The one percent rule serves as a handy benchmark for real estate investors to evaluate potential income-generating properties. While not a guaranteed indicator of success, it offers valuable insights when assessing investments, especially for those focused on rental income.
Exploring the One Percent Rule
The rule is a straightforward method to gauge a property’s financial prospects, comparing the potential rental income to the purchase and repair costs. It suggests that the monthly rent should be at least one percent of the property’s total cost. Similarly, it advocates for the monthly mortgage payment to be less than one percent of this cost. Note that this rule does not account for additional expenses such as taxes, insurance, or maintenance.
Importance of the One Percent Rule
This rule is essential as it provides a quick measure to determine if a property can break even or possibly generate profit by ensuring the rent covers the expenses. It also offers a reverse application, helping to establish the rent needed per square footage to be competitive within the market.
Applying the One Percent Rule to Rental Properties
The rule is particularly effective as a preliminary filter for rental properties, allowing investors to swiftly estimate a property’s viability and alignment with current market rates, applicable to both residential and commercial sectors.
Calculating the One Percent Rule with Examples
Calculating this rule is simple: take the total acquisition cost and multiply by one percent. This cost includes the purchase price, any financing and closing fees, and repairs—but excludes ongoing expenses.
- Example 1: A house costing $220,000 in total, requiring a rent of $2,200 to meet the one percent rule, which it does at a $2,400 rent.
- Example 2: A property with a high-interest mortgage results in payments exceeding the one percent threshold, barely missing the rule’s criteria.
- Example 3: In an economically struggling area, even with low mortgage payments, low rent rates may fail to meet the one percent mark.
- Example 4: A commercial property, after all costs considered at $600,000, would need to bring in $6,000 a month, which it surpasses, making it a suitable candidate per the one percent rule.
Weighing the Pros and Cons
The one percent rule is not without its advantages and drawbacks.
Pros:
- It provides a quick financial screening for properties.
- Helps minimize risks by avoiding investments that constantly require additional funds.
- It’s a good predictor for positive cash flow.
Cons:
- It’s an oversimplified measure that omits crucial costs like taxes, insurance, and maintenance.
- It may overlook potential appreciation values.
- In high-cost markets, it might limit available investment options.
- It neglects specific property expenses that could affect profitability.
Alternative Real Estate Investment Metrics
When the one percent rule doesn’t fit the bill, other metrics might come into play:
- 2% Rule: A more conservative version of the one percent rule, demanding double the rental income.
- 28% Rule: A guideline for personal homebuying, limiting housing expenses to 28% of one’s income.
- 70% Rule: A formula used by property flippers, focusing on spending no more than 70% of the after-repair value (ARV).
Final Thoughts
The one percent rule is a practical starting point for identifying promising investment properties. It’s a tool to weed out less favorable options quickly but should be complemented with a thorough analysis to determine a property’s true investment potential. Use this rule as the initial filter, and delve deeper into any qualifying property to make an informed decision.