What is the 1% Rule?
The 1% rule is a guideline that can be used to help determine if the purchase of a particular investment property will be a profitable and worthwhile investment. The rule is an evaluation of cap rate. Basically, the 1% rule states that the amount of monthly rate charged should be at least 1% of the price paid to own the property.
Philosophy Behind the Rule
The philosophy behind the 1% rule is that property investors who can collect at least 1% of the property purchase price each month in rent should be able to cover monthly expenses and actually be profitable on the investment.
Potential real estate investors should be aware that the 1% rule is not a hard-and-fast formula that should necessarily be adhered to in all cases. Over time, it has functioned as a guideline that some investors use to estimate the upside of a particular investment and the potential for generating positive cash flow. However, every situation is unique.
Obviously you can charge whatever you want for rent, technically. But you should understand the current market conditions for your location and property type. If you don’t feel that you can realistically get at least 1% of your purchase price in rent each month, then the property would not pass the 1% rule. It involves some estimation and subjectivity.
Calculating the 1% Rule
If the goal is to have monthly rent ≥ 1% of total purchase price, then you can calculate whether a specific property investment would meet the rule by calculating:
If the result comes out as less than 1.0, it would not meet the 1% rule.
Does that mean it’s a bad investment? Well, that’s for you to decide. How much risk are you willing to take on? Do you plan to make improvements that will allow you to charge more in rent? Is it close to meeting the 1% criteria, but not quite?
Once again, the rule is really more of a guideline to help gauge a potential investment. Usually, properties that meet the 1% rule are safer and more likely to be profitable in the long run.
If you purchase a property for $200,000, you would need to be able to collect at least $2,000 in rent each month (1%) in order for the investment to satisfy the rule.
Should I Use the 1% Rule When Investing in Real Estate?
The 1% rule works best as a screening tool, not the critical factor in deciding whether or not you will invest in a particular property.
Some investments that don’t quite meet the rule could still be smart investments. And some other properties that easily meet the rule could still be a bad idea, depending on factors such as property class, location, or your real estate investment strategy.
Providing a Baseline
For the property owners we serve in Utah, the Joseph Thomas pros recommend utilizing the 1% rule as just one piece of the puzzle.
It shouldn’t automatically qualify or disqualify any particular investment opportunity. But, it’s a good thing to have in mind as you weigh the risks and potential returns.
Some Costs Unaccounted For
The 1% rule formula does not include closing costs, repairs, insurance, or other costs associated with the property. It also doesn’t matter how much your actual down payment was compared to the total purchase price - the formula is the same.
Get Help With Real Estate Investing
Real estate investing involves large amounts of money and lots of things to consider.
As property management pros with years of investing across Utah markets, the team at Joseph Thomas can be a valuable partner in helping ensure your real estate portfolio produces consistent cash flow toward helping you reach your goals.
Get in touch with our team to learn how our property management services can make your life easier, and property ownership even more rewarding.
What about the 2% rule?
Similar to the 1% rule, the 2% rule is another screening formula for evaluating how likely an investment will be able to produce positive cash flow. The formula is essentially the same as the 1% rule, but with a more conservative baseline (monthly rental income must be at least 2% of property purchase price).