Are you someone who loves browsing real estate listing sites, imagining the possibilities? Whether you’re daydreaming or seriously considering potential investment properties, it’s always exciting to explore the options. But when it comes to evaluating whether a property could be a profitable investment as a cash-flowing rental, I rely on a straightforward tool: the 1% rule. This simple guideline helps me quickly decide if a property is worth pursuing further.
What Is the 1% Rule in Real Estate?
The 1% rule is a basic yet effective way to evaluate a property’s rental income potential. Here’s how it works: take the property’s purchase price and calculate 1% of that amount. Then, assess whether the market can realistically support that figure as the property’s monthly rental income.
An Example of the 1% Rule
Let’s break it down with a simple example. Say you’re looking at a property listed for $200,000.
1% of $200,000 is $2,000.
Now, the key question: Can this property command $2,000 in monthly rent in your market? If the answer is yes, it could be a strong candidate for a profitable investment.
Factors Beyond the 1% Rule
While the 1% rule is an excellent starting point, it’s just one piece of the puzzle. Here are some additional considerations:
- Expenses: Beyond the purchase price, account for maintenance costs, HOA fees, property taxes, insurance, and other expenses.
- Property Features: Factors like the number of bedrooms, square footage, and neighborhood location can significantly influence rental rates.
- Property Class: Real estate properties are often categorized into classes (A, B, or C), which indicate their quality, condition, and neighborhood. Ensure the property’s class aligns with your investment goals.
Next Steps After Applying the 1% Rule
If a property passes the 1% rule, it’s time to dive deeper. This is when I partner with my team to conduct a cap rate analysis and further evaluate whether the property aligns with our investment strategy. If the numbers look good, it might be time to make an offer.
Market Conditions and the 1% Rule
It’s worth noting that the effectiveness of the 1% rule varies by market. Ten years ago, it worked well in many areas where property prices were lower. However, rising prices in certain markets have made 1% opportunities harder to find.
That said, the rule can still be a valuable tool in specific markets or situations, especially in regions where property prices and rental rates are well-aligned. For high-cost or luxury markets, you may need to adjust expectations or explore alternative evaluation methods.
Does the 1% Rule Work Everywhere?
Not every market supports the 1% rule. For example, in areas with million-dollar properties, it’s unlikely the market can sustain $10,000 in monthly rent. Conversely, some luxury markets might support higher rental yields, even for expensive properties.
The key is understanding your local market dynamics and using the 1% rule as a starting point for further analysis.
Other Real Estate Evaluation Tools
In addition to the 1% rule, seasoned investors often use these tools to assess potential investments:
- Gross Yield
- Cash-on-Cash Return
- Cap Rate Analysis
- The 50% Rule
Want to Learn More?
If you’re interested in exploring other real estate evaluation methods or want to dive deeper into the details, let me know. The 1% rule is a great first step, but combining it with additional tools and strategies can lead to smarter investment decisions.
