The 1% rule is predicated on the idea that for an investment property to generate positive cash flow, the monthly rent earned from it must be greater than or equal to 1% of the total purchase price. The end goal is to ensure that the monthly mortgage payments never exceeds the rent. For instance, assume you purchased an investment property for $250,000. Using the 1% rule, we can determine that your monthly mortgage payments should be less than $2,500 and your rental income equal to or higher than $2,500.
In addition, the 1% rule can be a helpful tool when used in reverse to calculate a maximum purchase price for a rental property. The formula is given as follows:
100 x Monthly Rent = Maximum Purchase Price
Suppose you are an investor looking to buy a condo listed at $200,000. To cover upfront repair costs, you would factor in an estimated $20,000, for a total of $220,000. If you know that comparable properties in the neighborhood rent for $2,000, you can quickly deduce it is not in your best interest to pay more than $180,000 for it. This is particularly useful as you put together an offer on the property or negotiate contingencies to include in your offer.
While this rule serves a baseline for most real estate investors, it is only one step of several in determining whether a property is a good investment or not. A high cap rate is another popular metric to gauge your returns on a rental property. Other points to consider in your decision-making process may include the local market, forecasted price appreciate, and projected rent growth, to name a few.
A property that does not quite meet the 1% rule could still be a lucrative long-term investment based on appreciation if your goal is to build equity over time. An attractive commuting distance, easy access to or ongoing expansion of transportation systems and hubs, as well as steep demographic growth all suggest a desirable area that can be worth investing in.
Do you have more questions about rental homes? Are you ready to invest in real estate and build wealth? RLG has the tools and resources at its disposal to get you on your way. Call us today to learn more and experience firsthand the dedicated, personalized customer service and undivided attention that RLG has to offer!