If you’re considering investing in real estate, you first have to make sure that the property will generate enough income to carry you through mortgage payments and operating costs. Ideally, the property will generate more than that. After all, the goal of property investing is to see some returns and push cash into your wallet. This is where things can get tricky—how do you determine if the purchase price is worth the income the property will generate? To answer that question, let’s review what the one percent rule is and how it can help you make better real estate investment decisions.
1. What is the One Percent Rule?
2. How Does the One Percent Rule Work?
3. Where Does the One Percent Rule Fall Short?
What Is the One Percent Rule?
To truly calculate rental property cash flow, you have to crunch a lot of numbers, which can take up a lot of your time if you’re looking at multiple properties. That’s where the one percent rule comes in. The one percent rule is a calculation allowing investors to determine whether the property will generate positive cash flow on a month-to-month basis or, at least, break even.
The idea is that the property should be greater than or equal to one percent of the sale price. Again, it’s important to remember that this doesn’t give you an exact amount of how much income a property will bring. It simply acts as a guideline to help you decide quickly between properties.
How Does the One Percent Rule Work?
The one percent rule is a quick and simple calculation that tells you how much the minimum monthly rent should be. Multiply the purchase price of the property by 0.01. To give us a more solid idea of how this works, let’s use an example.
Let’s say you’re looking at a property that’s going for $150,000 but needs $15,000 worth of renovations. The total cost of buying that property would really bump up to $165,000. Now that we have the total purchase price, we can multiply that number by 0.01 to determine the minimum monthly rent you’d need to charge to generate positive cash flow. Using these numbers, you’d have to charge at least $1,650 per month to make up for the cost of the purchase price.
Once you know the minimum monthly rent, you should compare this price to other similar rental properties in the area. If this number seems to be the general average, then you can feel comfortable raising the price to cover other costs and pocket some of the returns. Conversely, if this number seems too high for the area, you’ll want to move on to another rental property.
Where Does the One Percent Rule Fall Short?
Now that we know what the one percent rule is, where does it fall short, and can it help investors make better real estate investment decisions? The one percent rule can help you sift through multiple properties at once so you can narrow down your choices. However, it doesn’t consider mortgage rates, maintenance fees, HOA fees, property taxes, and other reoccurring costs. All of this is to say that the one percent rule is not a replacement for all the other calculations and numbers you need to run. Only use this calculation as a guideline for how much rent you might need to charge.
