Real estate is often compared to baseball, using metaphors such as 'home runs', 'strikeouts' and 'singles'. While home runs are certainly possible under the right circumstances, investors should be leery of investing with someone who claims far fetched returns. In our view, if investing in these home run deals, you have just as high of a chance of striking out as hitting a home run. We would much rather invest and aim for singles and doubles.
That is where the 1% rule comes into play. For those who are unaware, the 1% rule is where you aim to have the rental income of a property be equal to 1% of the purchase price. For example, if a property costs $150,000, you should aim for a property where the monthly rent is 1%, or $1500. With this kind of rent you can basically guarantee that you will have some positive cash flow right off the bat. Even after factoring in for mortgage, property taxes, insurance, property management, vacancy, repairs and maintenance you should be able to put cash in your pocket each and every month.
This is very important when investing in real estate. We have seen first hand some of our friends get crushed in the Calgary market because they did not have a sustainable cash flow and had to subsidize the expenses with their own job income. An investment should be used to provide additional income to live off of. We work too hard to make money to invest in the first place, we should not have to pitch in more money just to keep the real estate business afloat.
This is exactly why we like investing in the midwest and southern US, where the 1% rule can be attained in solid markets with great job growth and a diversity of different industries. From our experience in Calgary (and most other major Canadian markets), the cost of rent is only about 0.5% of the average house price. This leaves investors to have to rely on hitting a homerun with appreciation and principal paydown to make a return. This is fine, but what happens when you get negative appreciation like we have seen in Calgary over the past 5 years? You end up working your butt off, self managing your own properties for negative returns.
Go for the 1% return and hit singles instead.