WHY THE 1% RULE of real estate investing DOESN'T WORK...

Ever wonder why the 1% rule of real estate investing doesn't work? What happens if you don't meet it?

Transcription:

Kenneth Yim:

So it's Kenneth Yim from Broadview Avenue group from Keller Williams.

Michael Ng:

and Michael Ng from the Broadview Avenue group,

Kenneth Yim:

actually we said that twice.

Michael Ng:

Did we?

Kenneth Yim:

Yeah. It's Ken- (both laugh)

Kenneth Yim:

Hey everyone. First of all, you guys should meet Michael Ng. He is new to the team. He's been here for three weeks now, learning training, but I don't have to train him much. He's been in the business for five years working with buyers.

Michael Ng:

Yep. Mostly first time home buyers, you know, some investment clients.

Kenneth Yim:

Okay. So it's five years in the business. So he knows what he's doing. His area of expertise is...

Michael Ng:

... East Toronto anywhere up until Woodbine and parts of downtown Toronto.

Kenneth Yim:

Okay. Awesome. I'm sure you guys, have heard about the 1% rule of investing in real estate. That's basically the gross monthly rental that you're going to get. So say you get $2,500 from a tenant, then rent should be no more than 1% of the purchase price, which makes the purchase price at $250,000. Where in Toronto are you going to find that? You're not going to find that anywhere.

Kenneth Yim:

If you miss out on the 1% rule, then that means... What is it now in Toronto?

Michael Ng:

Really, we see a range from anywhere from 0.3% to 0.4%. It really depends on what sort of real estate you're buying, whether it's commercial or whether it's residential.

Kenneth Yim:

or how many units.

Michael Ng:

or how many units. Exactly. It's sort of tough to gauge exactly how close to the 1% rule you should be, which is why I'd say the 1% rule probably doesn't apply to Toronto at all.

Kenneth Yim:

Yeah. It applies maybe in other parts of the States where purchase prices are lower.

Michael Ng:

Yeah.

Kenneth Yim:

Right. So if it's less, that means you're getting less cash flow. That means you may or may not be cash flow positive more than likely not cash flow positive with 20% down. And actually for that matter, it's not 20%. Now. It doesn't matter how much down you have because you don't, you're not supposed to include financing in your cash flow analysis.

Kenneth Yim:

Well, real cash flow. Yes. But not in your cap rate analysis. anyway.

Michael Ng:

So the cap rates, essentially what we look at to see if an investment is worth what the price is and its net operating income divided by the price of purchase with that cap rate, essentially we can gauge whether an investment's better than another one. It's just one of the tools that we use.

Kenneth Yim:

Sure. That's annual income. Its annual net income and net income, meaning the gross rent minus the expenses, which generally is about half of what your income should be, which includes property management, maintenance and repairs, vacancies, taxes, insurance, things like that. So it should be about 50% of your rental income.

Michael Ng:

Which is one of the rules that we talked about as well.

Kenneth Yim:

Right, right.

Michael Ng:

The 50% rule.

Kenneth Yim:

Right. Right. And that generally holds true, I think in Toronto, because I think labor is still the same as anywhere else really.

Michael Ng:

Yeah. For sure. I mean, unless you're buying in condominiums where sometimes your maintenance fee might throw that rule out of whack, but it depends.

Kenneth Yim:

Well, on one hand the maintenance fees like of you're paying maintenance fees in a condo, it's a little more expensive, but you don't have to change any roofs.

Kenneth Yim:

You don't have to do any kind of major buyer insurance. You have just condo insurance, a lot cheaper than regular house insurance, things like that. Right. So,

Michael Ng:

Yeah. I'd say it's a case by case.

Kenneth Yim:

Right? So what happens if its cash flow negative? Do you still want buy the property or not

Michael Ng:

It depends on your situation entirely. I mean, there's an opportunity for everyone. I think that if you are cash flow negative, maybe you are the type of buyer.

Michael Ng:

that needs to prove that you have a cash flow negative property for tax purposes or what not.

Kenneth Yim:

You can make anything cash flow positive.

Kenneth Yim:

Really, if you just count financing that is, you just got to put more money down, that's it. And it'll be cash flow positive.

Michael Ng:

Or, I mean, even if you're throwing an extra $200 or $300 on a property, it's, you know, you're, you're essentially paying down your mortgage anyway.

Kenneth Yim:

Right. And then by 25 or 30 years, you have the place completely paid off because that's the amortization of a mortgage and a lot can happen within that time.

Kenneth Yim:

Even if it's at 15 years, I'm sure you pay more than half of it off, which is great. And rents appreciate.

Michael Ng:

Yeah.

Kenneth Yim:

So in the short run, yeah. It'd be cash flow negative for a little while, but if you hold the asset long enough, I think it'll be fine.

Michael Ng:

Yeah. I mean, real estate should always be approached with a calmer state of mind. I think you should always think about the future and what you can do with your real estate investment.

Kenneth Yim:

It's a long-term investment in other words.

Michael Ng:

Well, I mean, long term depends on person-to-person. Maybe it's five years, maybe it's 10 years. But I do think that we probably shouldn't flip the property that you bought in six months.

Kenneth Yim:

Or you could, you make a small profit, but then as you're subject to capital gains.

Michael Ng:

Exactly.

Kenneth Yim:

and all that stuff and it just doesn't make sense. Right. We don't have any 1031 exchange (tax write offs) here,

Michael Ng:

Unless it's a great deal. And you can offset the land transfer tax on the capital gains and whatnot that you have to pay for it within a year.

Kenneth Yim:

Right. Right. And then re purpose that capital in something else.

Michael Ng:

Exactly.

Michael Ng:

So we'll talk about that in another video of when to actually exit your real estate investment. But this time around, let's talk about how I actually don't even like cash flow positive properties.

Kenneth Yim:

I don't like them. I mean their great and all, but you're not going to get rich off of cash flow.

Kenneth Yim:

Like the issue is you're not going to retire off cash flow. It's going to be really difficult. You have a lot of, at least in Toronto, you have to have a lot of (money in) assets for that.

Kenneth Yim:

And when it's cash flow negative, that just means that the asset is expensive and chances are probably still going to be more expensive down the road when someone else buys it off of you.

Michael Ng:

Absolutely. Because of its cash flow negative, the odds are, it's a highly desirable property.

Kenneth Yim:

That's right. That's right.

Michael Ng:

And that doesn't change overnight. I mean, if it's desirable now, unless people suddenly leave Toronto and never come back, it'll still be-

Kenneth Yim:

Which is kind of happening right now. But in the short run anyway, I think it's the change. Yeah. When offices get back to normal and the world and we get the vaccine and everything, but we'll see about that.

Kenneth Yim:

Okay. So it's Kenneth Yim signing out from Keller Williams, Broadway Avenue Group with Michael Ng. If you have any questions, go to the website, click on the button to book an appointment and we'll talk to you soon.

Michael Ng:

See ya guys.