If you're going to invest in rental real estate, follow this one rule so you'll actually make money.
Pay no more, including repairs, than 100x the potential monthly rent.
So, if you think you can rent a place for $1,000 a month. Don't pay more than $100,000 for the property.
If the property requires $20,000 of repairs, don't pay more than $80,000 for the property.
Follow this rule, and you'll make money. It's that simple.
What's the name of this rule?
Some people call it the "1% Rule" because you can multiply the value by 1% (or divide by 100) to see what the rent "should" be. I like to think of it as the "100x Rule" and start with the rent.What about all those property calculators and spreadsheets? Surely more analysis is needed.
Yes, you can get more detailed and calculate an accurate bottoms-up analysis of the property and calculate a precise return on investment (ROI = annual profit divided by your cash contribution). And yes, larger multi-family properties, especially if multiple investors are involved, requires a higher level of rigor to validate the numbers. And flips are a different type of investing which need a different kind of analysis.But you know what you'll find when you do the detailed analysis? In general, you won't want to pay more than 100x the rent.
I've analyzed a few hundred properties, and it's shocking how consistent this rule is.
Why is this rule so important?
The primary reason for investing in rentals is to generate income over a long period by renting a product. A product that requires maintenance, working with a customer, and complying with laws. These all require time and money. And if you don't meet the rule, you'll find your margins are too thin to do all the repairs you want to do. And you won't be able to afford to hire someone else to manage the property or do the maintenance.So instead you'll spend your time doing it all and making so little money, you'll be more rooted in the rat race. All the while telling yourself that the value is going up, or eventually, the mortgage will be paid off. When in reality, you should have put the money in an index fund and spent your time with family, or generating income some other way (overtime, freelancing, second job, side businesses, etc.). You would have been able to retire sooner because you'd have a higher return on your time.
It's sad when I talk to a landlord who's tired from working all the time and don't feel close to retirement despite owning a million dollars worth of rentals. Had they used this 100x rule, they would either be close to retirement, or able to afford to hire someone else to manage the property.
What if I provide a higher down payment to ensure a positive ROI?
You can, but you'll find your ROI drops to the point that you're better off putting the money in an index fund and keeping your weekends free.But I can't find any properties that meet that rule?
Then wait or look somewhere else. Don't buy just because you have money burning a hole in your pocket. Yes, real estate can be a good investment, but only if you buy at the right price. Which is no more than 100x the monthly rent.It took us 18 months to find our first deal that met the rule. Our annual ROI is 50%.
Some investors use a higher standard. They only buy places that meet a 50x rule. You can find them in the midwest. It's rare to find those ratios on the coast.
Here are 10 tips for finding cheap houses.
Fair warning: to mee the rule, you'll have to look at properties that need some work. Not necessarily a lot, but some. But that's fine because you're not looking for your dream house. The properties also tend to have been owned for a while, and the current owner is looking to sell for reasons beyond maximizing the sale price. So prepare yourself mentally.
What if I love the neighborhood? Or any other reason other than the ROI?
That's fine, but be honest about it. I get the appeal of wanting to buy your neighbor's house so you can control who lives there. But you might have to be OK with losing money and/or making less than if you put the money into an index fund.But property values go up over time. So it's OK if I lose money, right?
That's speculation. Ask people who purchased in 2007 how that turned out. Plus, and here's the crucial part: Housing prices tend to rise slower than the stock market. I laugh when people talk about how their house price doubled over the last 10 years, implying they're a financial genius. Cool. So did the stock market without the costs of taxes, insurance, and maintenance.Think about this: if you live in an area where houses don't meet the 100x Rule, not only do you want to avoid buying rentals there, you're better off to rent yourself. That's right, if you did a detailed analysis of living costs, you'd find that it costs more to own a home than to rent when this rule isn't met.
If your goal isn't to minimize your living expenses - perhaps you want to guarantee your kids go to a specific school - then be honest about it. Jessi and I bought the place we're currently living at for multiple non-financial reasons and happily pay the higher mortgage and taxes.
What if I currently own a place that doesn't meet that rule?
Is your goal to maximize your ROI? Be honest. If so, sell it and buy something that meets the rule.If I came across a property with a possible ROI higher than my lowest performing rental, I'd trade up. Yes, there are advanced strategies to minimize tax liabilities (such as a 1031 exchange), but stay focused on the big picture: If the goal is to maximize your ROI, you should sell a property if it's not performing, especially if it's equal to an index fund. Why bet on a possible future when you know you can get a better return today?
The 100x rule
It's not a perfect rule and doing a detailed analysis is good to do once you're further along. But if more landlords followed this rule, they would have the margins to properly maintain the property, make a significant contribution to their retirement, and avoid many problems that can arise later (like putting up with a bad tenant for too long because you don't want to lose the rent income).It'll also give the margin to afford a property manager if life changes, and you no longer want to do it all yourself.
That's why we follow this rule when investing in rental and why I think you should too.
