From a big picture perspective, the one percent rule is used in real estate investing to evaluate the cash flow of a property and can serve as a crucial component to determining its investment potential. For example, if the monthly rent for an investment property exceeds the its monthly mortgage payment and operating costs, the property is - at least on the surface - profitable.
The one percent rule states:
The monthly rent on a real estate investment should be equal to or greater than one percent of the total purchase price of the property.
“The goal of the rule is to ensure that rent will be greater than, or - at worst - equal to the mortgage payment, so the investor at least breaks even on the property”, wrote Investopedia.
The one percent rule can also provide a solid baseline when determining how much rent to charge on any given real estate investment, including both residential and commercial properties. Still, buying property for investment purposes requires an extensive analysis of many different factors, and the one percent rule is just one of many tools that can help investors evaluate the real risk and rate of return on any given piece of real estate.
How Flexible Is the 1% Rule in Real Estate Investing?
Since the one percent rule doesn’t take repairs, maintenance, taxes, insurance, closing costs and other property expenses into account, it’s definitely not an ironclad rule and should never serve as the single deciding factor for investors during the process of evaluating the viability of a real estate investment. Think of it as more like a “guideline” than a hard and fast “rule,” and just like pretty much everything else in life, you should never follow it blindly! Instead, use the one percent rule in real estate investing as a solid way to screen potential investment properties, but also be sure to take the overall quality of the property, its location and the existing tenants into consideration before jumping in.
Other Fundamental Factors to Consider Before Investing in Real Estate
- Your Personal Goals
- The Local Real Estate Market
- Forecasted Home Price Appreciation
- Projected Rent Growth
- Local Demographics
- Area-Specific Socioeconomic Trends
- Regional Foreclosure Rates
- Area Vacancy Rates
- How Many Days on the Market
- Barriers to Entry
If the market you are interested in is in the middle of rapid population or employment growth, it’s probably a great time to invest in real estate… Just be sure to get in before the increased demand causes a spike in prices and competition makes it cost prohibitive to invest. Finally, it’s essential for investors to determine the risk and return threshold for each investment property you are considering. For example, a lower-priced home might come with more inherent risk, but will typically generate much higher cash-on-cash returns. On the other hand, if you’re focused on secure ongoing income, you should invest in property with a proven track record of providing excellent ROI.
Now, more than ever before, it’s time to protect your assets! Stop losing sleep in the stock market and download our FREE guide, 6 Steps to Investing in Real Estate with an IRA Account.