The 1% rule in real estate helps buyers determine whether potential rental income from an investment property will be greater than the mortgage payment. The idea is that the investor can break even on the property, if not make a profit.
Once you understand the 1% rule, you can establish a baseline rental amount for your tenants. As long as you don’t fall under that baseline, your investment should break even.
An overview of the 1% rule
The 1% rule asks investors to add the property price plus the cost of necessary repairs, then multiply the total by 1%. Ideally, you’ll charge monthly rent above that baseline, with a mortgage payment that totals less than the figure.
While the 1% rule isn’t the only factor you should consider when evaluating rental properties, it can help you assess the risk across different properties. For example, if the 1% rule suggests you should charge rent way above market rate in order to break even, you’ll know that it’s probably not a good investment at that time.
Related: Should I sell or rent my house?
Why is the 1% rule important for real estate?
The 1% rule helps purchasers determine whether they can make back the mortgage payments each month, which in turn helps them understand the risk associated with the profits. If you’re able to fund a second mortgage while renting out the real estate at a loss, properties that don’t meet the 1% rule may still be a worthwhile investment in other ways. Most people, however, want the security and cash influx that comes with a profitable investment property.
How to calculate the 1% rule
The 1% rule is easy to calculate. Simply add the cost of the home and the repairs together, then move the decimal point two spaces to the left.
For example, a $1,200,000 property with $300,000 in necessary repairs would cost $1,500,000 in total. Multiply by 1% by moving the decimal two spaces to the left. On a calculator, you’d multiply $1,500,000 by 0.01 to get $15,000. That’s how much you’ll need to charge at a minimum per month for the property.
Once you know the 1% figure, compare it to your potential mortgage payments. If the mortgage is under $15,000 per month, you’ve passed the test.
Pass: an example that meets the 1% rule
Consider a home priced at $550,000 which has historically commanded $6,000 per month in rent. The 1% rule suggests that the rent should be at least $5,500 per month (0.01 * 550,000=5,500.) Given that the historic cost of rent is greater, you’d be making a good investment.
Fail: an example that doesn’t meet the rule
On the other hand, imagine a home for $300,000, which has been rented out for $2,000 a month in recent years. 1% of $300,000 is $3,000, so this does not pass the 1% rule. Accordingly, you should either choose a different property or make an offer for no more than $200,000.
Limitations of the 1% rule
The 1% rule isn’t the end-all, be-all factor when choosing an investment property. For instance, it doesn’t account for property taxes, insurance, basic maintenance, and other operating costs.
Furthermore, if you buy property in particularly expensive areas, the price of rent is often far below the 1% figure. This suggests that your investment will take longer to pay off — or you’ll need to supplement the mortgage payment out-of-pocket.
Ultimately, the 1% rule is just one factor to keep in mind. You’ll need other information to help you determine whether a property is a good investment, even if it doesn’t meet the 1% rule. Working with a real estate agent with experience in rental and investments is one place to start.
Other real estate rules to keep in mind
Because the 1% rule has its limitations, here are some other ways to calculate whether an investment is worth it:
The 2% rule in real estate
The 2% rule is just like the 1% rule, but uses a different number. This effectively doubles the minimum monthly rent, but it’s helpful when you need to finance major repairs or you have trouble keeping renters. You’re more likely to be able to cover costs by working with the 2% rule — but it won’t be right for every market.
70% rule for flipping
The 70% rule for flipping helps investors figure out how much to pay for a property they want to rehab. This rule states that an investor shouldn’t pay more than 70% of the home’s after repair value (ARV), minus repair costs. For example, imagine an estimated ARV $200,000 home that needs $50,000 in repairs. 70% of $200,000 is $140,000. $140,000 minus $50,000 in repair costs is $90,000. You should pay no more than $90,000 for the property to flip.
Thinking of buying an apartment building?Here's how.
20% for down payment
When you take out a mortgage, you’re usually asked to put down a down payment. The percentage can vary, but 20% is standard. Consider whether you have enough cash on hand to meet the down payment. While this is the down payment standard for a conventional loan, you can always put down less.
Always evaluate a potential property investment
The 1% rule in real estate is a quick and easy way to determine whether a property is a reasonable investment in that market. Combining the 1% rule — along with other ways to assess the risk — can help you understand whether a property is a good deal, how much to offer, and what it will take to make it profitable.
Whenever you consider buying property, be sure to calculate costs vs. potential profit. It’ll help you avoid money pits and pay off your mortgage faster.
Related: Should i pay off my mortgage or invest?
FAQs
What is the problem with the 1% rule?
The 1% rule is criticized for oversimplifying the complexity of real estate investments and not taking into account various expenses such as taxes, insurance, and maintenance.
Is the 1% rule applicable in all real estate markets?
No, the 1% rule may not be applicable in some markets where property values are very high or where rental demand is low.
What is the 1 and 10 rule in real estate?
The 1 and 10 rule is another real estate investment guideline that suggests that investors should aim for a gross monthly rent that is at least 1% of the property's purchase price and a net profit margin of at least 10%.
What is the 100 to 10 to 3 to 1 real estate rule?
The 100 to 10 to 3 to 1 rule is a guideline for real estate investors that suggests a property's monthly rent should be at least 1% of its total purchase price.
What is a Gross Rent Multiplier?
A gross rent multiplier (GRM) helps you calculate how long it will take to pay off the investment. This is the purchase price divided by the gross annual rent. For instance, imagine the purchase price was $1,000,000 and you bring in $100,000 per year in rent. Dividing $1,000,000 by $100,000 = 10: it will take about ten years to pay off the mortgage at this rate. Of course, it doesn’t factor in maintenance, vacancy rates, property taxes, and other operating costs.
