digest
Short Summary
Main recommendation: Stop treating the 1% rule as a required threshold for rental property deals and instead evaluate investments on total return, not cash flow alone. The speaker says rent-to-price ratio (RTP) remains a useful screening tool, but the 1% benchmark no longer fits today's market.
Key Points
- RTP is calculated by dividing median monthly rent by median home price; the speaker's example of $1,000 rent on a $200,000 home yields 0.5%.
- The speaker's study found RTP correlates with cash-on-cash return at 0.85, a strong relationship, so RTP is still a valuable metric.
- The 1% rule came from the post-financial-crisis era, when home prices fell faster than rents, and that gap has since reversed.
- The average US RTP cited by the speaker is 0.51%, and the average cash-on-cash return is negative 7%, so the 1% threshold excludes most markets.
- Philadelphia (RTP 0.77%, cash-on-cash return 11%) and Avondale, Arizona (RTP 0.56%, cash-on-cash return of 1%, which the speaker notes is well above the national average) show that deals below 1% can perform well.
Details Worth Noting
- Concrete instructions:
- To screen a city or neighborhood, divide median rent by median home price and treat anything above about 0.5% as worth considering.
- To screen a specific deal, use a threshold of about 0.65% as the point where it becomes worth entering detailed assumptions and expenses to calculate actual cash flow.
- Analyze deals using total return, counting cash flow, appreciation, amortization, and tax benefits together rather than cash flow alone.
- Build equity over time, since equity can later be converted into cash flow (for example, by selling and buying properties for cash).
- The speaker notes that for a cash buyer, the cap rate equals the cash-on-cash return; his illustration was $2 million at a 5% cap rate producing $100,000 a year, or $140,000 at 7%.
- Cash flow matters more for those planning to quit their job or retire soon; the speaker's view that cash flow is less important applies to investors who plan to keep working full-time for another 10 to 15 years.
- The speaker frames the 1% rule as a rough guideline, not a law, and says it used to be more useful than it is today.
Bottom Line
The 1% rule is outdated as a hard filter, so investors should screen with RTP using lower thresholds and judge deals on total return rather than cash flow alone.
