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1 rule in real estate method of evaluation for investors

Throughout my investing career, when I came across a rental property I thought might turn out to be a profitable deal, I would frequently rely on a simple 1 rule real estate calculation that helped me evaluate possible returns. In a nutshell, it’s a quick math equation that lets the investor know if the monthly rent will at least equal 1% of the property’s purchase price, giving them an idea if pursuing the deal will be worth their time and money or not. This 1% rule real estate method simplifies the initial decision-making and helps investors avoid purchasing a rental property that could end up producing a low ROI.

With all that said, let’s dive in to learn more…

What is the 1 Rule in Real Estate?

The 1 percent rule real estate calculation is a straightforward formula where you multiply the property purchase price by 1% to get the estimated monthly rent. When doing the math, the goal is for the property’s rental income to be at least 1% of its purchase price. In other words, it means the 1 percent rule is used by investors to make sure a property can generate a gross monthly rental income of at least 1% of the total acquisition cost to get an idea if there’s a chance for profitability or not. Also, this evaluation method helps investors judge if the anticipated cash flow will be enough to meet monthly expenses while still providing a positive cash return.

1 percent rule real estate formula for calculating rental property cash flow

To give you a better understanding, here’s a step-by-step guide on how to calculate the 1 rule in real estate manually with a simple math equation using the following examples:

1. Basic Example of How to Use the 1 Rule Real Estate Formula

The 1 percent rule real estate calculation is as follows for a piece of real estate that has an asking price of $100,000:

Property Purchase Price × 1% = Monthly Rent

($100,000 × 1% = $1,000)

As you can see from the above math equation, learning how to calculate the 1% rule in real estate is pretty simple and straightforward. Using this equation, let’s move on to examples that are more in-depth.

2. Detailed Examples of Using The 1 Rule Real Estate Equation

Now that you have the math equation in hand, let’s breakdown the one percent rule even further with the following examples of a property passing and failing the real estate 1% rule:

A. Rental Property that Passes the 1% Rule: An investor is looking into a rental property that’s selling for $150,000. After doing the math, it turns out that the property’s condition and its neighborhood can reel in a monthly cash flow of $1,500. These numbers meet the 1% rule, which means the property is worth evaluating further to make sure it’s a good deal.

B. Rental Property that Does Not Pass the 1 Percent Rule: An investor is considering a piece of real estate for $200,000. The property has been newly renovated and looks fantastic, but it’s located in a neighborhood where crime is on the rise, which has brought the rents down considerably in the area. Based on the actual going rate, the max monthly rent that the investor can get for this piece of property is $1,200. However, when the 1 rule in real estate formula is used, it suggests that the rent should be $2,000 a month. In sum, this property does not pass the 1 percent rule because its monthly rental cash flow is $800 below the 1% minimum. Put simply, the property owner would not be able to collect $2,000 a month because it’s too high for the market conditions in that area.

If you need more information to understand the question at hand, which is, “What is 1 rule in real estate?” I think diving into its benefits will help…

Benefits of Using the 1 Percent Rule to Evaluate a Potential Real Estate Investment

When evaluating rental properties such as single-family homes, duplexes, triplexes, and the like, starting with the real estate 1 rule can set you on the right path for the following reasons:

1. The 1 Rule in Real Estate Investing Strategy is a Helpful Starting Point for Assessing Rental Properties

Since the 1 percent rule for real estate investing is a starting point in analyzing a rental property’s financial risk and cash flow potential, it can make the search for good real estate deals more streamlined and profitable. This is done by quickly eliminating suspected low cash flow generating properties.

For instance, let’s say that an individual has ten investment properties lined up to visit. He applies the 1% rule in real estate to all ten properties in less than 10 minutes, weeding out the properties that may be a potential waste of time to view. This frees up valuable time to focus on other rental real estate that may yield the proper cash flow.

When it comes down to it, it’s really about lowering risk and making sure a rental will be profitable. With that in mind, these related articles would be great future reading material if you would like to increase your knowledge base on the subject:

2. The Real Estate Investing 1 Rule Determines if There’s a Baseline Cash Flow that Makes Sense

Although many factors come into play when calculating a buy-and-hold property’s cash flow potential, the real estate 1 percent rule is a great way to determine if the cash flow at least makes sense up front. If your 1 percent rule calculations show that you require a higher rent than what can actually be collected, you may come up short after your mortgage and operating expenses are paid.

This reveals that the property’s cash flow factor may make the deal not worth looking into any further. After all, you most likely became a real estate investor with the goal of getting ahead of the game financially. With this in mind, ensuring that a real estate asset has the potential of securing a positive monthly net income is what can set successful investors apart from hit-or-miss investors.

3. The 1 Real Estate Rule Helps Set Target Rental Rates

It can be a bit confusing for some investors when figuring out what to charge their tenant for monthly rent. At the same time, it’s imperative that the final number that’s sealed in a rental agreement is enough to produce a positive cash flow. The 1 rule real estate calculation serves as a useful guide in figuring out your target rental rate. A rule of thumb would be to set the rental amount to 1 percent, or more, of the property purchase price. This 1% buffer can be used to better your chances of having money left over after all your rental property expenses are paid.

Here’s another example of the 1 percent real estate rule to elaborate on the above points:

A real estate investor is considering a small property for $100,000. He uses the 1 percent rule to determine that the rent would need to be at least $1,000 per month for the deal to have a potential positive cash flow. From his market research, he knows this amount per month is feasible, so he moves forward with the deal after it also meets certain other criteria.

After his purchase, his tenant is placed, and his first month yields the $1,000 he was expecting. He now pays his monthly mortgage of $450, and operating expenses of $365, which leaves him with a total net income of $185 per month. In this case, the 1% rule predicted a positive cash flow, and deemed the property was worth looking into further.

Imagine if the numbers were slightly different, and the calculations were not taken into consideration while vetting the property. What if the investor figured out late in the game that he needed at least $1,000 a month in rent, but the property can only be rented for $800? In this second scenario, with the same expenses, the investor would be in the red each month for -$15. The property would clearly not be worth investing in with a net loss such as this, and he would have known this from the start by using this helpful calculation. Are you starting to see the usefulness of the 1% rule for evaluating rental real estate?

As you can see, this is all about ensuring positive cash flow and profitability. That said, be sure to bookmark my related post for future reading – How Much Profit Should You Make On A Rental Property?

What Should You Consider Next After a Rental Property Passes the 1 Percent Rule?

what is the 1 rule in real estate

Since you shouldn’t base a purchase solely on this calculation, once a property passes the 1 percent rule in real estate, it’s time to dig deeper to further confirm that the asset is a deal worth committing to.

There are a few elements you’ll want to take into consideration to properly run the numbers on the buy-and-hold property you’re considering:

1.  Certain Aspects of a Rental Property That May Influence Your Projected Bottom Line:

Investors typically do a quick calculation with the 1% rule, and most likely some quick research into the allowable rent for the single-family home, duplex, or another type of real estate asset they’re considering. However, there are several questions an investor might want to ask themselves to confirm the monthly rent estimate is what they thought it to be, and to estimate what it might be in the years to come:

  • What are the current tenants paying? If vacant, what have tenants paid in the past?
  • What’s the quality of the neighborhood the potential rental property is in?
  • Is the property old and in rough shape, or is it in good or at least fair shape?
  • What does the property’s overall rental market look like?
  • Is the home price appreciation on the rise for the city and specific neighborhood?
  • How are the demographic and socioeconomic trends in the area looking?
  • Is this area prone to high foreclosure rates and vacancies?
  • How many days has the real estate asset been on the market for?

2. Real Estate Purchase Costs That May Not Have Been Added to Your 1% Rule Calculations:

There can be quite a few closing costs involved in the purchase of a real estate investment. If you have a general idea of what those may be, it’s wise to add those numbers into the mix so they don’t end up having a surprise negative impact on your bottom line. Some investors may include a few of these costs into the loan total, and are therefore already calculated into the 1 percent rule. Here’s a short list of typical closing costs for a rental property:

  • Appraisal Fees
  • Survey Charges
  • Home Inspection
  • Title Fees
  • Possible Attorney Costs
  • Loan Fees
  • Incorporation Fees

When it comes to incorporating, there are some upfront fees, but it can save you money in the long run through significant tax deductions, as well as protection of your personal assets. If you’d like to look into incorporating your real estate business, Corporate Direct is an excellent resource.

3. Recurring Operating Costs and Other Expenses for a Typical Real Estate Investment

There will always be operating costs, and this is one reason the 1% rule for real estate investing is so helpful. Starting out on the right foot by taking into account that you should have a buffer of at least 1 percent of the purchase price, will give you a better chance of having a positive cash flow.

The alternative would be possibly having your operating costs eat away at your monthly rental income that was too low from the start, leaving you in the red. Here are a few examples of operating costs that you may want to take into consideration when running the numbers on a rental property that you are evaluating:

  • Property Management Fees
  • Lost Income from Vacancies
  • Periodic Repairs & Renovations
  • HOA Fees if Applicable
  • Property Taxes
  • Landlord Insurance
  • Rental Advertising
  • Possible Utilities
  • Pest Control
  • Business Permit
  • Possible Legal or Emergency Costs

Since property taxes can be a huge burden and chip away at your cash flow, we recommend reading Tax-Free Wealth. It’s an outstanding book by Tom Wheelwright, who is the tax advisor to real estate legend Robert Kiyosaki. It provides in-depth details on how to lower your taxes.

Summary of the Main Limitations of the 1% Rule

The 1 rule real estate strategy is limited because it’s only meant to be used as a quick analysis of a property’s cash flow potential. Since this is the case, I’d like to point out two main factors that highlight how limited it can be.

Expenses: As I touched on above, the 1% rule real estate evaluation method doesn’t take into account expenses, which can add up and cut into profitability. Taking into account typical costs like management fees, property taxes, appliance replacements, insurance, and the like, is important when calculating a property’s overall potential to cash flow.

Market Conditions & Growth: The 1 rule of real estate calculation also doesn’t factor in market conditions, such as a neighborhood’s proximity to good K-12 schools, which is a selling point for renters. Or, if nearby neighborhoods are declining, starting to look run down, and crime is on the rise, which would mean it’s only a matter of time before the neighborhood will decrease in value also. In a case like a declining housing market, the 1 rule real estate metric won’t really work because it just can’t reveal the fact that the investor will most likely lose money.

Because of these limitations, it’s best to only use this 1% rule real estate investing evaluation strategy as a rule of thumb. If the calculation indicates that it may be a good deal, then take it to the next level by running the property specs through more detailed evaluation methods.

Variations of the 1% Rule and Alternative Methods of Analyzing Profitability

There are a few variations of the 1 percent rule, as well as alternative strategies for evaluating a rental property. We’re going to focus on three of them today – the 2% rule, the 4 3 2 1 rule, as well as utilizing an ROI formula.

1. The 2 Percent Rule for More Aggressive Investments

The 2% rule uses the same math formula as the 1% rule, and is used for a similar purpose, which is to ensure the property’s monthly rent to be at least 2% of its purchase price. Although the equation is the same, it’s typically used for more aggressive investments where an individual is hoping for a higher monthly rent. But it only works well when you happen to find a GOOD property that fits the 2 percent rule. I mention this because you typically have to find lower-priced properties to make it work since the monthly rent may be too high when multiplying a high property price by 2 percent.

As you can imagine, these lower-priced properties are generally found in markets that sport purchase prices that are below the market value. So, with the purchase price lower, it may be in an unattractive area or it could be a distressed property that needs major repairs, which would be costly.

Let’s do a breakdown comparison of both rules…

1% Rule vs 2% Rule – How They Compare for Real Estate Investors

I’ll say right off the bat that many investors prefer utilizing the 1 percent real estate rule because it allows an easier entry into a good housing market. To explain further, let’s say you have a property purchase price of $300,000, and using the 2 percent rule, you would want it to produce a monthly rental cash flow of $6,000 to be super profitable, which would be 2% of the purchase price. Now, it’s obvious that having a rental property that cash flows 2% of the purchase price would be more financially rewarding than a 1% cash flow, right? Well, it’s not as simple as it sounds because there are many factors to consider. To better understand the differences between the two, let’s take a look at the PROS and CONS of both:

PROS of 1% Rule Properties

  • 1 percent rule rental properties are easier to find.
  • They can often be located in decent neighborhoods with a great overall housing market.
  • There’s a good chance of finding properties with little repairs needed.
  • It’s common for the appreciation of a 1% rental property to go up in value over time.
  • 1 percent rule buy-and-hold real estate properties can be a stable investment.
  • Perfect for new or seasoned investors.

CONS of 1% Rule Properties Compared to 2%

  • When comparing to the 2 percent rule, there are no obvious CONS when utilizing the 1 percent rule except that one can say that a 1% cash flow is not as much as 2%, is a CON.

Now, let’s take a look at the PROS and CONS that may apply to the 2% rule of real estate investing so you can compare. This will give you a better understanding of what makes the 2 percent rule so great when everything comes together for the better, as well as what can make a 2% rule property risky:

PROS of 2% Rule Properties

  • When you do find a buy-and-hold asset that is workable and can produce a positive cash flow of 2% of the purchase price, the investor will come out on top with double the amount of income that a 1% rule property would bring in.

CONS of 2% Rule Properties Compared to 1%

  • Although it’s possible, it’s difficult to find properties that fit the 2 percent rule.
  • In many cases, the investor is limited to searching specific states and areas to locate good 2% rule real estate.
  • Most times, investors need to make costly upfront repairs to get the property into shape for renting to a tenant.
  • Tends to have a higher amount of issues, maintenance, and upkeep while rented, resulting in less cash flow.
  • 2% rule properties are often found in low-income, high-crime areas, and this is why the property price is typically lower.
  • Higher chance of evictions and vacancies.
  • Appreciation of the property is uncertain.
  • Investment is not as stable as a 1% rule property.
  • Not recommended for investors who are just starting out.

Even though 2 percent rule properties are difficult to find, when an investor does locate one that works well, it can be financially rewarding and worth the extra time and effort it takes to pinpoint a property such as this.

2. The 4-3-2-1 Rule Real Estate Property Evaluation Strategy

This rule is a whole different ball game, but at the same time, its purpose is the same as the 1 percent rule, which is to do a quick evaluation before investing in a property. So, what is the 4 3 2 1 rule in real estate? It’s an easy way for rental real estate investors to do a loose appraisal of different parts of a property.

How it works is that the numbers 4, 3, 2, 1, represent percentages and are assigned to specific aspects of the property. Here’s a breakdown…

4: The land should represent about 40% of the home’s value

3: Total living area would represent 30%

2: Other areas such as the garage, attic or basement are 20%

1: Outside features such as a pool and yard represent 10%

Determines if the Overall Purchase Cost is Priced Fairly

When an investor uses this 4-3-2-1 rule real estate evaluation strategy, they can get a better idea if the overall purchase cost is priced correctly. In other words, this metric can be used to judge if a property price might be inflated due to the overvaluation of certain features.

For instance, according to the 4 3 2 1 rule, the land should be valued at about 40% of the asking price of the property. But what if the land had significant issues that make the property as a whole unattractive? This scenario could certainly lower the value of the property. A few examples of land issues that I’ve seen over the years that lowered the value of the home are contaminated soil, uneven terrain, drainage issues, property line conflicts, and so on.

It’s important to remember that the 4-3-2-1 rule is really just a guideline, and the actual value of a property can depend on various other factors. For example, these values do not take into consideration if crime is on the rise in the area, or if the population is growing or declining in the city. Also, the 4-3-2-1 rule real estate metric can be confusing or more complicated to calculate, and therefore it’s not commonly used.

As you can see, the 1%, 2% and 4-3-2-1 rules don’t take expenses into account, but the following ROI formula does, making it a more accurate assessment. However, you’ll still have to do independent research on the market conditions to further evaluate if a property will have a positive cash flow.

3. Using an ROI Formula to Pre-Screen a Rental Property

ROI formula vs 1 percent rule real estate metric

As mentioned, the 1% rule for real estate investors is a quick calculation that doesn’t take into account the operating expenses. Because some investors like to include these numbers in their upfront calculations, they may use an ROI formula to calculate the property’s potential cash flow loss or gain. ROI, or return on investment, represents the amount of return on a property relative to the investment’s cost.

Utilizing an ROI formula can give the investor a look at the bigger picture while evaluating a potential rental property. This is because it considers operating expenses from the beginning.

Let’s look at the following detailed ROI formula example broken down into steps:

Step 1 – Gathering basic info such as purchase price and projected monthly rent: An investor is evaluating an off-market property where the owner is looking to sell quickly and is asking for a cash transaction. The asking price is $100,000. The potential buyer conducts research by asking a local property management company what the going rents are for the neighborhood, and comes up with $800 per month.

Step 2 – Calculating the gross yearly income: The monthly rent of $800 is multiplied by 12 to come up with a yearly gross income number. This comes to a total of $9,600. Sounds like a good amount of money per year, but the investor now has to take into account his operating expenses such as taxes, repairs, a property manager, and insurance. If you’re a new investor and are just starting your insurance vendor search, we use and recommend National Real Estate Insurance Group.

Step 3 – Deducting estimated expenses to see what the net yearly income might be: He doesn’t know what his exact operating expenses would be, so to be on the safe side, he takes out a conservative amount of 40% in potential expenses from the gross yearly income, which would leave 60% for himself. To see what is left after 40% of expenses are deducted, the yearly income of $9,600 is multiplied by 0.60 (60%), and he is then left with a net income of $5,760 per year.

Step 4 – Calculating the return on investment: To calculate what his final ROI is, he then takes the net income of $5,760 and divides it by the total purchase price, $5,760 ÷ 100,000, which comes to an ROI of .0576%. To make it a simple, rounded number, multiply .0576% by 100, and you have your final ROI calculation of 5.76%.

Quick Summary of the Above ROI Formula

  1. $800 (monthly rent) × 12 (months in the year) = $9,600 (gross yearly income)
  2. $9,600 × 0.60 (60%) = $5,760 (net yearly income)
  3. $5,570 ÷ $100,000 (total purchase price) = .0576% (ROI)
  4. .0576 × 100 = 5.76% (final return on investment)

This particular example produced an ROI of 5.76%. This percentage is decent and performs better than some investments, such as a 401(K). In reality, most investors would like to see a final ROI in the range of 7 to 12%.

As for the 1 percent rule, although it doesn’t account for the operating expenses, that’s ok for some investors who prefer not to add the expenses into the mix during this upfront property evaluation process. But for investors who would like to consider their expenses from the start, using this ROI formula is a good choice.

If you’d like to see some visual examples of the ROI formula, take a look at this video by Clayton Morris that goes over evaluating a rental property with ROI calculations. Additionally, if you feel you would like more real estate tools to confirm a buy-and-hold property is a good deal, you may want to utilize DealCheck. Its advanced software can analyze any rental property to estimate its cash flow.

I also encourage you to check out these articles that discuss additional methods of rental property evaluation:

1% Rule Real Estate Investing FAQs

Investors contact me with questions like “What is the 1 rule in real estate investing?” or “What’s the best way to calculate the 1% rule,” and so on. That said, I’d like to include a few of the most common questions I receive on this topic:

1. Is the 1 rule in real estate realistic in today’s housing market?

I’ve found that the 1% rule can be just as useful today as it was when I started using it years ago. A word of caution though, investors should take into account that in today’s real estate market, the final numbers may not line up with reality months or even years later because of the rapid market changes that we’ve been seeing.

For instance, we’ve seen property prices rising faster than normal, unpredictable mortgage rates, as well as rents quickly elevating. To demonstrate this point, if an investor buys a property for $300,000 and, using the 1 percent rule for real estate they calculate that the asking rent should be $3,000, they may find these values drastically change in a matter of one year.

With the path the housing market has been on over the past few years, that same property that was worth $300,000 could be worth much more in a short period of time. In fact, Fannie Mae predicts property prices will rise 6.1% year over year by the end of 2024. So, what this means is that the 1 rule of real estate may show less profitability than would be in reality. It’s still worth using the 1 percent rule real estate calculation to get a quick evaluation, but it’s also worth factoring in predicted market changes, if possible.

2. Can the 1% rule be applied to commercial properties?

Yes, the 1% real estate rule can be used to evaluate commercial investment properties, but because this type of property operation can be much more complex as compared to a simple residential property, the 1% rule real estate investing formula may not be the best method to use.

The reason for this is that a residential property has much more straightforward operations, while commercial properties can be more volatile with a higher tenant turnover rate, higher maintenance costs, complex leases, and so on. Also, because commercial properties can have a much higher purchase price, as well as have startup costs involved, an investor will want to use a more complex and reliable method of evaluating if it’s a good deal or not.

3. Where can I find a 1 rule real estate calculator online?

As of today, you won’t find many 1% rule real estate calculators online. The reason for this is because the math equation is so simple that any basic calculator will do. However, there’s one website that provides a 1 percent rule real estate calculator, and you’ll find it on the Calculator Academy. It’s a clunky page with many ads and a poor design, but the calculator itself does the job. It provides two tabs, one for a basic calculation and another for advanced that allows for repair costs to be added in.

For your reference, you can manually calculate the 1 percent rule with the following equation I shared earlier:

Property Purchase Price × 1% = Monthly Rent

($300,000 × 1% = $3,000)

A Real-Life Success Story Using the 1 Percent Rule Real Estate Equation

I thought I would wrap things up with an encouraging real-life story of a fellow investor of mine. His name is Mark, and he started his investment journey looking for properties in the surrounding area where he was living at the time. He used the 1% rule real estate strategy as his guiding principle for locating profitable properties. If a property passed the 1 rule real estate formula, he would then use secondary evaluation methods, as well as taking the local housing market into consideration. This all seemed to work for him every time, and he swore by it.

Mark bought his first rental home for $150,000 in a fair neighborhood that had good potential. For this particular property, the 1 percent rule for real estate came to $1,500 a month in rent which covered his mortgage and property management costs, and brought in positive cash flow. Over the years, as this neighborhood appreciated, the property’s value increased, and he was able to refinance it and use the funds to buy a second property. This was the beginning of his journey. Today, he’s a successful, wealthy investor who still uses the 1% rule.

Because I’ve been a real estate investor for so many years, I actually have many success stories I could share of fellow investors who used this metric, but Mark’s situation stood out to me because he started from zero properties and now his portfolio holds over 50 cash flowing rentals.

Use the 1 Rule in Real Estate Evaluation Method to Quickly Analyze Potential Properties

I hope those of you who needed answers to the question, “What is the 1% rule in real estate?” are moving on with a full understanding of the topic. As you can see, this initial evaluation method is an excellent way to pre-screen potential properties. It allows investors to weed out rentals that may not generate the proper cash flow, enabling them to allot more time to the properties that may be worth pursuing. As discussed, the 1 rule for real estate investing is only a jumping-off point, and more advanced methods of evaluation should be used as a secondary measure.

If you’d like to invest in properties that pass the 1 percent rule, or want to discuss this subject with experienced investors, simply book a call with a Morris Invest team member. They can fill you in on how we provide a full-service investment experience for our clients who purchase our new construction properties.

By full-service I mean that we’ll do all the work for you with our turnkey properties – locate a cash flowing property, provide funding options, assign a property manager, and even place a tenant in your rental. That said, we invite you to schedule a call to discuss your investing goals and how we can help you achieve them.

In the meantime, check out our resources that can kickstart your investment journey:

Dive into the video below that covers the topic “What is the 1 percent rule in real estate investing?” It will be sure to increase your knowledge base:

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