The 10% rule actually consists of three rules. They are meant to be a quick and minimal way for real estate investors to check that they’re making a good deal on a new investment. Having some simple-to-follow rules in your back pocket is always a good tactic to help eliminate potential bad deals early on and with little effort.
10% Down Payment
The first part of this rule is a maximum down payment of 10%. This allows you to use plenty of leverage. Rather than tying money up in a single investment, you’ll have more to use towards other investments.
For example, you find a house that’s priced at $300,000. 10% down is $30,000. After one year, the house increases to $320,000, a 6.25% increase in value. However, a $20,000 increase on a $30,000 down payment translates to a 66% return. Keep in mind that this is a simple example and isn’t factoring in loan interest, closing, and other transactional costs.
To see the impact of using less leverage, if you had put down 20% or $60,000 and the house would have risen in value to $320,000 after one year, the return would have been lower. Now we’re talking about 33%, which is still great, but only half of the return from the previous example.
From these examples, you can see that the more leverage used (i.e., the smaller the down payment), the higher potential for more returns.
However, leverage works both ways — if the house goes down 20%, now you're looking at a -66% return on $30,000 invested.
Buy 10% Under the Market Price
This rule is basically to avoid paying the sticker price. Instead, look to buy at least 10% under the listed price. In real estate, there's a saying that most of the return is made at the time of purchase. Meaning that most of the money is made on the purchase rather than rental income.
It may seem impossible to find anything under 10% in today's hot housing market. While it may be difficult, it isn't impossible. Here are a few things to try:
- Auctions and foreclosures
- Pocket listings — these are non-public listings (i.e., not on the MLS). With a pocket listing, a realtor shares a private listing with only a select few people. The downside, you need to be one of those select few.
- Depressed neighborhoods — these are neighborhoods that are currently depressed, but you believe they have the potential for an upswing (i.e., gentrification). It requires seeing something that others aren't and willing to wait it out.
- Exclusive-Agency Listing — the seller doesn’t pay a commission with this listing. While it might not get you to 10%, it can come close.
10% Interest Rate Maximum
Current 30-year mortgage rates are nowhere near 10%, so this rule doesn’t apply in modern times. That doesn’t mean it isn’t valid. There may come a time again when rates are over 10%.
Getting a lower rate depends on several factors, including credit score, down payment, and whether the property is a residence vs. an investment.
Following the 10% rules can be a great starting point for beginners. It provides a way to quickly evaluate an investment before laying down any money. These three rules can also provide a foundation for beginners to build on by adding their own rules with time.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Examples shown are hypothetical and for illustrative purposes only.