Buying A Rental Property

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Hey guys! Just a reminder that today marks the first day of the 28 Day Network Challenge.  I plan to share on Saturdays my updates for the week.  I’d love for those who are participating to also share their victories along the way!

 

My wife and I are currently at a crossroads trying to figure out what to do.  Here is a quick backstory.  My wife’s older sister has special needs.  Her sister’s full-time caregiver was her mother until she passed away in 2011.  So, my wife has stepped into that caregiver role over the last 5 years.

 

My Sister-In-Law’s Dreams Come True

rental propertyOne of my sister-in-law’s overwhelming desires is to move into her own apartment.  She has wanted to exert some independence in that manner for about 10 years now.  Recently, her prayers were answered.  She was awarded a voucher from the county that would subsidize an apartment for her up to a certain amount.  She was actually the first person in the county to get approved for this specific program.  Since she has a steady job that will cover her portion of the rent each month, this seems like a great situation.

 

Because of her special needs, my sister-in-law is also eligible to have a Live-In Aide.  So she will have adult supervision and care when needed.  It’s great that the county takes care of its aging special need adult population in this manner.  They are phasing out group home settings at this point, so integrated apartment living seems to be the trend.  My sister-in-law is excited to say the least.

 

Experiencing Difficulty Securing a Place

rental propertyUnfortunately, 99% of apartment complexes in our area do not accept this voucher from the county.  I don’t know exactly why.  It’s similar to a Section 8 voucher, and most complexes around us definitely do not like those.  Maybe because the voucher creates extra steps for them with paperwork.  Additionally, getting approval from the county is not a fast process.  After getting rejected from virtually every apartment complex in the area, we finally found a landlord that was willing to accept the voucher.  

 

A Lengthy Process

rental propertyWe filled out the preliminary application and agreed to terms in mid-December.  We are still going through the final approval process through the county.  To say that this is a long, drawn out ordeal is an understatement.  Why it takes going on 45 days to process a stack of paperwork is beyond me.  It doesn’t help that most parties involved in this process have made mistakes here and there, creating more delays to the process.

 

One of our biggest fears at this point is the condo owner will decide to back out.  This would cause us to have to restart our search.  On top of that, when we found the unit, the owner was listing it to sell and rent at the same time.  So it’s clear that she may decide to sell the place in the future.

 

Buying a Property Ourselves

rental propertyMy wife and I have been discussing whether or not it makes sense to buy a place in the future.  If we did, we would specifically rent it out to my wife’s sister through the voucher.  The county actually encourages families to do this, as it provides for a stable environment for the special needs individual.

 

The 1% Rule

Something I learned early on is that you should not buy a place if it doesn’t meet the 1% rule.  For those that are unfamiliar with the 1% rule, let me quickly run through it.  

 

The 1% rule states that the gross monthly rent should be at a minimum 1% of its final price.  1% of it’s final price includes all of the repairs and renovations needed to maintain the property.

 

  • A property that costs $200,000 should rent for at least $2,000 per month.
  • A property that costs $250,000 should rent for at least $2,500 per month.
  • A property that costs $300,000 should rent for at least $3,000 per month.

 

My Reality vs the 1% Rule

Living here in the DC area, I have yet to find a house that meets this threshold.  And believe me, I’ve been looking over the past few months.  The best that I can find is close to 0.5% of the property value.

 

  • A property that costs $200,000 rents for at least $1,000 per month.
  • A property that costs $250,000 rents for at least $1,250 per month.
  • A property that costs $300,000 rents for at least $1,500 per month.

 

Other Costs Involved

rental propertyWho’s kidding who though?  There aren’t very many properties that are that low.  Plus, most of the condos in our area charge HOA fees in excess of $300-700 per month, which contributes to the cost of the property.

 

On top of that, the problem with a 0.5% gross rent of the property value is most experts will say that you need to buffer in 50% of the rent to cover unexpected repairs.  Most years, you probably won’t have to spend this money.  But when it comes to a new roof or a new HVAC system, you’d be spending quite a bit.  Having good credit is essential to being approved for being able to buy rental property.  If you are looking to improve your credit, please visit here

 

Not a Good Option for Us

rental propertySo based off that analysis, it appears that I would barely break even.  And that is without the risk of some major appliance breaking or another expensive repair.  Initially when I started the analysis, I thought, even if I don’t make any money, it would still provide a stable housing situation for my sister-in-law.  But upon further analysis, it appears that I would have to subsidize her housing if I utilize 50% of the rent for house upkeep.  That means the whole mortgage is coming out of my pocket each month.

 

While I would love to help my sister-in-law out, I’m just not sure it would be a wise financial move.  As I have mentioned before, we plan to move ourselves in the near future to another home with a little more space, so we need to save up all the cash we can!  

 

Readers, have you bought an investment property eschewing the 1% rule?  Do you consider the 1% Rule necessary, or something to loosely considered?  Share your thoughts below.

Mustard Seed Money

Welcome to the website. A mustard seed is a very small seed but astonishingly grows very large over time. My hope is that through your financial journey that your small investment in time, money and faith will grow beyond anything that you could ever imagine.

58 Comments

  1. That was like reading a story from my life. I did this very thing with my parents. I ended up subsidizing their living expenses to the tune of about $800/mo. Now, I was getting “free” childcare for a portion of those years, so I consider that a win. But, repairs and maintenance were not included in that $800. I shudder to think how much money it actually was. I eventually couldn’t do it because I was sacrificing my own financial well-being. I had to move my mom (my father passed away soon after I bought the house) into a subsidized apartment building.

    When I bought the house a decade ago, I had plenty of disposable income each month because I was living with my fiancé at the time who did rather well. That ALL changed when we broke up months after the purchase. Basically, it was a terrible financial decision because it was made out of emotion. I bought at the height of the housing market and ignored the 1% rule. D.C. is a tough area. To meet the 1% rule, you would need to find a deal. You can do this by going to your local REI meetings and finding people already in the business of finding deals. You can search craigslist for people renting their properties, give them a call and see if they would want to sell instead. Heck, ask the owner of the condo she’s moving into if she’d be willing to sell to you. You never know how desperate someone is to get out of the rental business. But I’d recommend staying away from condos, in general, if you can. The HOA fees coupled with slower appreciation don’t make them the best rental purchase option out there. Head over to biggerpockets.com and search their forums and ask your questions. You’ll get tons of feedback from professionals already doing this. I highly recommend it.

    If you’re planning to move, maybe look for a two-unit or a house with a separate, built-in apartment.

    Anyway, that’s my 2 cents. Good luck!

    Mrs. Mad Money Monster
    Mad Money Monster recently posted…Invest Extra Cash Or Pay Off The MortgageMy Profile

    • Thank you for your detailed response Mrs. Mad Money Monster!!!

      I remember reading your story and your difficulties which definitely has me a bit shy to jump into something that could be detrimental to my finances.

      I will definitely check out biggerpockets.com and check out the forums.

      I really appreciate your advice!!!

  2. Hey Mustard Seed Money,

    Given your analysis, it might be best to look outside the city if you are set on a rental property. I think at a minimum, you should shoot for 1% but if it doesn’t happen, it’s not the worse thing. When I move out of my house, my rental income will probably be 0.75% of my property value… not optimal, but I will be cash flowing $300 a month before taking into consideration depreciation, appreciation, equity build, and other tax benefits.

    Would you consider looking in another area?
    Erik @ The Mastermind Within recently posted…My Goal to Read 75 Books – January 2017 Check-inMy Profile

    • I was thinking the same thing. Depending on how close your wife wants to be to her sister, and your sister-in-law needs to be to her job, relocating her to a less expensive area could be a viable solution. Living in Silicon Valley, I know how difficult it can be to make rental property work with a mortgage. We’ve only been looking outside the area.

      Kudos to you both for stepping up to help your sister-in-law. Special needs cases can be extremely difficult for the supporting family. So take care of your sister-in-law but more importantly take care of yourself so you can take care of your family and support your sister-in-law.
      Jack @ Enwealthen recently posted…Successful Retirement Planning For Every AgeMy Profile

      • Thanks for stopping by Jack!!! My wife definitely would like to stay as close to her sister as possible. Her new apt. is 2 miles down the road from us 🙂 It was picked in case there was a mega snow storm that we could walk to her 🙂

        With that said as much as we’d love to move to a cheaper area the voucher is only good for the county we live in 🙁

    • Thanks for stopping by and sharing Erik!!! The biggest problem for us is that we are restricted to staying in the county.

      So while we’d love to be able to buy a place a little further out, the voucher that she has would no longer work.

  3. I’d recommend venturing a little further away for a lower cost. I have not ventured into the rental world but my father-in-law rented to his mother in law for years. Ultimately it was as much about family as money. Free babysitting probably balanced his situation as did the appreciation of the house over decades. Still you can’t do these things unless your stable financially yourself.
    Full Time Finance recently posted…Travel Hacking Methods: See the World on a DimeMy Profile

    • Thanks for sharing Full Time Finance!!! Sounds like a great situation for your FIL his MIL. I wish we could venture out a bit further but we are restricted by the requirement for her to live in the county.

  4. The 1% rule is tough. I can’t think of many houses in my area that would qualify for it. Our current house probably wouldn’t, especially after factoring in expenses. But it would be close. The 1% rule sounds like a good idea, I just don’t know that it’s reasonable. I would focus more on how much of the mortgage payment and monthly upkeep you’re able to cover through the monthly rent.
    Go Finance Yourself! recently posted…Life Insurance: How Much Do You Need?My Profile

    • Thanks for the advice Go Finance Yourself!!! I’ll play around with the numbers this weekend based on your advice and see what shakes out. The 1% rule is definitely pretty difficult to stay within.

  5. First off, that’s great news for your sister-in-law! Hopefully you guys will be able to find something that works.

    I don’t have any RE experience, so can’t help you there, but where does your sister-in-law live right now? Is it your place? Could you rent out a portion of your house to her when you buy a bigger house?
    The Green Swan recently posted…Why The Government Doesn’t Want you to Retire EarlyMy Profile

    • Thanks for stopping by Green Swan!!!

      Unfortunately the way the voucher is set up she can’t rent from family. Otherwise, I wouldn’t mind the rent money 🙂

      Plus on top of that she really would like to have her own space to be an adult.

      So we’ll see how she likes living on her own with an aide.

  6. In my opinion, meeting the 1% rule is extremely important… however it is not always easy (or sometimes even impossible) to find property that meets this rule if you are searching in an area with inflated property values such as DC. Having a solid monthly cash flow is very important if you want to have a successful rental property… unless you plan on carrying the property with a nugative cash flow with money from your personal bugdet each month. I would suggest expanding your market to some areas that have a little bit more reasonable property values. Places like maybe Frederick, MD or Richmond, VA. Just a thought…
    Your First Million recently posted…Amazing video! Brian Tracy explains how to set goals for 2017 and how to make the most of the new yearMy Profile

    • Thanks for sharing Your First Million!!! That is sound advice and I would love to look outside the county but unfortunately one of the restrictions is staying within the county lines to use the voucher.

  7. My current rental property is very close to the 1% rule. The current value is around $110,000 and we rent it out for $1,200/month. I’ve found that in our area (Detroit suburbs), that an inexpensive property can be rented out for more than the 1% rule and the more expensive properties are generally rented out for less than 1%. For example, our other home we rented out for $1,900/month while we were expats, but the home was worth closer to $250,000.
    We’ve looked at purchasing rental properties as investments in the future, but ultimately decided that we don’t want to deal with the issues of being landlords. Once we sell our only remaining property, we’ll stick to the stock market or spend our time creating other passive income streams.
    Making Your Money Matter recently posted…RE404: Social Security & Medicare EssentialsMy Profile

    • Thanks for sharing Kathryn!!! I’m curious to hear your experience as a landlord and why you’re more interested in the stock market or other passive streams? I feel like most real estate investors can’t wait to buy more and more properties.

      • A big part of my reasoning is just due to our season of life right now–we have young kids and don’t want to spend the time to manage properties. We have a great property manager that we used when we lived abroad, but between hiring her and hiring out all the repairs, we would not make enough of a return to beat the average stock market returns.
        Another reason is because of our past rental experiences–we had to an evict a renter who never paid us rent (literally never ever did…) and our current renters are having issues with the next door neighbor, who pulled a kitchen knife on them last week (we lived there next to this same neighbor for 5 years and never had any issues). I prefer the drama of the ups and downs of the market over people dramas. I think rental properties are excellent for some people, just not my thing!
        Making Your Money Matter recently posted…RE404: Social Security & Medicare EssentialsMy Profile

        • Oh my gosh!!! I can’t even imagine what has to happen for a neighbor to do that. I can definitely understand wanting to get out of the people drama that you’ve had. Thanks for sharing!!!

  8. Yes, we brought a property for a close family member that is cash negative. We purchased the property all cash ($43,000) and the family member only pays the HOA, but we pay property taxes, upkeep, etc. This year we got hit with a $2,400 assessment to repair the porch landing.

    This was not a financial decision for us but a decision by faith 1 Timothy 5:8. This family member had lived with us for several years as she had a hard time time keeping jobs (not special needs but there are some other issues at play).

    One thing that helped was that we went 50 miles outside the city to get a the price of $43,000 in Southern California. Feel free to shoot me an e-mail kevin@coupleofcents.com if you’d like to discuss.
    CoupleofCents recently posted…2016 Financial Review: +$61,330 Net WorthMy Profile

    • Thanks for sharing Daniel!!! I was a little burned out when I was living in my property as a landlord but was curious how’d it go not living in the place. But at this point the numbers haven’t worked out.

  9. I’m a real estate investor and I don’t use the 1%. It seems pretty arbitrary to me. I have four properties that actually get rents closer to 2.5-3%. The key is to understand your holding costs and long term costs. When I run a quick calculation before I even think about making a purchase, I make sure that on a typical monthly basis, the cash flow (rent minus all expenses, including taxes, HOA, Etc) is at least a 15% ROI, it is usually more in the 20% range for me. If I don’t get that ROI, then the hassle and risk is too much and I’d be better off putting the money into a mutual fund or something.

    Anyway, that’s just MY rule, but the key is that YOU need to feel comfortable. Real estate, while it can be lucrative, can be very risky. It sounds from your article that you are not whole-heartedly into this as a pure investment, but rather more of an emotional investment.

    Just my humble opinion. I hope you do a follow up and let us know what you finally decide!
    Primal Prosperity recently posted…“Some Travel, Others Journey”My Profile

    • 15-20% ROI I would be ecstatic with 🙂 I definitely agree it’s not a pure investment as much a emotional investment that we wouldn’t have to worry about her living situation moving forward.

      Ideally I’d love to find some land with a guest cottage that she could live on her own. But I’m not sure I’m going to find that in the DC area 🙂

    • Thanks for sharing Mr. Defined Sight!!! It’s always fascinating to hear other people’s perspective on the 1% rule and if it’s a guideline or hard and fast rule 🙂

      I was hoping if we bought the place that it’d be more like a 2nd property than a landlord type issue. I’m pretty sure if there’s a problem in her new apt. at 2 am that I’ll be the first one over there anyway.

  10. I’m also looking for my first rental property. In the Netherlands the best I see so far is around 0.8-0.9%, but I’m still in the beginning of the process.
    I agree with Mad Money Monster, you should try to give an offer to the future landlord…
    Roadrunner recently posted…January 2017 Financial OverviewMy Profile

    • Thanks for sharing your perspective on the Netherlands Roadrunner!!!

      You know interestingly enough the owner was trying to sell it first before she relented on renting it. She was trying to sell it for 0.5% of what we’d get for the monthly rent.

      So unfortunately it didn’t come close to the 1% rule.

  11. My husband and I are actually about to close on our first real estate deal next week! We are buying an out-of-state property (in an area we used to live in and would like to return to in the future) and have been looking for deals that fell within 1-2%. I developed a super simple spreadsheet that allowed me to run a variety of numbers (including the 50% rule, the 70% rule, ROI, etc.). In order to make the numbers work we eventually found a house that someone else had purchased and started renovating but either ran out of money or interest part way (i.e., the furnace is still in the box and there are no light fixtures!). However, that appealed to us because we could get the property at a low cost and my husband grew up working in his family’s construction business. The financing was a little tricky since we couldn’t get a conventional mortgage, but things are working out so far (though we haven’t had our closing yet!).

    So best of luck with your real estate ponderings. I listen to the Bigger Pockets podcast and I know they have had some guests who lived in expensive markets and couldn’t make the numbers work on single family homes. So instead they went for triplex or fourplex homes. I know for me personally the idea of getting into multi-unit properties seems very intimidating, but it be worth considering.

    • That’s incredibly exciting that you all are buying your first real estate deal!!! I can’t wait to read your updates along the way.

      I definitely wish I was more handy. I for whatever reason will try to fix stuff but I feel much better with my Dad looking over my shoulder and more times than not will default to him.

      So I am definitely envious of your husband’s know how.

  12. I hope the landlord does not bail out on your sister in law.
    When investing, emotions should be kept out. It sounds that buying the rental at 0,5pct is not that a good of a deal.
    I like the suggestions of buying a twin home or so.
    Amber tree recently posted…Our first banking crisisMy Profile

    • I would love to get her a twin home or guest cottage on a forever home for us. That would definitely make life much simpler 🙂

      I guess we’ll see what the future holds

  13. Being a realtor and landlord myself, I have yet to find a property that comes close to getting 1%. I have seen a couple that come close to 0.75%. With today’s low interest rate, I think that if you get 0.5% or more, you should be able to at least break even in terms of cash flow.

    Having a child with special need, I know first hand how much efforts it takes to take care of a special needs family member. It’s a great thing that you are doing for your sister in law. Hang in there, you guys will find something suitable.
    Leo T. Ly @ isaved5k recently posted…The First Step To Saving A Million DollarsMy Profile

  14. There is a fundamental reason the 1% rule doesn’t work in high-cost areas (NYC, D.C., SF, LA): A bigger percentage of the value of real estate is in the land, not the physical structure. In cheaper areas, it’s the other way around and because a structure depreciates and land appreciates you can probably never get a 12% p.a. rental yield in the big city. You don’t need to because the depreciation and repairs are much less as % of the property value, hence the lower rental yield.
    Another thing to consider: If there’s a voucher program and stable rent income you can probably still do all right with a 6% p.a. rental yield. At least you don’t need any allowances for deadbeat renters, vacancies, renters trashing the place, etc. That’s worth a lot! 🙂
    Anyway, kudos to you for trying to help out a relative in need.
    earlyretirementnow recently posted…The Ultimate Guide to Safe Withdrawal Rates – Part 8: Technical AppendixMy Profile

    • Thanks for the great perspective EarlyRetirementNow!!! I didn’t even think about the allowances needed for vacancies and trashing the place 🙂

      I will definitely need to factor that back into the calculation.

      Thanks for sharing!!!

  15. $700 / month HOA fees? Yikes! That seems a bit steep – do they deliver your groceries to your refrigerator? In all seriousness though, we are looking to move from our primary residence and then rent the property out, but our potential rent looks to be about 0.8% as opposed to the 1%. We’ll see if the market changes down here much over the next few months before we finalize the sell vs rent decision.
    TPOHappiness recently posted…Human PlanetMy Profile

  16. Congratulations to your sister-in-law for her first rental property!

    I haven’t been able to find any 1% cashflow properties in the California area. It seems that most of these properties are now in the middle of the US and not anywhere along the coastlines. Hopefully, this will change in the future as most people except the “housing bubble” to pop soon.
    Smart Provisions recently posted…The 5 Factors That Affect Your Credit ScoreMy Profile

  17. Congrats to your sister-in-law for securing the voucher. It’s unfortunate you’ve had such a hard time finding a place for her to rent. I hope the condo works out! 🙂

    I second some of the other suggestions. Maybe your next property could have a cottage or attached, yet separate living space she could rent?

    We’ve been shopping for a property and the only ones that really meet the 1% rule are the distressed properties. We’re not afraid of renos (we’ve done a ton of home improvements/renos on our own homes), but we’ve been outbid on everything so far.
    Amanda @ centsiblyrich recently posted…Debt Free Story: How I Paid Off My Student Loans And Escaped The Golden HandcuffsMy Profile

    • Thanks for stopping by Amanda!!! It’s definitely tough to find good places for the 1% rule. There is definitely way more competition these days 🙁

      You’ll have to share when you find the perfect property. I can’t wait to see what you all find!!!

  18. Congrats to your sister in law, that for sure sounds like a difficult way to have to go about getting a property to live in although glad its sorted.

    Excellent analysis on whether or not you can buy a property as well.. I must admit I usually find a way although it’s vital to have that level of comfort before doing anything 🙂

  19. I hope the landlord is patient and waits for all the paperwork to get done and your sister in law is able to move in.

    The 1% rule is a generic rule of thumb. For example, if you purchase a condo, that meets the 1% rule, however has a high monthly HOA fees, then you may be barely experiencing positive cash flow after taking into account all the expenses. You need to evaluate each home as a separate project and see if it makes sense.
    Michael recently posted…Know Your Net WorthMy Profile

    • Thanks for sharing Michael!!! The HOA for condos are crazy around my area. Some of them come close to the mortgage. What I’d be getting in return, I’m not exactly sure. So we have definitely been turned off by them. So unfortunately nothing has come in our range yet.

  20. I’m a little confused. In response to Green Swan, you said that the voucher is set up in that you can’t rent from family. But if you bought the property, you could get the voucher and that is encouraged according to your post? Why do they make things so complicated?
    In any case, I live in the NYC area and the 1% rule definitely wouldn’t work here either…which is why I bought a rental out-of-state. I think if you can get the numbers kind of close, I would be okay if it is slightly below the 1% rule. While you don’t want to count on appreciation…I think the DC area has strong growth. Plus, a lot of the numbers take into account possible vacancy and being a landlord, one of the biggest concerns is having a good tenant. Being that it’s your wife’s sister…at least those factors make the investment a little safer.

    • Also, I wanted to add that if you purchase a 2-family house or maybe a house or perhaps a “mother daughter house” you can rent out a part of the house to your sister in law. It might get you closer to the 1% rule in a high cost area.
      Andrew@LivingRichCheaply recently posted…Buying a Used Rental CarMy Profile

      • Thanks for sharing Andrew!!! My wife and I definitely looked at a guest cottage and we were told that the houses have to be two separate addresses. But once again awesome ideas.

    • Sorry I didn’t explain that well. Let me try again.

      If we owned a property that we didn’t dwell in and rented it to her. We could collect rent.

      If we live in the property and she dwells with us we wouldn’t be able to collect the rent.

      You bring up some great points and it’s definitely something that my wife and I were going to discuss again this weekend. I love the feedback that you provided b/c sometimes it doesn’t boil down to just numbers.

  21. It’s great you can help take care of family.

    With regards to the 1% rule I haven’t seen anything like that in the neighborhoods around me. To be honest, the idea of renting a house and dealing with (potentially needy) tenants makes me a bit queasy!
    Andrew recently posted…5 Financial Mindsets To Improve Your LifeMy Profile

  22. Hey Mustard Seed, I would keep searching and look for triplexes and quads, you can still get residential loans on these but they end up cash flowing better since the property taxes don’t hurt as much spread across the units. Look for areas with cheaper taxes, some towns get subsidized property taxes from the state.

    My wife and I bought a quadplex in October of 2015 in Garfield, NJ. Only 13 miles from NYC. We bought it for $430,000. It has 4x 3bed/1bath units.
    We live in Unit1, in-laws in Unit2 and pay cheaper rent at $1000, Unit3 we rent for $1710, and Unit 4 we rent for $1710. So even while we live in one of the units and subsidize the rent for our in-laws we meet the 1% rule. $4410/month.
    If we were to move out we could easily get $1500 and an additional $500 in my i laws unit. So it could cashflow at $6,400; closer to 1.5%

    We found this property through the MLS on realtor.com . there are still deals to be had, just keep looking, good luck and Godspeed!

    If you want more details about this particular deal you can read up on my blogpost here: http://www.FamVestor.com/MetalHorseProperties

  23. My wife and I are thinking about buying a rental property as well, partly because of the instability of my wife’s employment situation, but also because I think it is a great way to build wealth. There are two problems I have with it: 1) I think I am scared because I don’t have the money for a down payment (I would have to use our home equity and we do have a fairly sizeable amount); 2) my wife has a ton of student loan debt (I do have it as well, but it is a bit more manageable). Not sure what to do and the rental property would be right next door to us. I guess I will have to figure it out.
    Jason recently posted…Public Student Loan Forgiveness Storm Clouds, Part 2My Profile

    • Thanks for sharing Jason!!! I definitely am scared of making mistakes with investments especially real estate since it has such a huge cost associated with it. Sounds like you are really weighing the pros and cons as well. Good luck with your decision down the road.

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