Definition and Examples of the 1% Rule
The 1% rule is a guideline real estate investors can use to evaluate potential rental properties for monthly cash flow. Multiplying the total investment (purchase price plus the cost of repairs) by 1% will give investors a number they should aim to charge for monthly rent. If 1% of the total investment results in a competitive rental rate that also covers costs and produces a monthly cash flow, investors can feel more secure.
Properties that meet or exceed the 1% rule have a good chance at making profits. Properties that do not meet the 1% rule may have a hard time making money on a monthly basis. There are, however, other methods investors should use for evaluating long-term rental properties before ruling out a property based on the 1% rule alone.
How the 1% Rule Works
Applying the 1% rule to a real estate purchase involves a relatively simple formula that investors can use two different ways:
- Total purchase price x 1% ≥ Monthly rent
- Monthly rent x 100 ≥ Total investment
You can use this easy formula to get a general idea of what rents would work for the price point of an investment property. For example:
- A $100,000 property should return at least $1,000 in monthly rent
- A $200,000 property should return at least $2,000 in monthly rent
- A $400,000 property should return at least $4,000 in monthly rent
Generally, investors can use the 1% rule for two purposes:
- Evaluating a property’s potential for profit before buying it
- As a guideline for how much rent should be charged
Keep in mind that the 1% rule is a general guideline and will not often work for properties in more expensive areas, such as New York, San Francisco, Boston, or San Jose.
In reality, investors can acquire whichever properties they can afford. What the 1% rule helps in determining is if that property is going to produce enough rent to cover expenses and cash flow each month. Real estate investors who use the 1% rule use it for properties they’re considering owning long term.
Jim Fitzgibbon, an investor and licensed real estate broker with Florida-based Ledge Real Estate Solutions, told The Balance via email that he uses the 1% rule to evaluate properties.
“If a home can adhere to the 1% rule, then I keep it in my portfolio of rental properties,” Fitzgibbon said.
He recently purchased and renovated a home in Winter Garden, Florida, that follows the 1% rule. His total investment in the property was $200,000 and he collects $2,150 in rent, which exceeds 1% of his investment.
Limitations of the 1% Rule
The 1% rule isn’t the only factor that should be considered when evaluating long-term rental properties for profit.
Mark Ferguson, a veteran real estate investor with Colorado-based InvestFourMore, told The Balance by email investors should only use the 1% rule once they have determined it will work for them.
“Real estate is so unique,” Ferguson said. “Every property is different, every state is different, every town is different. Even neighborhoods and streets differ within a town. While the 1% rule can provide a very broad overlook of properties in a certain area, I do not think it should be used to decide if a rental will be a good investment or not.”
He explained the limitations of the 1% rule, which include:
- Property taxes
- Insurance rates
- Maintenance costs
- Interest rates
“Those costs will be different in every area. Property taxes in New Jersey may be 10 times higher than they are in Colorado, but the 1% rule ignores this,” he said.
Interest rates are also lower now than they were a decade ago when investors started to use the 1% rule. “With rates as low as they are, an investor can make just as much money, or more, by purchasing properties that don't meet the 1% rule as they could 10 years ago with properties that met the 1% rule,” Ferguson said.
Another limitation investors may find is that the 1% rule works better for less-expensive properties that may not be in great condition (known by investors as “lower property class”).
“The ability of a property to meet the 1% rule will vary greatly depending on the property class,” Serena Parton, co-owner of Alabama-based Azalea Home Buyers, told The Balance by email. “Typically, the lower the class the property is, the more likely they can meet this rule.”
Pros and Cons of the 1% Rule
Easy to calculate
Conservative analysis can help an investor choose a profitable property
Ignores interest rates
Doesn’t take into account local conditions, vacancies, or maintenance costs
Doesn’t figure in property taxes
Works better for a less-expensive property class
- Easy to calculate: A 1% calculation is easy to do without a calculator or formal training in business, accounting, or finance.
- Conservative analysis can help an investor choose a profitable property: Properties generating 1% monthly rent will be able to cover the monthly mortgage, at a minimum.
- Ignores interest rates: With low interest rates, investors can still make money on properties that don’t meet the 1% rule.
- Doesn’t take into account local conditions, vacancies, or maintenance costs: Every piece of real estate is unique, and the various factors at play should all be considered. Many investors who use the 1% rule regard it as a starting point. It shouldn’t be the only factor, or even the most important factor, when choosing long-term rental properties.
- Doesn’t figure in property taxes: Property taxes can be vastly different across the country. Taxes in New Jersey are much different from taxes in Nevada, a cost that isn’t accounted for when analyzing properties using the 1% rule.
- Works better for a less-expensive property class: Properties that can generate 1% in monthly rent tend to work better for less-expensive properties.
Alternatives to the 1% Rule
The 1% rule isn’t the only way to evaluate the potential profit of a property. Here are some other commonly used calculations to help real estate investors decide on a property:
- 50% rule: Set aside 50% of the monthly rent you collect for monthly expenses, not including the mortgage.
- 70% rule: Never spend more than 70% of a property’s after-repair value on the property.
- Gross rent multiplier (GRM): Divide the property’s market value by its annual gross income. The resulting number is the number of years it will take for the investment to pay for itself.
- Capitalization rate: Known as “cap rate,” this is the net operating income divided by price. Investors use this ratio to compare different investment properties.
- Return on investment: Also known as cash-on-cash return, ROI is calculated by dividing the net cash flow by the amount invested. A rule of thumb is to earn at least 8% ROI.
- Internal rate of return (IRR): Internal rate of return is your annualized rate of return on your investment. It is used to compare investments against expected rates of return within a business.
- Real estate investors use the 1% rule to see if the amount invested in a property will generate enough monthly income to cover expenses.
- Not every home will be able to meet the 1% rule.
- Investors can use the 1% rule as a starting point, but should also consider other factors.
- Investors have other tools to analyze properties.