There always seems to be a lot of talk surrounding the 1% and even the 2% rule. For some reason, new investors seem to be inexplicably drawn to this rule more than anything else. Generally, when we hear rules, we think these are things we need to pay attention to and follow. The 1% rule may not fit the typical definition of a “rule”. We’ll talk about what the 1% rule is, what it is good for and some of the problems with it.
What is it?
The premise of the 1% rule is that a rental property is a good investment if the monthly rental income is equal to or higher than 1% of the purchase price of the property. For example, a property for $100,000 must have monthly rental income of $1,000 or higher to fit this rule. $100,000 x .01 = $1,000.
It’s extremely easy to calculate, maybe that’s where some of the appeal comes from.
When To Use The 1% Rule
This rule is great for determining a properties price to rent ratio. Practically, the 1% rule should really only be used as a screening tool. Trying to decide if a property is worth buying or not requires more than a simple price to rent ratio. A properties cash-on-cash return, cap rate and appreciation potential should also be considered. The 1% rule should probably be called something, anything other than a rule.
Drawbacks Of The 1% Rule
The 1% rule doesn’t give a calculation of net cash flow. For example, a property that costs $50,000 and rents for $500 per month. This property meets the 1% rule, right? What the rule ignores is all the expenses that accompany a rental property that will likely eat all of the $500 rent and some. Buying this property using only the 1% rule would likely result in a negative cash flowing property.
The 1% rule also doesn’t take into consideration the condition of the property. If you bought that same $50,000 property in the previous example using just the 1% rule, you wouldn’t know that it needs $50,000 in repairs and renovations. Now, your 1% just turned into 0.5%. You shouldn’t use this single metric to decide if an investment is “good” or “bad”.
Takeaway
The 1% rule should be called the 1% guide. Or even the 1% screening tool. It can be useful in finding properties to run more analysis on. But, it’s not thorough enough to be used as a standalone property analysis tool. It is a good indicator of the property price to rental income ratio but, that’s really about it.
What do you think about the 1% rule? Is this something you have used, will use or thought about using?
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