HERE ARE THE BASICS
These real estate investing rules are all about using income discipline when buying investment properties. That said, they are not hard and fast rules. The 1% rule is simply a quick test to see if a property’s rent-to-value ratios are healthy or not. Next, I’ll show you how to calculate the 1 percent rule and when it might be helpful to use.
WHAT IS THE 1% RULE IN REAL ESTATE INVESTING?
The 1 percent rule in real estate is used to determine if the monthly rental income earned from the property is more than, or at least equal to one percent of the purchase price.
Monthly Rental Income ≥ One Percent of Purchase Price
You can get the same result by reversing the 1 percent rule:
[100 x Monthly Rent = Maximum Purchase Price]
If a property rents for $1,700 per month, after a quick calculation, you know that the purchase price should be around $170,000. Keep in mind that the rental market dictates rental values, not the purchase price of a home.
How the 1% Rule Works
To calculate, multiply the purchase price of the property plus any necessary repairs by 1%. If you’re financing, compare the result to your potential monthly mortgage and you will have a better understanding of a property’s monthly cash flow. Note: The 1 percent rule is best used as a quick, “back of napkin” litmus test that investors use to determine whether rent to value ratios are healthy or not. It doesn’t account for additional costs like insurance, taxes, and maintenance.
Example of the 1% Rule
Let’s assume that you are looking to get a mortgage loan on an investment property with a value of $200,000. Using the 1 percent rule, multiply $200,000 by 1%. The result of your calculation would be $2,000.
What the result of the 1 percent rule tells us is that your mortgage payments each month should be no more than $2,000. If the mortgage owed exceeds $2,000 per month, it will be difficult to earn positive cash flow on the investment property.
An exception would be if you are confident you can rent out the property for more than $2,000 per month. In most cases, it’s wise for investors to dig deeper into numbers beyond the 1% rule to adequately determine if they add up and whether there’s a good opportunity for a positive return on investment.
Takeaways:
According to the 1% rule, rental income should be equal to or greater than the purchase price.
Take the purchase price of the property plus expenses for necessary repairs and times by 1% to determine whether rent-to-value ratios are healthy or not.
Rental markets dictate rental values.
