#104 Does The Potential Property Pass The 1% Rule?

Welcome to the Passive Income MD Podcast, where we talk about creating your ideal life through multiple streams of income. I'm your host, Peter Kim. If you enjoy hearing about this stuff, make sure to hit subscribe so I can bring it to you every week. Now let's get on with the show. Hey, everyone. Hope you're having a great week. Just before we start this episode, I just wanted to say thank you and I wanted to honor you for taking time out of your busy days to listen to this podcast and sharing it with your friends. I know that you're extremely busy and many of you have said you listen to it, this podcast on you on your ride and commutes to and from work. Maybe you're taking a little bit of a road trip this spring or the summer with the family and you happen to listen to this. Maybe you're in between cases. I was actually do read some of the reviews and. And it's funny, I listened to. I read one recently where someone said they're basically listening to this on their lunch break while shoveling food in their mouth. I thought that was hilarious. Made me laugh. But I mean, I do the same thing. We're all busy. I think everybody listening to this is a busy person. And if you don't feel like you're busy, you probably wouldn't be listening to this. But you found time. I find time for things that are important to me. You probably do the same. So again, I want to honor you for that and whatever I can do to continue to support you, I'm trying to bring it to you here on this podcast. So let's get to this week's episode. This week I'm gonna be talking about a rule of thumb that I've used quite a bit when evaluating rental properties. It's called the 1% rule, and it can save you a lot of time or at least give you a way to do some quick filtering when you start looking at rental properties. As everyone knows, listening to this, I'm a big advocate for real estate investing. I'm often asked for a ton of advice, and one of the most common questions that I believe that actually the hardest question to answer is, how do I know if a property is good to invest in? You know, there are a lot of properties that might work out financially on numbers, on paper, and might not. I obviously there's a lot that goes into this decision because it kind of all depends on what your goals are and what you want. That's why I kind of always tend to start there whenever anyone asks me A question I usually start with, what are your goals and what are you trying to achieve and when are you trying to achieve it? But let's say you get past that and you were looking at a potential property. And it's safe to say that the actual question that you should be asking, whether it's a good one to invest in it should be this question. Will this property create the type of cash flow now or in the future that's gonna help me reach my financial goals? So that should be the overall question to keep in mind. Can I get the cash flow out of this investment that will help me get where I wanna be? Of course, finding out the answer to that question, it's usually easier said than done. But there are ways to help you figure these things out pretty quickly. But I do want to back up a little bit. Let's talk a little bit about goals and gaining knowledge. Maybe you're just learning to invest in property, you're just trying to figure out how before you actually get started. You know that real estate might be a great vehicle for you to achieve financial freedom, to give you that cash flow, that stream of income, so you can ultimately live your life both in and out of medicine however you want and have those options. Now, hopefully you've created some definitive passive income goals at this point. If you haven't listened to some of the podcasts in the past, I always start there. But maybe you've done that and you're not sure what the next step is. Maybe you haven't learned how to do the full due diligence on a property and that's okay. It takes time to learn how to do this in the beginning. I read so many different books, like the ABCs of real estate Investing, the book on rental property Investing, which are both great books. I've also taken a bunch of courses on the topic. I have friends, a semi retired MD for example, that have great courses on this. And I've taken those because I'm trying to learn as much as possible in the shortest amount of time and have it curated. I think that as all of us know, because of Google, all the information is out there. For any patient coming to you, they have all the information out there at their fingertips. The key is how do you know what information is good, how do you know what information is relevant and how do you filter that all down to something that's actually usable? And the same thing goes with real estate. The key is to figure out where is the information that you need and then how do you distill that down to stuff that is important to you and relevant and that you can use, and that goes hand in hand with the goals that you've already become crystal clear about in your mind. Then you can go out and find the investments that will help make all this a reality. Now, you might have heard the old saying when it comes to real estate that you, you make money when you buy. What I mean by this, and what other people mean by this is that once you're in a poor deal, it's hard to recover. Learning how to properly vet deals before you make the investment, whether you invest actively or passively, that's where most of the battle is done, in my opinion. It takes time to really dig deep and decide if something is the right property or the right investment for you. Now, you'll get better, I promise you, with the due diligence over time, but it takes practice, it takes education, and that's what we talk a lot about on this podcast. So before we get to that 1% rule metric and how to use that rule of thumb to help you evaluate some of these properties, let's talk again about my two favorite words in personal finance, cash and flow. I have to mention this every time. I don't know if people are listening to some of the previous episodes. I hope you are. But if you've been listening to this for a while, you know that cash flow is extremely important. In my book. What do I mean by cash flow? It refers to the amount of money flowing through your personal finances. Like cash comes into your life and cash goes out to cover expenses. Whatever's left over at the end of the day, it's net cash flow. So, meaning that you have income probably from your day job and hopefully from investments that goes in and helps pay for your stuff in life. Your schooling, your kids schooling, your mortgage, your car, whatever those expenses might be, it covers all of that stuff. And then whatever you have left over, you hope that you're in the positive situation. So netflow, net cash flow can be positive, mean that you have money left over at the end of the month. Negative, which happens to a lot of people, means that your expenses are greater than your income. That happens to a lot of people who start to accumulate debt over time, particularly credit card debt. So looking at the definition of cash flow, it's simply income minus expenses. Now, when it comes to real estate and investing, we're always looking for positive cash flow. There are situations where some people invest for negative cash flow because they expect that property to shoot up over time. To me, that's pure speculation. And you're relying on so many different things to work out right in your favor. That's why I prefer to go and look for positive cash flow, because that's what comes into your pocket and that's money that you can spend today to adjust how you live in life. So when you look at a property and you start to evaluate it, we talked about income minus expenses. Let's quickly talk about what income is and what expenses are. When it comes to income, it's simply the rent that comes in and then maybe some other income that you might get from owning the property. You might be charging for utilities, laundry, parking garages, that sort of thing. And that goes all into the income bucket. Now, when you look at expenses, there are tons of expenses that come with owning a property. That includes property management, Some of the more routine maintenance and repairs, something called capital expenditures, oftentimes shortened to capex. And these are major expenses to maintain or upgrade the property over time. For example, like the big items, roofs, H vac system, the air conditioning system, appliances, some of the flooring, these kind of things that you know are going to come down the line that really are large upgrades or maintenance items for the building. That's usually called capex expenses. Then another expenses that you need to think about are taxes, like property taxes and such. Then the cost of utilities, insurance, the mortgage itself, accounting and legal, pest control. There are a number of expenses that go into managing and owning a property. So when you ask yourself whether property will produce positive cash flow, you got to take all of that stuff into account. I know when people look at property, sometimes they just look at how much money you can make in rent and then how much your mortgage is. But there are a lot more things to think about. So to figure out all these things, you need to learn to do a deep dive into the due diligence that involves when you try to buy a property. Let's say you're doing this all on your own. You ask the seller for something called the rent roll. The rent roll is essentially a list of the leases and actual rents that have been collected over the past year. It also indicates if there have been any what's called concessions made to tenants. Like, I don't know, if you moved to apartment building, they said first month free, for example, and these kind of concessions. Then to calculate expenses, you're going to want to see all the seller's records, including all of their maintenance, their taxes, a lot of times their property management statements. I mean, this hopefully sounds pretty easy, but to Be honest with you, when you're searching for properties, you might have to look at 20, 30, maybe even 50 properties before you find a good one. Might sound a bit daunting, but sometimes that's what it takes to find these good properties. The reality is that you can't do a deep dive and into the due diligence for every single one of them. You don't have time for that. So for many of these properties, maybe even all of the due diligence factors that might not be there and available to you right away until you're in contract for the property. So wouldn't it be nice to have a way to quickly filter out these properties that don't make sense? And that's where this whole 1% rule comes into place. So again, I've talked about it briefly before, but but it really bears repeating because it's such a powerful tool. The 1% rule states that you should be looking for properties where the rent per month is greater than or equal to 1% of the purchase price of the property. So let me state, so let me say that again for everyone. The 1% rule is the rental income per month should be greater than or equal to 1% of the purchase price of the property. For example, now let's say that Property is a $540,000 property. Then you'd like to see the rents at 1% of that. So which is $5,400 a month. So it's just a quick screening tool, but it's very, very useful in weeding out properties that likely won't perform the way you want, likely won't give you that cash flow that you're looking for. It's kind of like using simple blood work for health screening. Obviously it doesn't tell you if someone has severe disease. Sometimes it does, but maybe it doesn't tell you about the amount of plaque or calcification in their arteries. But sometimes some of the blood work that we use, like cholesterol, it gives you a quick idea of whether you need to take a second look, some things to look for, Maybe you should look and take a deeper dive. So this 1% rule when looking at these properties gives you a basic idea of whether the property that you're looking at will be able to create a positive cash flow situation or not. So I know some of you are thinking when you look at a property, you might see it online on one of these platforms. How do you actually find out what the rents are? Because you'd like to use actual rents. You might get that Rent roll and occasionally the sellers, they're going to list the actual rents on the listing itself. Other times you're going to get something called a pro forma. You might have heard that term before. It's basically just a projection of potential rents that they could be getting or you could be getting as a buyer. Now this is good, but I tell people, ignore the pro forma, look at the actual rents. It's always nice to think, oh, you could get this amount. But when you're buying the property, you're usually buying it for its current value. Take a look at the actual rents and see if they meet the 1% rule. If the actual rents aren't available, there are ways to do some research to try to figure out what market rents are. There are things you can look on websites like Zillow or Trulia or, or Rent O Meter is another one. Now if it doesn't meet the 1% rule, but it's close and maybe there are other reasons that make you want to dig in a bit. You have other factors. You're like, oh, I really like this area. I think this area's getting, you know, it's getting better. It's, it's a place where you're, you see a lot of growth and economic growth. Figure out why it doesn't meet the 1% rule currently. But see if you're close and see if that might make sense for you in the near future. Maybe you gotta factor in construction costs. Could you still meet the 1% rule? You know, use these potential market rents to your advantage, meaning that let's say you renovate that property, you gotta put in construction costs and then now you know you can get new rent. Does that meet the 1% rule? Now if you find something far below, like you'll find in my area, these high cost of living areas, then it might not make sense for you if you're looking for positive cash flow. Now I know that people start looking at properties. I've done it, I've looked especially in different areas like I mentioned in coastal cities. For example, in Los Angeles you might find a three bedroom, two bath house for one and a half million dollars. Maybe it averages 4000, 5000, maybe $6000 a month in rent, who knows? And that ends up being a far below the 1% rule. In other Midwest cities you might find a $500,000 apartment building that nets at least $5,000 a month in rental income. Who knows? The thing is that there are still properties that fit that scenario. And, and you just have to be creative and resourceful to find where those are. All right, so let's say you're in that situation. You're like I've been looking for a while. No properties seem to fit that 1% rule, especially as the properties have gone up in value over the last so many years. Well, what do you do? You either move on or you look for a place that matches your rule. Or maybe you relax your standards a bit and then you look for places that you can add value to that you can do some construction on and bring up to market rents and maybe come closer to the 1% rule. Or maybe you wait in the future for prices to go down. But to be honest with you, that last one is going to be hard to predict. Today's environment, inflation is rampant, which should help rents overall, should also help real estate prices. But again, interest rates are going up as well, so it's hard to predict exactly what's going to happen. So in thinking about the 1% rule, just so you know, how do I use it? I simply use it as a basic pre screening rule. I also find that as you look at more units, multiple units, larger apartment buildings, I tend to find those numbers get closer to the 1% rule, which is why a lot of people tend to like buying properties at scale. You come closer to finding that 1% sweet spot. Now instead of looking at 50 properties, maybe you can quickly use that filter, get down to a like maybe six, eight or 10 properties and then you can dive in and do your due diligence to figure out what makes sense for you. Make sure you do the proper due diligence on the front end because remember again, you make money when you buy. I think that is so true. Of course there are things that you can do in the middle of the deal to help your situation, but putting yourself and starting on the right foot is absolutely important. And I believe that the 1% rule has potential to definitely help you do that and honestly make your due diligence a lot quicker and faster. Hope that's been helpful. Hope you're having an amazing week. Have another great week and let's talk again soon. Thanks. Enjoy the show. Let me know by dropping a review in the podcast app you're listening to us in. And if you haven't already, make sure to hit subscribe. Are you part of our community yet? Join thousands of physicians who are also on this journey to creating their ideal lives through multiple streams of income. You can join us on our Facebook group Passive Income Docs and you can always learn more at our website. Passiveincomemd.com thanks again for allowing me to be a part of your journey. See you next time.