The 1% rule is a general guideline for figuring out the potential cash flow of a property. In short, it rules that investors ought to set the monthly rent of property at least 1% of the total spent on purchasing it. Does every investor need to follow this rule? Not necessarily, as it does not tell the entire story of an investment property’s potential, but it can be helpful as a baseline evaluation. So let’s talk about it.
What is it?
The 1% rule is frequently cited by real estate investors when they evaluate the potential cash flow of an investment property. This guideline states that to make a solid profit, the monthly rent ought to equal greater or equal to 1% of the investment property’s total purchase price. It’s a tool to assist you in quickly determining whether you will be able to earn a monthly income from the rental property that exceeds your monthly mortgage payment.
For instance, if you are looking to invest in property that costs $140,000, then according to the 1% rule, you can set the rent at $1,400. Once that is set, you can focus on getting a mortgage payment under $1,400, which means that you’ll be able to meet your monthly payments and earn extra on the side.
Is it realistic?
While many investors may find the 1% rule useful, this strategy has a handful of shortcomings. For instance, many investors may use the 1% rule as their main initial screening, which is a big mistake. More seasoned investors, on the other hand, will take into consideration their personal tax strategy. An investor who addresses all approaches in terms of tax deductions and depreciation, for example, will find more value in a property that doesn’t meet the 1% rule.
Another shortcoming is that the 1% rule does not necessarily consider additional property expenses. These might include repairs, fees resulting from acquisition and closing costs, insurance, or property taxes.
Rental properties that do not meet the 1% rule are not automatically bad investments. On the flip side, just because a property meets the 1% rule does not mean that it is necessarily a good investment either. In some markets, the 1% rule is not at all practical, while in others you can find properties that will easily attain the 2% rule. But since it isn’t a rule to be applied in all situations, let’s look at when it is a useful guideline to use and when it is not.
When to use it
The 1% rule helps prescreen rental properties. If you have several properties that you are evaluating, then this rule can quickly help you narrow down your lists to identify which may be the best investment for you. After which, you are free to do more research.
When not to use it
While good in helping narrow down a list of properties that you are interested in, the 1% rule should not be used as a deciding factor on whether you’ll invest in a property or not. Instead, there are other determining factors (such as the condition of the property, what kind of neighborhood, or current market trends) that you should be looking at instead. Remember that the 1% rule does not completely rule out properties that do not meet it, and to make sure to look at your tax strategy when screening properties.
The 1% rule is best used when looking at single-family homes. But if you’re looking at multifamily units or high-priced markets, it may be too small.
When a property doesn’t meet the 1% rule
Properties that don’t meet the 1% threshold still have investment potential. Before writing a potential investment property off, consider some of these other factors that can influence the overall rate of return. Some of these factors include the quality of the neighborhood, current renters, projected growth in rent and local market, appreciation, property condition, and local amenities.
Some properties might not check all the boxes but might check enough of the right ones to be considered a good investment, depending on what kinds of risks you are willing to take. While not all properties make the 1% rule at first, other factors can turn those properties into lucrative long-term investments.
Although the 1% rule is just one part of the screening process, it can be a useful way to gauge a quick estimate of a potential property’s cash flow capacity and provide a target rental rate. This will lead to properties that match your investment goals.
At the end of the day, there isn’t any single rule that will determine which properties to invest in. Rather, it’s best to know what your investing criteria are, and then follow up with a blend of factors and screening tools to help assist you to make an informed decision.
As leaders in the turnkey real estate investing arena, our team at High Return Real Estate aims to assist our clients to achieve financial freedom through real estate. We make available professionally managed turnkey rental properties performing at high rates of return to create lucrative streams of income for our investors.