolio is at least cashflow neutral I can hold tight even if downturn hits. Yes, I am “speculating” on appreciation.

10

Come on, reality time boys and girls…reward does not come without risk. With multi unit buildings, you have the real potential to be gaining way income streams that will take you into retirement. You can’t be scared of everything…

11

Buy multi family built after the rent control laws cut off…Or even better build new…The best returns I ever had were in multi family and self storage. …

12

They can always change the law. And if we continue to not build anything, expect mob with pitchforks at the door.

13

Give the mob land, lumber and nails and let them build…They need to direct there anger at nimbys not landlords…

14

Good point. There is no way you can get 5% gross rental yield in Cupertino/West Sunnyvale/ West San Jose/ Mountain View/ Palo Alto/ Los Altos/ LA Hills. 3.2% I would be very happy.

15

Rents and property price don’t have a linear equation for SFH . After a certain limit people don’t want to pay more for rent. I see properties in birdland area renting for ~3500 which are in decent condition. They would sell for atleast 1.4 million.
Appreciation vs cash flow positive for SFH vs condo , you get to pick one :slight_smile:

2 Likes
16

Too low. At least $500 including repairs and replacement of appliances. Add up the cost of all the appliances* in the houses and divide by 120 months (average life span), should be at least $250 per month.

*Furnace, water heater, dish washer, dryer, washing machine, microwave oven, oven, cooktop, cooktop hood, fridge, garbage disposal, Carpet, garage opener, smoke/ carbon detectors, trash compactor, painting, and curtains.

17

But if the trend is towards a world of renters wouldn’t multi unit properties get a healthy dab of appreciation too in addition to cash flow?

18

I’m worry that one day, pitch forkers would appear at my doorstep. There is a growing resentment against landlords, aka rent seekers. Chances are high that those staying in multi-family are pitch forkers vs SFH renters who may aspire to be landlord one day.

19

If downturn hits, rental market will take a hit, so I’m not sure if you can maintain the cashflow neutral status under this scenario.

1 Like
20

Exactly. At the bottom of the recession, rent in Singapore dropped by 75% from the peak! Have not reached peak yet (about 80% of peak) but property price did jump to ATH (about 30% above previous peak).