See It In Action (Part 3): What is the 1% Rule in Real Estate?

Source: Listing on Zillow

So, you want to buy a rental property, but are having a hard time figuring out which ones will generate a decent return on your investment?

The 1% Rule is a guideline that helps rental property investors filter properties for in-depth analyses. It’s a quick-and-dirty way to get through your long list of options, so you only spend time focusing on the properties that have more potential—those that will generate positive returns.

Imagine if you have 100 properties. Use the 1% Rule and you’ll see that 85 of them is less than 1%. So skip them. There might be good ones there, but you’ll get guaranteed good ones with the 15 you’ve shortlisted. The 1% Rule basically helps you get a higher ROI for your time.

Here’s how to use it.

How to Use the 1% Rule to Spot a Good Investment Property

To use the 1% Rule, add up the property price and necessary rehab costs and divide them into the anticipated monthly market rent. If the resulting number is 1% or higher, then the property will likely generate positive, strong cash flow. Any property with a figure below 1% isn’t worth your time, especially if you have other properties that do pass the standard.

Here’s the formula:

(Anticipated Monthly Rent) / [(Property purchase price) + (Rehab and repair costs)] >= 1%

For example, if an agent sends you a list of 10+ properties to consider, you can use the 1% Rule to quickly figure out which ones are duds and which ones are potential studs. You can even scan Zillow and already calculate the formula in your head (e.g., if the average rent in the neighborhood is $1,000, don’t waste your time with properties selling for more than $100,000).

The 1% Rule in Action

To help you visualize it, let’s pull up two examples to show you what fits the 1% Rule and what doesn’t.

Check out these two properties listed on Zillow in the City of Detroit:

Given that these two homes don’t look like they need any obvious repairs to rent out, we'll assume that the total purchase price of these two homes is $72,000 and $170,000, respectively.

Note: We’re doing this only for the purpose of an example, as you’ll still have to consider all other costs (e.g., closing costs) in reality.

Thankfully, Zillow makes things easier for us. If you scroll down the listings, you’ll see Rental Zestimates, which are the average rent amounts Zillow estimates for the home. Case in point, for the home on the left, the Rental Zestimate is $1,342, and for the property on the right, the figure is $1,399:

Let’s do the math. Using the formula we mentioned earlier, we see the following rent-to-price ratios:

So, the Dale property has a much higher CHANCE of being a better rental investment than the house on Braille. Of course, you need to dig deeper into all the numbers to confirm this.

The 1% Rule is a litmus test for you to sort your options quickly. Looking at our examples, you can already see that the house on Dale St. may be a better rental purchase than the one on Braile St. You can then proceed with other considerations before investing, knowing that you’re in the right direction.

Invest like Pro Real Estate Investors

The 1% Rule is a rule that guides you toward better real estate investments. You’ll significantly cut down the time it takes to sift through hundreds of properties, and immediately zone in on the ones that have the most potential to generate strong cash flow. Then, take a deeper dive into their details before purchasing.

Of course, rules are sometimes meant to be broken—but only if it opens up lucrative deals.

Do you need investment advisory services? Get in touch with our team! And if you have any comments or concerns, feel free to drop them in the comments below. We’re all for simplifying real estate analysis to protect and expand portfolios without pulling your hair out.