The 1% rule is an informal rule of thumb frequently used in real estate investing to determine the amount of rental income required to meet or exceed the expenses associated with owning an investment property. The rule provides a simple way to ensure that the property is likely to be cash flow-positive, assuming selling price and market rent. Through the application of the 1% rule, investors can have access to better property options vs. properties that they should steer clear of.

Basics:

There is a general consensus that the monthly rental income from a property investment should fall on or above 1% of a property’s current asking price, while holding necessary repairs constant. This rule is a really fast and convenient guideline on the estimation of whether the property is potentially profitable. The property would be far better situated to be covering cash flow issues when a rental can approximate or exceed this 1% guideline, freeing up more money to pay those mortgage amounts and eventually realize a positive cash flow. That is, conversely, if the rental rate does not hit the psychological threshold of 1%, the property will not cash flow and there is likely no business deal to even contemplate.

How to Apply the 1% Rule?

The 1% rule could be used many times over in any real estate investment process. To start with, it can amount to a preliminary screening tool assessing candidate properties. This, an investor should be able to quickly do for every candidate property: apply the 1% rule in checking whether it is worth a closer look; that is, further analysis. By further analysis, it necessarily means more in-depth financial projections and reviews, property condition reviews, and location reviews.

Yet another application of the 1% rule in practice can be seen in finding the right rent price for a vacant property. As is always the case, local market conditions and comparable rents need to be considered, but the rule itself offers a jumping-off point for the rent level likely to cover your mortgage and other expenses.

 The 1% Rule in Action:

One valuable rule used is the 1% rule for a really rough idea of a property’s cash flow abilities. A property consistent with the rule highly likely has a positive cash flow, other things held constant, including the rate of repairs and management through fees. On the contrary, a property not meeting the 1% rule may potentially have a negative cash flow, which might put financial stress on an investor.

The 1% rule is sort of a litmus test that most cash flow investors perform. If a property doesn’t pass, they will consider it non-viable for investment and move on to another with better potential for cash flow.

 Limitations and Considerations:

As useful as the 1% rule can be, it is not free from limitations. Real estate markets are so varied, and at times, this rule may not be applicable. For instance, in high-cost areas, it might be problematic to find such conforming properties although still remaining profitable. Nor does the formula take into account other important variables, such as property taxes, insurance, or maintenance, which may impact the overall profit or loss a property incurs.

Investors should also consider other real estate rules and calculations beyond the 1% rule, though. As just one instance, there is the 50% rule, which suggests that, on average, non-mortgage expenses need to reflect 50% of collected rent. In the flip niche, the 70% rule explains that an investor should not buy if the potential flip property price is higher than 70% of the After Repair Value. This additional measure joins the others in an even better measurement of a property’s potential profitability.

Conclusion:

The 1% rule applies and is supposed to very quickly let an investor know whether an investment rental is more likely than not to produce a positive cash flow. It should not be a deal killer; instead, it should be the starting point that influences the analysis in determining the price to rent your property. The 1% rule, together with other criteria for owning real estate and the overall analysis of a property in terms of its condition and market conditions, make an investor come up with very informed, very low-risk decisions, thereby increasing his chances of success in the real estate market.