Real estate investment is very different from some of the other investment routes that you may consider exploring.
There are lots of things that you need to consider with real estate investing that you don’t have to with other types of investments, and a lot of this is due to the fact that real estate investing comes with tangible assets.
One of the biggest things that you need to consider is which property you should initially invest in. Especially if there are a range of options available.
Thankfully, through the many years of real estate investing being popular, there are a number of rules that you can use to help you choose the right property for you.
The 1% rule is one of these. But what is the 1% rule in real estate investing? And how ironclad is it?
In this guide, I’ll be taking a look at what the 1% rule is in real estate investing, and how ironclad this rule is. So if you want to find out more, keep on reading!
What Is The 1% Rule In Real Estate Investing?
Before I tell you about anything else, let’s take a look at what the 1% rule is. The 1% rule is essentially just a very basic calculation that is priceless when it comes to analyzing properties that real estate investors plan on purchasing to have as rental properties.
It allows you to calculate the profit that you could make through renting that property
Basically, the 1% rule says that the monthly rent for the property should cost equal to or greater than 1% of the value of the property. If it is not, then the property will not make you any profit, and it will actually have a negative impact on your cash flow.
So, when you are analyzing a potential rental property, you should consider the 1% rule.
While the 1% rule is commonly used in real estate investing, it doesn’t take into account all the expenses that are associated with owning a rental portfolio.
It also doesn’t take into account other metrics that need to be considered, including cap-rate and long-term appreciation. For this reason, some investors will choose to dip below the 1%. However, this will typically be done after the purchase.
Generally, the 1% rule is just a very useful tool to use when it comes to purchasing properties to add to your rental portfolio. It can help you screen out properties that could cause you to lose money and really help you find diamonds in the rough.
But is it an ironclad rule? Let’s find out.
How Ironclad Is The 1% Rule?
While the 1% rule is commonly used in rental properties in real estate investing, it isn’t actually ironclad. There was a time when this rule would have been followed steadfastly.
However, the property market is constantly changing, and as a result, so are the rules associated with real estate investing.
As we have just mentioned, the 1% rule is commonly used by those in real estate investing to figure out if a property is worth it, or not.
When you are looking at properties that may potentially be available, it is really easy to calculate the potential value, and as a result calculate what 1% of that value would be.
With your market knowledge, you will be able to tell if this is a realistic amount to charge for rent, and as a result calculate if the property is worth the purchase.
As a screening rule, the 1% rule works incredibly well. However, beyond this, the rule does start to falter and that is why it is no longer as ironclad as it once was.
While it would have commonly been used in the past, there are now simply too many circumstances where the rule may not work, and this mainly comes down to accuracy.
Is The 1% Rule Accurate?
Unfortunately, the 1% rule is no longer as accurate as it once was, and this is the main reason why most people only use it as a pre-screening tool.
The 1% rule doesn’t take into account a lot of things, including maintenance, property taxes, expenses, insurance, and lots more.
The 1% rule is also inaccurate depending on where you plan on buying. The property market can vary greatly depending on location, and the 1% rule is particularly ineffective in certain cities.
Purchasing homes in cities is often very expensive, and as a result it is very common for rent to be charged at less than 1% of the property’s values.
While you can utilize the 1% rule, it is very important that this isn’t the only rule that you use. Especially when you are purchasing in a new area.
Do your research of the area as well just in case the average rental price is lower than 1% of the value of the property. This will help protect your investment and ensure that you do not lose money through your rental portfolio.
Pros And Cons Of The 1% Rule
As you can see, the 1% rule can be both useful and unhelpful when it comes to real estate investing. So, let’s take a look at some of the pros and cons to help you decide if this rule will be beneficial to you.
- Quick and Easy – It doesn’t take long to calculate the 1% rule and it is a very basic calculation to make.
- Helpful Screening Tool – If you have a lot of properties to choose between, the 1% rule can really help you screen out inappropriate properties.
- It Has Worked – In the past, the 1% tool was incredibly accurate, so as long as it is adapted with the property market, it could be useful to you.
- It Leaves Things Out – The 1% rule doesn’t take into account a number of things, including insurance, property tax, expenses, etc.
- Doesn’t Consider Location – There are some areas where rent is cheap and doesn’t translate to 1% of the property’s value. The 1% rule doesn’t take this into account.
Other Rules To Consider
The 1% rule isn’t the only rule that is used in real estate investing. So to avoid any confusion, here’s a quick overview of some of the other rules you may want to consider in real estate.
The 70% Rule
This rule is commonly followed by those who invest in real estate by flipping homes. This rule states that the investor should pay no more than 70% of the after repair value (ARV) of the house minus the costs for repairs when purchasing a property.
The 50% Rule
This rule says that operating expenses (excluding mortgage payment) should equate to about half of the gross rental income. This ensures that you are making a profit on your portfolio.
The 2% Rule
This is essentially a stricter version of the 1% rule that states that the gross monthly rent must equate to 2% of the property’s value.
In short, the 1% rule in real estate investing is by no means as ironclad as it once was. This rule is now commonly used as a pre-screening tool to discount properties that wouldn’t be suitable for your rental portfolio.
In this guide, I have taken a look at the reasons behind this.
Thanks for reading!
Frequently Asked Questions
How Accurate Is The 1% Rule?
It is important to recognize that the 1% rule isn’t foolproof. As we have said in this guide, it is a rule of thumb, rather than something that should be seen as set in stone.
While the 1% rule is fairly accurate, this isn’t always the case, as we have discussed in this guide. So it is very important to bear this in mind when using the 1% rule.
How Important Is The 1% Rule?
The 1% rule is pretty important as a pre-screening tool. But beyond a pre-screening tool, the 1% rule becomes less important as there are lots of other important factors that you should consider.
If you are at the early stages of real estate investing, and are simply looking for properties to take out of the running, then the 1% rule is important.
Is It Worth Using The 1% Rule?
If you are thinking of using the 1% rule as a pre-screening tool, then it absolutely is worth it. But beyond this, we would generally say that it isn’t worth using the 1% rule, simply because it isn’t as effective as some other rules you can use.
Paul Martinez is the founder of BendingDestiny.com. He is an expert in the areas of finance, real estate, and eCommerce.
Join him on BendingDestiny.com to learn how to improve your financial life and excel in these areas. Before starting this blog, Paul built from scratch and managed two multi-million dollar companies. One in the real estate sector and one in the eCommerce sector.