Starting research on real estate investing can be overwhelming since there are many metrics and factors needed to consider. Facing a long list of properties and figures, you don’t know where to start. There is a rule called the one percent rule (1% rule), which is used by real estate agents to quickly screen prospective properties. This article below will determine what the 1% rule in real estate investing is, how it works, and when to use them to evaluate an investment.
The one percent rule is a tool used to set rental rates, applicable to residential and commercial real estate properties. It is used to help investors determine if the monthly rental income can cover the monthly mortgage payment of that property. The way the 1% rule works is very simple, which is to multiply the property purchase price plus any necessary repairs by 1%, resulting in the base monthly rent. If you are financing, compare the results with the monthly mortgage to ensure that the rental will be greater than or at least equal to the mortgage payment. This is considered a quick test that investors use to determine if the rent-to-value ratio is appropriate.
Let’s take a look at an example. Assume that you are considering an investment of $200,000. Applying the 1% rule, we get the result of $2,000. That means, your monthly mortgage payments should be less than $2,000. If your mortgage debt exceeds $2,000 per month, it may result in a negative cash flow. In addition, you should rent out your property with at least $2,000 a month, ensuring it covers monthly mortgage debt.
So, when to use the one percent rule? It is used as a prescreening tool to save time while looking for good investment purchases. For example, you have a long list of properties that don’t know where to start, the 1% rule is the first thing you can use to help filter the results. Use this method to estimate 1% of the selling price. Once you have a series of results, compare those numbers with the real estate rental rates in the market. If the rental is close to or greater than 1% of the asking price, then that property is worth further research. Otherwise, you can just remove that option.
While this rule can help investors assess the potential risks and achievable returns, it should not be considered the determinants of investment property’s success. As noted above, the 1 percent rule is only useful when being used as a screening tool in the early stages of evaluating real estate investments. Moreover, this rule does not take into account other costs, which are insurance, taxes, repair and maintenance. In most cases, investors should analyze many factors and look for numbers beside the 1% rule to determine if there is a good opportunity for a positive return.
The 1% rule is a useful method in the initial evaluation of a real estate investment. However, it is just one of many indicators to consider before buying an investment property because it does not provide a full overview of the potential of an investment. In order to make an investment decision, there are many important factors such as status, location, expenses, income, or the value of the property should be determined throughout the purchase.
Author: Vy Yakushenko
Carson, C. (n.d.). The One Percent Rule – Quick Math For Positive Cash Flow Rental Properties. Retrieved from https://www.coachcarson.com/one-percent-rule/
Christensen, K. (2020, November 23). What are the 1% and 2% Rules in Real Estate Investing? Retrieved from https://www.realwealthnetwork.com/learn/1-percent-rule-2-percent-rule-real-estate-investing/
Kopp, C. (2020, November 11). One Percent Rule. Retrieved from https://www.investopedia.com/terms/o/one-percent-rule.asp