1% rule—how much flexibility is allowed?

Question

I am bit of a beginner located in Southern California and was looking at rental properties in the Orange County area. I am having a hard time finding properties that satisfy the 1% rule (whereby monthly rent should be >/= 1% of purchase price).

Most decent properties are at least $500-600,000, and these properties are unlikely to rent for more than $3K/month in this area. Many resources have suggested using the 1% rule to analyze rental properties, but most properties are closer to 0.5-0.75% in this area. Any thoughts on the 1% rule in this type of market? Is this a hard and fast rule or is some flexibility allowed in different markets? In this situation, would it be better to place a larger down payment to ensure that my mortgage payment is low enough to ensure that I am cash flow positive?

Kevin Sobilo · Answer

@Saba Motakef, the 1% rule isn't for analyzing deals. Its for screening/filtering.

If you look at 100 listings, you can't physically go look at 100 listings today. So, you want to filter them down to the ones that are likely to cash-flow. So, if you only look at the ones that meet the 1% rule you might cut that number to 15 deals and then you can look deeper into those.

If a deal meets the 1% rule there is a fair chance it will generate positive cash-flow. At least a small amount.

In more expensive markets, sometimes people aren't investing for cash-flow. They are investing for market appreciation, mortgage pay down, and since they might have negative cash-flow, a loss they can harvest for their taxes.

Sam McCormack · Answer

In my market at least, the 1% rule is almost the absolute minimum to see anything turn a profit. Maybe a year ago the 1% rule would be jackpot but not now. I mean it still is a sign of a chance but not a guarantee. You likely won't see SoCo having anything make any cash flow when it comes to LTR. This is why the midwest is so popular. Low price and surprising rents. Like Cincinnati. You even get good appreciation in some areas! Hope this helped!

Eliott Elias · Answer

The 1% rule is outdated and should not be how you analyze property. There are so many more factors that play into buying a property. If you buy something 50% under market value and it doesn't cash flow are you passing?

Peter Mckernan · Answer

SoCal the 1% rule is very hard to find and where I have found it and exceeded this rule is in value add deals, for instance doing an ADU. We are bought a property and we are building onto a garage that will cost us in total $180K and we can rent it out for $2,500. If you are buying in a place in SoCal that is an existing structure and no value add I would say it will take you a long time to find the 1% rule.

Charles Carillo · Answer

@Saba Motakef

The 1% rule is a good guideline since it measures the property's price vs the gross income. If your property passes the 1% test, you can make a typical investment down payment and generate monthly cash flow. This 1% rule provides a quick estimate of the rental potential for a 1-4 unit property.

In expensive markets like yours. You will typically not satisfy the 1% rule. In most situations, you can cash flow but your down payment must be much higher. For example; in your market, as you mentioned; a $500k property will rent for $3,000 per month. For you to cashflow, you need to make a larger down payment, like $200k+. Your other choice and the one I would suggest is to find a different market since your return on equity is very low if you are making 40% down payments. If you are deadset on your market, maybe try finding properties that require work. You can renovate them (to rental standards) and rent them out.

Albert Bui · Answer

HI Saba,

In south OC the rent ratio or RV Ratio can be even worst sometimes as low as .3-.4% of price when compared with the monthly gross rental rates. With rents going up at the tail end of 2021 its bumped these ratios in the .50-.6% ranges I’ve noticed.

In early 2023, the  short term rentals (STR) and  Mid term rentals (MTR) rentals were being converted to long term rentals (LTR) rentals along. Additionally, the wave of sellers who couldn’t get their covid pricing 2021 on MLS - multiple listing service have decided to rent out their homes via LTR has made the supply of rentals sky rocket. This should put a damper on rental increases and possibly rental decreases going forward so time will tell right?

If you’re lucky you might get both pricing decrease such that the RV ratio (rent to value) will work out in your favor.

The other strategy is to buy at a RV ratio that is acceptable however having plans to increase your RV ratio through value add improvements such as a renovation, adding washer/dryers to shared laundry buildings, amenities, or billing out utilities and etc to improve the income and RV ratio on the building.

Now some folks may say well thats going to cost more money so shouldn’t that be factored into the “RV,” Ratio and the answer is “yes.” This is where “cost adjusted RV ratio,” comes into play. A cost adjusted RV is the  proforma future rents / Acquisiton price + improvement/rehab cost = CARV ratio.

If the CARV is high enough then it might still justify the deal.

This is one of the many rule’s of thumb that I’ll use to pre-qualify a deal so I dont end up doing a full analysis on every single deal I come across.

@Matthew Kwan @Carlos Valencia @Bradley Dosch @Michael Haas

Peter Mckernan · Answer

I would look at not only the 1% rule in the midwest, but the goals overall and how to maximize the leverage on that property now and the future. The thing that a lot of people do is get a property in the midwest that cashflows and they keep it for 25 years and nothing changes.. To better serve you and your future value add a deal or plan to buy it and level up to a small multifamily in a couple years with it and so on.

Theresa Harris · Answer

Where I am, nothing would fit the 1% 'rule' and they still cash flow...at least under the lower interest rates from previous years.  Find a place and run the actual numbers.  Don't worry if it fits some 'rule' (more like a quick check).  As long as the numbers work for you, go for it.

Becca F. · Answer

@Saba Motakef

I'm in the San Francisco Bay Area and I'm also having a difficult time finding properties that meet the 1% rule. I have 2 properties here but I'm not buying in California anytime in the near future. Even 2 hours out of the Bay Area it's high $400,000 range.I looked at a house just east of S.F., listed for $649,000 sold for $680,000 back in late September - the realtor told me it had all cash offers, which is crazy. It's listed on Zillow Rents and the investor has lowered the rent twice from $3900 to now $3600 for 3 bedroom 1 bath. So this investor just put up $680,000 cash and the cost of the renovation and now is having trouble renting it out. If you put a larger down payment, aren't you tying up more cash?

I have a SFH in Indiana that is meeting above the 1% rule but I bought it almost 10 years ago. I'm not using the 1% rule since I wouldn't find anything now. I'm looking mostly in the Midwest: Indianapolis area and Ohio. Memphis is a possibility. I'm looking in the $120,000 to $170,000 range (ready to move in). If I want to do a BRRRR I could find something under $100,000.  I don't know that much about SoCal but I would recommend looking out of state. Good luck!

Saba Motakef · Answer

Appreciate everyone’s insights, thanks guys!

1% rule—how much flexibility is allowed?

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