Is the 1% rule that important?

Question

I’m currently in the market to purchase my first property with the intention to homestead, live there for a year, and then rent. I am having a hard time being able to follow the 1% rule! The rule says the gross rent of the property should equal at least 1% of the purchase cost.

Is this something real estate investors swear by? The property I’m looking at is a brand new tract home in New Braunfels, TX. The house is in the highly desirable Gruene area. The expected gross rent is more like 1.5% of the purchase price, including closing costs.

Another thing, I’m not seeing the 1% rule really applying in this market on other homes either so I’m curious to know how important it is!

Ujwal Velagapudi · Answer

Rules, like this one are just general. I would say as a new investor learn more about the fundamental of the rule, and why it's there. At the basic level it is simply saying have enough gross so you can cover all your expenses and hopefully have some margin as a monthly net cash flow. If you do that, you'll be fine.

Each market will differ, and some just aren't good rental homes or good rental neighborhoods/cities since the rents are too little relative to the home value.

Nathan Gesner · Answer

Kate, you completely misunderstand the 1% rule. I recommend you use the search feature and look for blogs about 1% rule to get a better understanding.

In a nutshell, the 1% rule is really a method of quickly assessing a property to determine whether it's worth investigating further. For example, if you found a house for $100,000 that can rent for $1,500 a month, that is better than the 1% rule so it's worth digging deeper to investigate and determine what the real return would be. If it were a $100,000 home that rents for $650 then you'll probably want to pass.

If something does better than 1% then it's even more likely that it's a good investment. But you still have to investigate and crunch the numbers to confirm. The 1% rule is a quick, surface assessment that enables you to quickly identify properties worth pursuing.

Ross Kerne · Answer

Are you saying that you are finding properties that meet the 1.5% rule in Gruene? I'm also in New Braunfels, so I'd be interested in hearing more about those.

The "1% rule" is more of a high level check than a statement of thou shall. You still need to run detailed numbers on the property to make sure it meets your cash flow goals. Some folks would love to find 1% properties in their neighborhood, but some won't buy a property unless it meets the 2% rule.

Greg Weik · Answer

@Kate Cavanaugh, that's interesting that a new construction home will rent for 1.5% of the sales price.

Are you sure?  Sometimes, I find that new clients get bad information on rental rates, either from a Realtor trying to close a deal or a neighbor who dramatically inflates the actual rental-rate.

In my experience, new construction is a poor play for a rental property.  When you buy new construction you are always buying at "top of market".

If you buy new construction, at the top of the market, you will not see any significant appreciation for years to come.  This is why I always advise my clients to look for homes in established neighborhoods, preferably without HOAs.  Owning a rental property - in my opinion - is not about cashflow only.  This is missing the forest for the trees.

Example: $500,000 new construction home near me rents for $3,000/month.  Meanwhile, a $500,000 home in an established neighborhood rents for $2800/month.

The new construction home makes $200/month more in cashflow.  The new construction home does not see any appreciation for 5 years.

Meanwhile, the established neighborhood home appreciates 5% (conservatively)/year.  $525k year 1, $551,250 year 2 and so on.  So that $200/month or $2400/year cashflow on the new construction home is a red herring when compared to $25,000+ in appreciation annually.

Hope this helps you!

Waleep Alvi · Answer

@Kate Cavanaugh You should probably consider running the numbers with something likehttps://www.biggerpockets.com/buy-and-hold-calculator especially as others have pointed out this will likely be a losing investment baring a large speculation win.

Michael Doherty · Answer

@Kate Cavanaugh keep in mind that with the new build your looking at one could assume lower deferred maintenance and cap ex costs. If you are close to the 1% rule on a new build it seems like a no brainer. Use the BP calculator to re run your numbers with perhaps 2-3% cap ex and maintenance.

Aigo Pyles · Answer

It is just a general rule and a quick method to know if the property will be profitable. There are still other factors to consider.

Ed Moran · Answer

@Filipe Pereira makes sense worcester is also getting under 1% which to me is not worth it

Stone Saathoff · Answer

If I read your post correctly, it sounds like these properties you're finding are actually beating the 1% rule.

As others mentioned, it really is just a first initial check before you do a deep dive.

What issues are you having?

Filipe Pereira · Answer

Wait - did I read this right @Kate Cavanaugh ?

Your gross rent will be 1.5% of the purchase price? That's BEATING the 1% rule. (Gross rent divided by purchase price).

If you're doing that well on a new construction build, you will be in great shape.

Many places in the north east (think Boston, NY, lots of eastern MA, etc.) can't touch the 1% rule, and here you are beating it by quite a bit on a new build. Seems like a no brainer!

Is the 1% rule that important?

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