The 1% rule is a guideline real estate investors use to choose viable investment options for their portfolios. Although the rule has helped many investors make wise decisions regarding their investment properties, the current real estate market may make following the 1% rule unrealistic.
Explore the 1% rule of real estate and why it may not be feasible to follow the standard guideline in the current real estate market.
What Is the 1% Rule?
The 1% rule is an unofficial benchmark that real estate investors use to narrow profitable investment opportunities. The 1% rule says that investors should only buy properties for which they receive a gross monthly rent payment equal to or greater than 1% of the property’s purchase price.
Investors must calculate a rent-to-price ratio to determine if their investment property meets the 1% rule. To find this ratio, multiply the property’s purchase price by 1%. This number represents the minimum amount you should charge in rent to make a profit. For example, if you have a property to purchase for $180,000, you’ll want to assess a minimum of $1,800 per month.
This number doesn’t include operating expenses or repairs, but it gives you a base amount to consider. You can add these expenses to the total purchase price for the 1% rule test to gain a more accurate representation of what you should charge for rent.
Traditional Benefits of the 1% Rule
The most significant benefit of the 1% rule is that it allows investors to prescreen properties. It is an easy tool that eliminates undesirable properties from your list of possible investments. We believe the rule makes it an excellent screening method under typical market circumstances.
Limitations of the 1% Rule
Although the 1% rule is helpful in many situations, investors may not trust it in specific situations. These include purchasing real estate in cities where rent is typically less than 1% of the average home purchase price.
For example, if the median list price in a metro area is over $1 million, the 1% rule would necessitate rents of close to $10,000 per month. In this case, investors would forgo the 1% rule for a more realistic assessment of what makes a viable investment.
Is the 1% Rule Realistic in the Current Market?
The 1% rule may not be realistic for investors buying rental property in the current market. According to a recent Forbes article, median housing prices have risen to $450,000 in many areas, nearly 17% higher than the highest recorded average. A monthly rent of $1,326 is the average, with an average asking price of $1,900.
The 1% would have the average renter paying $4,500 per month, much higher than most renters can afford. With the wild fluctuations in the housing market and a downward swing projected on the horizon, you should work with a local real estate agent and financial advisor. This will enable you to potentially determine the right investment property and rent for your area.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Programs that depend on tenants for their revenue may suffer adverse consequences as a result of any financial difficulties, bankruptcy or insolvency of their tenants. All examples are hypothetical and for illustrative purposes only.
