What Is the 1% Rule?

The 1% rule is a real estate investment guideline that says that the monthly rent for a property should be 1% or more of the total investment in the property. This rule is an unofficial guideline and has its limitations, but it can help investors find profitable properties.

While it is not the only analysis tool, investors using the 1% rule can quickly evaluate a potential property for its ability to generate monthly rental income.

Learn what the rule is, how to use it, its limitations, and what alternatives investors have for evaluating a potential property for profit.

Definition and examples of the 1% rule

The 1% rule is a guideline that real estate investors can use to assess potential monthly rental cash flow. Multiplying the total investment (purchase price plus repair cost) by 1% will give investors a number that they should try to charge for the monthly rent.

If 1% of the total investment results in a competitive rental rate that also covers costs and produces monthly cash flow, investors can feel more secure.

Properties that meet or exceed the 1% rule have a good chance of making a profit. Properties that don't meet the 1% rule may have a hard time making money on a monthly basis.

However, there are other methods investors should use to evaluate long-term rental properties before disposing of a property based solely on the 1% rule.

How does the 1% rule work?

Applying the 1% rule to the purchase of a property involves a relatively simple formula that investors can use in two different ways:

Total purchase price x 1% ≥ Monthly rent
Monthly rent x 100 ≥ Total investment

You can use this simple formula to get a general idea of ​​what rentals would work for the price level of an investment property. For instance:

A $ 100,000 property must return at least $ 1,000 in monthly rent.
A $ 200,000 property must return at least $ 2,000 in monthly rent.
A $ 400,000 property must return at least $ 4,000 in monthly rent.
Generally, investors can use the 1% rule for two purposes:

Assessing the Earning Potential of a Property Before Buying It
As a guide on how much rent to charge

Keep in mind that the 1% rule is a general guideline and won't always work for properties in more expensive areas like New York, San Francisco, Boston, or San Jose.

In fact, investors can buy any property they can afford. What helps determine the 1% rule is whether that property will produce enough rent to cover expenses and cash flow each month. Real estate investors who use the 1% rule use it for properties they believe they own for the long term.

Jim Fitzgibbon, a licensed real estate investor and broker with Florida-based Ledge Real Estate Solutions, told The Balance in an email that he uses the 1% rule to value properties.

"If a house can adhere to the 1% rule, then I keep it in my portfolio of rental properties," Fitzgibbon said.

He recently bought and renovated a home in Winter Garden, Florida that follows the 1% rule. His total investment in the property was $ 200,000 and he receives $ 2,150 in rent, which is more than 1% of his investment.

Limitations of the 1% rule

The 1% rule isn't the only factor to consider when evaluating for-profit long-term rental properties.

Mark Ferguson, a veteran real estate investor at Colorado-based InvestFourMore, told The Balance in an email that investors should only use the 1% rule once they have determined that it will work for them.

"The housing market is so unique," Ferguson said. “Every property is different, every state is different, every city is different. Even the neighborhoods and streets are different within a city. While the 1% rule can provide a broad view of properties in a certain area, I don't think it should be used to decide whether a rental is a good investment or not. "

He explained the limitations of the 1% rule, which include:

Property taxes
Insurance rates
vacancies
Maintenance costs
Interest rate

“These costs will be different in each area. Property taxes in New Jersey can be 10 times higher than in Colorado, but the 1% rule ignores that, ”he said.

Another limitation investors may find is that the 1% rule works best for less expensive properties that may not be in optimal condition (what investors refer to as a "lower property class").

“A property's ability to meet the 1% rule varies greatly by property class,” Serena Parton, co-owner of Alabama-based Azalea Home Buyers, told The Balance via email. "Generally, the lower the property class, the more likely they are to meet this rule."

We hope you enjoy watching this video about What Is the 1% Rule

Source: Chandler David Smith

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