The 1% rule states that a propertys monthly rent must be at least 1% of its purchase price in order for the owner to break even. The 2% rule states that a propertys monthly rent needs to be at least 2% of its purchase price in order for the owner to make a sustainable profit.In this article:
Are you thinking about jumping into real estate investing but feel overwhelmed by all the numbers and calculations? Let me introduce you to a super handy tool that might just become your new best friend the 1% rule in real estate
When I first started looking at investment properties, I was drowning in spreadsheets and complex formulas. Then a seasoned investor showed me this simple trick that changed everything for me. Today, I’m gonna break down exactly what this rule is, how it works, and when you should (or shouldn’t) use it to evaluate potential rental properties.
What Exactly Is the 1% Rule in Real Estate?
The 1% rule is basically a quick math shortcut that helps real estate investors figure out if a rental property might be profitable. Here’s the simple formula:
Monthly Rent ≥ 1% of the Property’s Purchase Price (including repairs)
In plain English the monthly rent you can charge should be at least 1% of what you paid for the property (plus any fix-up costs)
For example if you buy a house for $200000, the 1% rule says you should be able to collect at least $2,000 in monthly rent for it to be a good investment.
Why the 1% Rule Matters for Investors
Think of the 1% rule as your first line of defense against bad investment deals. It helps you:
- Quickly screen potential properties without crunching tons of numbers
- Ensure the property will generate enough income to cover the mortgage payment
- Compare different investment opportunities in a standardized way
- Avoid properties that are likely to create negative cash flow
- Make faster decisions when moving through multiple property options
How to Apply the 1% Rule in 3 Easy Steps
Using the 1% rule is super straightforward:
Step 1: Calculate the Total Investment Cost
Add up the purchase price plus any repair costs needed to make the property rentable.
Step 2: Multiply by 0.01 (or Move the Decimal Point)
Take your total from Step 1 and multiply by 0.01, or simply move the decimal point two places to the left.
Step 3: Compare to Potential Rent
Research what similar properties rent for in the area and compare it to your 1% number. If the going rent is equal to or higher than your 1% calculation, you might have a winner!
Real-World Examples of the 1% Rule
Let’s look at a few examples to make this super clear:
Example 1: The Perfect 1% Property
- Purchase price: $150,000
- Repair costs: $10,000
- Total investment: $160,000
- 1% calculation: $160,000 × 0.01 = $1,600 monthly rent
- Local market rent for similar properties: $1,650
This property passes the 1% rule with flying colors! The market rent is actually higher than what the 1% rule requires, suggesting this could be a profitable investment.
Example 2: The Borderline Case
- Purchase price: $250,000
- Repair costs: $5,000
- Total investment: $255,000
- 1% calculation: $255,000 × 0.01 = $2,550 monthly rent
- Local market rent for similar properties: $2,500
This one’s very close! It’s just slightly under the 1% threshold. In cases like this, you’d want to look more closely at other factors before making a decision.
Example 3: The Fail
- Purchase price: $400,000
- Repair costs: $15,000
- Total investment: $415,000
- 1% calculation: $415,000 × 0.01 = $4,150 monthly rent
- Local market rent for similar properties: $2,800
This property falls well short of the 1% rule. Unless there are exceptional circumstances or you’re investing for different reasons (like long-term appreciation), you might want to pass on this one.
When the 1% Rule Works Best
The 1% rule tends to work great in:
- Affordable and mid-market neighborhoods
- Areas with strong rental demand
- Markets where home prices haven’t skyrocketed
- Properties that don’t require massive renovations
- Areas with reasonable property taxes and insurance costs
I’ve found it particularly useful when I’m reviewing multiple properties quickly and need to narrow down my options before doing deeper analysis.
Limitations of the 1% Rule: When It Falls Short
While I love using the 1% rule as a starting point, it’s important to recognize its limitations:
1. It Ignores Operating Expenses
The 1% rule doesn’t account for costs like:
- Property taxes
- Insurance
- Maintenance and repairs
- Property management fees
- Vacancies
- HOA fees (if applicable)
These expenses can seriously eat into your profits, especially in high-tax areas.
2. It Doesn’t Work in Every Market
In expensive coastal cities like San Francisco, New York, or Los Angeles, finding properties that meet the 1% rule is nearly impossible. As the article from Rocket Mortgage points out, the median home price in San Francisco is about $1.1 million, which would require over $11,000 in monthly rent according to the 1% rule – but the median rent there is only around $3,000.
3. It Overlooks Appreciation Potential
Some properties might fail the 1% rule but still be excellent investments due to strong appreciation potential. Many investors in high-cost areas focus more on long-term equity gains than immediate cash flow.
4. It Doesn’t Consider Financing Terms
The rule assumes similar financing across properties, but your actual mortgage terms (interest rate, down payment, loan period) will greatly affect your monthly costs.
Beyond the 1% Rule: Other Important Investment Calculations
While the 1% rule is great for initial screening, savvy investors use several additional metrics to evaluate properties more thoroughly:
The Gross Rent Multiplier (GRM)
This calculation helps determine how long it will take to pay off the investment:
GRM = Purchase Price ÷ Annual Gross Rental Income
For example, if you buy a $200,000 property that generates $30,000 in annual rent, the GRM would be 6.67, meaning it would take about 6.67 years to pay off the property using only rental income (not accounting for expenses).
A lower GRM generally indicates a better investment opportunity.
The 70% Rule
This rule is specifically for house flippers:
Maximum Purchase Price = (After-Repair Value × 0.7) – Repair Costs
For instance, if a home will be worth $150,000 after renovations that cost $30,000, you shouldn’t pay more than $75,000 for it ($150,000 × 0.7 = $105,000 – $30,000 = $75,000).
The 2% Rule
This is a more aggressive version of the 1% rule, suggesting that monthly rent should be at least 2% of the purchase price. Very few properties meet this threshold in today’s market, but it can be a useful benchmark in some very affordable areas.
Net Operating Income (NOI)
This is the income left after subtracting all operating expenses (but before mortgage payments):
NOI = Annual Rental Income – Annual Operating Expenses
A Step-by-Step Decision Process Using the 1% Rule
Here’s how I incorporate the 1% rule into my property evaluation process:
- Initial Screening: Apply the 1% rule to quickly filter out properties that don’t meet the minimum threshold.
- Market Research: For properties that pass, research comparable rentals to confirm the rental estimate is realistic.
- Expense Analysis: Calculate all operating expenses to determine the true cash flow.
- Return Calculation: Determine the cash-on-cash return and overall ROI.
- Long-term Outlook: Evaluate appreciation potential and long-term prospects for the neighborhood.
Real-Life Success Story
My friend Jake used the 1% rule to build his rental portfolio in the Midwest. He started by screening hundreds of listings online, immediately eliminating any property that didn’t meet the 1% threshold. This saved him countless hours of research on properties that would likely produce negative cash flow.
After finding properties that passed the initial 1% screening, he’d dig deeper into the numbers. Over five years, Jake has built a portfolio of 12 single-family homes, all meeting or exceeding the 1% rule, and all generating positive monthly cash flow.
Common Questions About the 1% Rule
Does the 1% rule work in all markets?
No. In expensive coastal cities and high-end neighborhoods, it’s nearly impossible to find properties that meet this rule. It works best in affordable and mid-tier markets.
Should I reject a property that doesn’t meet the 1% rule?
Not necessarily. The rule is just a screening tool. A property might still be a good investment if it has other strong points like exceptional location, low maintenance costs, or high appreciation potential.
How do I account for property management fees?
The 1% rule doesn’t include management fees. You’ll need to factor those in separately when calculating your actual cash flow. Typically, property management costs 8-12% of monthly rent.
What about taxes and insurance?
These aren’t included in the 1% calculation either. You’ll need to estimate these costs separately when determining true profitability.
Final Thoughts: Is the 1% Rule Right for You?
The 1% rule isn’t a magic formula that guarantees success in real estate investing. It’s simply a useful screening tool that can help you quickly identify potentially profitable properties and weed out likely money pits.
I’ve used it successfully in my own investing journey, particularly when I’m overwhelmed with options and need to narrow down my choices. But I always follow up with more detailed analysis before making an offer.
For beginners, the 1% rule offers a great starting point that prevents you from diving too deep into properties that are unlikely to generate positive cash flow. For experienced investors, it remains a valuable first-line filter in your evaluation process.
Remember, the goal of any investment rule isn’t to blindly follow it, but to use it as one tool in your overall strategy. Real estate success comes from combining smart rules of thumb with thorough research, local market knowledge, and sometimes, a bit of investor intuition.
Have you used the 1% rule in your real estate investing? I’d love to hear about your experiences in the comments!
What Are the 1% and 2% Rules in Commercial Real Estate?
If youre a commercial real estate investor deciding whether a property is a good fit for your portfolio, you may wish to consider the 1% or the 2% rule. These rules are often used by investors to quickly and easily understand the risk and opportunity present in acquiring a property.
The 1% rule figure is a straightforward calculation. Simply calculate 1% of the acquisition price plus any immediate and necessary improvements or repairs. The result can be used as a baseline for rental income. If a property generates more income than this calculation, that means it is likely to be profitable.
The 2% rule uses the exact same formula, except calculated to 2% of the total sale price and immediate improvements. The use of this rule can be controversial, and finding a property that clears this threshold can be extraordinarily difficult. Generally, only assets at the low end of the quality spectrum tend to near or clear this rental income hurdle.
How the 1% and 2% Rules Work in Practice
If, for example, an investor is considering purchasing an office property for $1 million, a monthly rental income of $10,000 would clear the 1% rule threshold. But the revenues would need to be $20,000 every month to meet the 2% requirement.
Of course, the above example assumes that there are no immediate repairs or work to be done on the asset. If you need to immediately inject $200,000 into the property to make it attractive to potential tenants, the 1% and 2% thresholds would raise to a respective $12,000 and $24,000 per month.