Have\nyou heard of the 1% rule for real estate? If you\u2019re looking to invest in real\nestate, it\u2019s basically your guideline for evaluating that potential for a\nproperty purchase. This rule of thumb can be pretty handy when it comes to\nmaking smart investment decisions in real estate. <\/p>\n\n\n\n
Basically,\nthe monthly rent of that property should be at least equal to (ideally greater\nthan) 1% of that total purchase price. If it\u2019s not, it\u2019s probably not a smart\nway to invest your money, not to mention your time too. <\/p>\n\n\n\n
Of\ncourse, this isn\u2019t a hard and fast rule. There are times when going with the 1%\nrule will certainly be the right path, but there are also times when you\nshouldn\u2019t use it. Not to worry though, I\u2019ll cover all of that below as well as\neverything else you need to know so keep reading!<\/p>\n\n\n\n
All\nit takes is a little bit of math to make this simple calculation. You\nmultiply the purchase price of the property in question and add in any\nnecessary repairs you\u2019d need to make all by 1%. The number you get is the base\nlevel you should charge for monthly rent.<\/strong> It\u2019s basically to give you a\nbetter understanding of how much cash flow you can generate per month on the\nproperty.<\/p>\n\n\n\n But\nit\u2019s a quick estimation method for it doesn\u2019t factor in all those other costs\nthat come with owning a property as such. There\u2019s the insurance, the upkeep,\nand the taxes too that will all come into play. <\/p>\n\n\n\n It\nreally just serves as a jumping-off point for you to determine if the property\nis feasible for you to invest in. There might be so many repairs that need to\nbe made that it would be foolish to invest in. Conversely, you might determine\nsomething is a relative steal. <\/p>\n\n\n\n However,\njust because the 1% might work out in your favor in numerical terms doesn\u2019t\nmean it is always the logical choice. If you were to invest in a property in a\ndeclining neighborhood, this decision might not bode well. Conversely, going\nfor an up-and-coming area that\u2019s going through a renaissance might make your\nchoice a wise one.<\/p>\n\n\n\n Talk\nis talk though. Let\u2019s go with a speculation in terms of numbers to illustrate\nthis point. <\/p>\n\n\n\n Imagine\nyou find a duplex that costs $400,000 which includes all the closing costs and\nrepairs. So, you invest your own $80,000 into it (a standard 20% investment) and\nthen borrow the remaining $320,000 for 30 years at 5% interest. This gives you\na monthly payment of $1,730. <\/p>\n\n\n\n Therefore,\nthe gross rent for this property meets the 1% rule as it would be $4,000 per\nmonth. You\u2019ve also got to factor in operating expenses which include\nmaintenance, taxes, insurance, management, and vacancy, among others which, for\nthis example, are $1,600 per month or roughly 40%. That amounts to $28,800 per\nyear for your net operating income which is what you get before making the\nmortgage payments. The cap rate of 7.2% puts it at $28,800 over $400,000.<\/p>\n\n\n\n To\nput it another way, the pre-income tax income you\u2019ll be putting in your own\nwallet will be $8,040 per year. So, it returns you roughly 10% on that $80,000\ndown payment or your investment. That\u2019s a good chunk of money you can take to\nthe bank to save for making another investment purchase.<\/p>\n\n\n\n You\ncan use it to pay the debt on this property or any other properties you hold,\nthough I don\u2019t recommend that so much for paying off your mortgages. You have a\ngreat interest rate and the property is really paying its own way in the world.\nPaying off a property early would be foolish. Even the behemoth that is Disney,\nleas their island Castaway Cay in the Bahamas. Why? Because it\u2019s a smarter\ninvestment move. <\/p>\n\n\n\n You\nmight not be Disney but you can still make a smart investment move for\nyourself. Use what you generate to fund your living expenses or make more\ninvestments. <\/p>\n\n\n\n And\nby the way, you\u2019re about to be getting $5,900 in equity that first year and\nevery year to come so really, you will be benefiting even more from the\nproperty as it appreciates from here on out.<\/p>\n\n\n\n My\nlast example was for a property that was ideal. But if you\u2019re new to investing\nin properties, you should know how to spot what happens when you find a\nproperty that doesn\u2019t meet that 1% rule. <\/p>\n\n\n\n Again,\nwe\u2019ll go with a duplex for the example. But let\u2019s say this one is cheap at\n$200,000. The price includes those closing costs and repairs like my other\nexample. You give the standard 20% investment of your own cash (in this case\nit\u2019s $40,000) and you then borrow $160,000 for 30 years at 5% interest,\nbringing the monthly payment to $859 a month.<\/p>\n\n\n\n The\ngross rent on this property comes in at $1,000 a month which means it\u2019s not in\nthat 1% rule. For this example, you still have those operating expenses\n(management, insurance, taxes, etc.) but the cost is $400 a month. So now, your\nnet operating income is just $7,200 per year, giving you a cap rate that\u2019s only\nhalf as good as the other one \u2013 3.6% for $7,200 over $200,000 (unless you\u2019re\ninvesting in large multi-family property in an extremely wealthy area, that cap\nrate is too low). <\/p>\n\n\n\n Before\nincome taxes, your rental will be generating -$3,108 every year. You\u2019ll have to\npay the fees associated with this property from either your own job earnings or\nany positive cash flow you\u2019re generating from another property. As you can see,\nit\u2019s not a good deal. <\/p>\n\n\n\n As\nyou can see, the 1% rule can be handy when computing simple math about how to\nmake a smart decision for properties that can make you money. Now that we\u2019ve\ngone over a couple of examples, let\u2019s delve into when you should use this rule.\n<\/p>\n\n\n\n This\nrule of 1% is best to be used to prescreen properties and save you time (not to\nmention money). You\u2019ll use this as you pursue good investment opportunities. It\ncan help you cut through the clutter, especially if you have a list of 20\nproperties from your real estate agent. You\u2019re not going to buy all of those.\nAnd while some of them might LOOK good, they might not be worth your time. The\nconverse of that can also be true.<\/p>\n\n\n\n So,\nwith this list, you\u2019d look at the list of asking prices to see what that 1%\nwould be for each. You can even do it in seconds by just sliding the decimal\npoint over two spots to the left. So, $100,000 in a listing price would be\n$1,000.<\/p>\n\n\n\n Once\nyou get that 1% number figured out for each property, you\u2019ll want to compare it\nto the market rent for this property. If that rent number is close to that 1%\nasking price, it\u2019s worth your time to look into the property a little further.\nIf it\u2019s far below that 1% then you can simply skip that option completely.<\/p>\n\n\n\n When you\u2019re first getting into real estate investment, you will need to put more time forth to making a smart buy. Reading over the sources to find the market rent is the best way. Eventually, it becomes intuitive, but initially, be prepared to study up on it. Places to look are Zillow<\/a>, Trulia<\/a>, and Loopnet<\/a>, but do keep in mind they aren\u2019t always fully accurate. It should give you a ballpark for what to expect for rent prices in the area though to help you separate your potential opportunities. <\/p>\n\n\n\n Remember,\nthat 1% rule is only meant to help you narrow down your list of available\nproperties to invest in. Once you\u2019ve narrowed it down, you shouldn\u2019t rely on\nthe 1% option anymore. You should get down to it with a more in-depth analysis.\nIt certainly requires more of you to make an offer and close on the property\nthan this simple rule.<\/p>\n\n\n\n See,\nthe 1% rule only uses the gross income for a property, or rather, what you\u2019re\ngoing to net from any tenant. However, your bottom line for rental investing is\nthat net income which is what you have left after all those expenses. So if you\nwant to understand the cash flow of a property, you have to deduct y our other\nexpenses. We touched on this in the examples above but because it\u2019s not a real\nproperty and there are so many variables, these costs can fluctuate. <\/p>\n\n\n\n Things\nlike the insurance, maintenance, management, taxes, vacancy, capital expenses,\nand of course, the mortgage payments, will all come into play. One way to go\nabout figuring this all out is to set a goal for your property\u2019s cap rate and\nthe net income generated after financing. You might find that a property that\npassed the 1% test also meets these criteria. You may also find that it won\u2019t. <\/p>\n\n\n\n The\nother time the 1% rule might not benefit you is with certain properties. Small\nresidences make sense with it, like the duplexes mentioned above, preferably in\nA or B neighborhoods. Lower-priced C neighborhoods, multi-unit buildings, and\ncommercial property will in some cases need to have a better income than the 1%\nallows to make it worth your time, money, and effort. <\/p>\n\n\n\n Real\nestate investing is definitely something to be locally-tuned to. The numbers\nand trends always vary in every location. In some places, big cities in\nparticular, it\u2019s almost impossible to see any properties that even fall into\nthat 1%. <\/p>\n\n\n\n Take\na look at some of the hottest markets for real estate in the country. There\u2019s\nSan Francisco, one of the most notoriously expensive markets. With a median\nsales prices at $1,289,300 by 1%, it\u2019s $12,893 with a median rent of $4,285 per\nmonth. Denver\u2019s median sales price is $391,300. That\u2019s $3,913 for the 1% and a\nmedian rent of $2,047. That means you\u2019ve had to buy an average home at nearly\nhalf its value to qualify that 1% rule in Denver. And in San Fran, forget it!\nThat would be one-third of its value for the 1%. <\/p>\n\n\n\n Of\ncourse, these are primitive examples that would likely never happen in these\nhot markets so you need to either buy in another area outside that market or in\nlower-priced areas of the same market, or drop your criteria down, perhaps to a\n0.5% rule.<\/p>\n\n\n\n Most\ninvestors go with the first option and stick to buying properties in other\nmarkets from afar. But you can also go with the second option and lower your\ncriteria. You could still pull it off if you bring in money from other sources\nlike appreciation by buying a fixer upper.<\/p>\n\n\n\n However,\nthere\u2019s still a bit more to know here so keep reading on my special rule that\ncould really help you invest wisely. <\/p>\n\n\n\n There\u2019s\nalso the 50% rule. It\u2019s ideal to do a quick analysis to see if a rental\nproperty qualifies for your intentions. Basically, the total expenses\nassociated with the operation of a rental property should be roughly 50% of the\ngross rents and the expenses are 50% (taxes, repairs, insurance, management,\nand the whole shebang). <\/p>\n\n\n\n Again,\nI\u2019m a numbers guy so I\u2019d like to illustrate this rule with a little example.<\/p>\n\n\n\n Surprise!\nYou\u2019ve found a property to invest in that\u2019s going for $100,000. And even\nbetter, your research of the local area leads you to conclude that you can rent\nthat property for just $1,000 per month. When you use the 50% rule, the\noperating expenses would be about $500 per month. In other words the expenses\nequal the gross rents of 50% of $1,000 which is $500. <\/p>\n\n\n\n What\nyou’re left with at the end of the month to pay the mortgage and your profit\n(the NOI, or net operating income) is $500. Under the assumption that you\u2019d put\n20% down, have a 30-year fixed interest mortgage (6%), then you would have a\nmortgage payment of $480 per month which comes to $20 in profit. <\/p>\n\n\n\n Yes,\n$20 per month is nothing to jump up and down for. But the potential to\nnegotiate the price down from there and lower your monthly payment might be\nworth it. If you could talk your way into buying it for $85,000 then your\nmonthly payment falls to $408 per month and that comes to $100 in profit. It\u2019s\nstill a tight squeeze but there\u2019s potential.<\/p>\n\n\n\n However,\nif you plan to manage the property yourself, the fees that would go for that\nwill go to you so you\u2019ll actually be bringing more in per month on this\ninvestment. While it\u2019s not wise to use these basic rules as your full deciding\nfactor, it can help you see if making time to figure out the more intricate\ndetails is worth your time and money. <\/p>\n\n\n\n When\ntalking about properties that don\u2019t meet the 1%, like in our example, the\nprincipal on that mortgage reduces by nearly $2,400 in the first year. When\nyou\u2019re doing this basic computation, it doesn\u2019t seem so bad with a loss of\n-$708. Plus, if that property appreciates by 3% in the same year, things could\nreally be looking up. When there\u2019s a 3% price increase on a $200,000 property,\nthat\u2019s $6,000. That means you\u2019d move ahead by $5,292. <\/p>\n\n\n\n Remember,\nthe example-you put down $40,000 for this property. That means you\u2019d get a 13%\nreturn on your investment. Basically, this is how most real estate investors\nstill get money even though it doesn\u2019t measure up to the 1% rule. They have to\nrely more heavily on the appreciation of the property to make that happen.<\/p>\n\n\n\n Keep\nin mind though, price appreciation is very subjective. There are no guarantees\nnow what the future will hold. It could work in your favor or you could wind up\nkicking yourself. Hard.<\/p>\n\n\n\n The\nreturn you get above in the example is just what it comes out to on paper until\nyour property is sold or you refinance. With illiquid investments, this isn\u2019t\nan easy task. Still, the speculations that mount don\u2019t necessarily have to be a\nbad thing. <\/p>\n\n\n\n One\nof the best aspects of real estate to generate profit is to force appreciation.\nIn other words, add some value. Improve on the property in some way, and\nbelieve me, there are so many ways to do this. Make it more beautiful, add on\nanother room, convert an otherwise unused space like a basement so it can be\nused as a rental unit, raise the monthly rent, and other tactics like this and\nyou\u2019ll start making more money.<\/p>\n\n\n\n Patience\nalso pays. Investors that hold onto rental properties for longer where the\nneighborhood itself is appreciating can stand to make lots of money down the\nroad. You\u2019ll need to be prepared to feed into the property in the short term\nbut it will all catch up if you make wise investments. It takes some staying\npower and extra cash, but it can be done.<\/p>\n\n\n\n What\nyou need to sort out is this speculation for the properties you consider and\nhow much rental income you can generate. So if you\u2019re buying properties that\ndon\u2019t meet the 1% rule or any other measure for income generation, then you\u2019re\ngoing with speculation to chase those profits. If you\u2019re comfortable with it\nand have a plan to bring it all to fruition, it can be a great thing for you.<\/p>\n\n\n\n But\nnot everyone is comfortable with this level of risk. You might feel best if you\nhave a more balanced combination of profit from the rent and that speculation.\nIf so, choose properties in quality locations that fit that 1% rule or another\nmeasure for income to feel more secure in your choices.<\/p>\n\n\n\n Investing\nis risky after all, but it can net you quite a bit of money when you do it\nright. Study what those successful before you have done and attempt to emulate\nthat strategy for yourself. <\/p>\n\n\n\n Even\nif you come out $20 ahead, it\u2019s still a success, though I advise aiming much,\nmuch higher than that!<\/p>\n\n\n\n The\n1% rule can be very helpful for determining which investment properties are\nworth your efforts. It\u2019s not something that can help you see your exact income\npotential from the investment, but rather, helps you have a basic point of\nreference to work with. This is what you\u2019ll use to whittle down a massive list\nof properties to consider.<\/p>\n\n\n\n But\nthis rule doesn\u2019t always apply. You may find a property that doesn\u2019t meet this\nrule but because you plan to do your property management yourself, then you\u2019re\nnot expensing it to someone else. Finesse your numbers and get all the\nprojections for the area first. Just because it\u2019s not there yet doesn\u2019t mean it\nwon\u2019t be the hottest neighborhood in 5 or 10 years.<\/p>\n\n\n\n By\nthinking with forward vision and focusing on a little math, you can find a real\nestate investment opportunity that will have you profiting hugely from simply\nsigning on the right line. <\/p>\n","protected":false},"excerpt":{"rendered":" Have you heard of the 1% rule for real estate? If you\u2019re looking to invest in real estate, it\u2019s basically your guideline for evaluating that potential for a property purchase. This rule of thumb can be pretty handy when it comes to making smart investment decisions in real estate. Basically, […]<\/p>\n","protected":false},"author":1,"featured_media":94,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"nf_dc_page":"","_jetpack_newsletter_access":"","_jetpack_dont_email_post_to_subs":false,"_jetpack_newsletter_tier_id":0,"_jetpack_memberships_contains_paywalled_content":false,"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[5],"tags":[],"class_list":["post-91","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-real-estate"],"yoast_head":"\nAn\nExample of a Property That Meets the One Percent Rule<\/strong><\/h2>\n\n\n\n
An\nExample of a Property That Does NOT Meet the One Percent Rule<\/strong><\/h2>\n\n\n\n
When\nto Use the One Percent Rule<\/strong><\/h2>\n\n\n\n
When\nNot to Use the One Percent Rule<\/strong><\/h2>\n\n\n\n
Is\nthe One Percent Rule Even Possible in Some Markets?<\/strong><\/h2>\n\n\n\n
Why\nI combine the 1% rule with the Fifty Percent Rule<\/strong><\/h2>\n\n\n\n
How to Break the One Percent Rule and Still Come out Ahead<\/strong><\/h2>\n\n\n\n
Conclusion<\/strong><\/h3>\n\n\n\n