What is the 1% rule for profitability?

Question

David Greene briefly mentioned the 1% rule for shopping for investment properties.  I am shopping now for my first property, can someone explain this?

I guess I am really trying to find out what the minimum cash flow should be?

Thanks in advance!

Scott E. · Answer

I was simply just answering the question in his original post since I didn't see that it had been answered yet in this thread.

Joe Villeneuve · Answer

1% is used to describe milk...and should be left on the shelf when it comes to REI.  Don't start using %%%% to make decisions...only use $$$$$.

How much CF you need depends on your plan and the requirements you have for it.  What others accept/need or justify as OK for CF is up to them, and should never be used by you.  For me, my CF requirements are based on how quickly I can get me cost back (5 years of less).  Keep in mind the cost to the REI is only the cash that comes out of their pocket, which should be just the DP.  So, the required CF in my case, would be based on how fast the CF of a particular property returned my DP to me...in cash (not equity).

Equity is not the same thing, and should never be combined with CF to compensate for negative CF.  Also, there is never a good reason to have negative CF.

Will Barnard · Answer

the 1% rule is a guideline metric not a rule and was used a lot by agents in the early 2000's and its continued use remains. The error in this guideline is that it was stated to equate to cash flow positive which is a fallacy. 1% rent to purchase price does NOT equate to cash flow. While it is possible to have a unit cash flow at the 1% mark, it is not common when one actually factors in all operating costs (including vacancy and management), capital expenses, and debt service. SO often, investors (or agents) fail to include proper vacancy factors, repairs (or other operating costs such as legal, accounting, etc.) and almost always forget about capital expenses. I hear it all the time, "my property cash flows $800 monthly". Yeah right, only when you fail to include ALL of the expenses does it show cash flow that high on one unit.

I will have to respectfully disagree with this opinion from @Joe Villeneuve - "Also, there is never a good reason to have negative CF." I personally do not like words like "never" or "always" as so often they are just not true. There are certain situations where negative cash flow results in a win for the investor using a specific strategy that fits their goals. For an example, many investors who purchased a single family home in Southern CA in 2014-2019 where the cash flow was negative at purchase and then the property gained massive equity through market (and forced) appreciation. Once sold, any negative cash flow over the holding period was returned with handsome returns from the sale proceeds and the ultimate profit (cash in pocket) well exceeded any cash flow positive deal from day one in the Midwest (or other similar area of the country). That said, I do understand Joe's point that having cash flow from the start is of vital importance for most investors using a buy and hold strategy.

There are many % rules (or more accurately/appropriately described as "guidelines") used by investors other than the 1% rule, including the 2% rule which states that the monthly rent = 2% of your purchase price (including any repairs after COE). When you have a 2% rule, you are almost always going to be in the cash flow positive position but you are also more likely to be in an area of lower to low appreciation and more likely in a C class or lower area as finding a 2% deal in a B or A class would be a grand slam of a deal.

Scott E. · Answer

To answer your question, the 1% rule that you heard David refer to is a "rule" established to do a really quick and rough underwrite of a buy and hold investment deal. It's saying that the gross monthly rent on a deal should be at minimum 1% of the purchase price (for example, a $200,000 property should rent for $2,000 per month)

Scott M Dorau · Answer

Thanks Joe, well stated, good info!

Michael Porche · Answer

So the 1% rule is good for a general rule of thumb to see if something pencils really quickly in terms of cashflow. Normally for properties that are around 100k-400k would cashflow anywhere from $100-$500 a month with that. However I use the 25% rule on Short term rentals. I look for rental rates to equal 25% of the purchase price on an annual basis. If thats the case I cashflow anywhere from $2,000-$5,000 depending on the property. Let me know if you need any help with that

Conner Olsen · Answer

@Scott M Dorau It's possible to hit the 1% rule of thumb by renting a property out creatively. I bought my property in November 2020 and am hitting the 1.25% rent/value by renting the property furnished on Airbnb for 30 day minimums.

Steve K. · Answer

@Scott M Dorau the 1% rule is what our forefathers used to evaluate deals in ancient times ;). It’s a good metric to be aware of but hasn’t been nearly as relevant since the time when property values were going down across the country and rents were staying more stable (early 2010’s). Cashflow was much more important then than it is today because appreciation was highly uncertain. In today’s market, if you see a 1% deal, it’s probably priced that way for a reason (bad location, lots of deferred maintenance, tenant problems, aka money pit). It’s also possible that the seller has no idea what their property is worth I suppose/ you’ve found a unicorn, or you’re in a market with less competition than most of the country, but in most cases in most markets you’re not going to find a property with 1% RTP these days unless it has some problems. Most investors now consider .75% rent to price ratio a deal worth considering. I look at anything over .5% in my market (which is much more of an appreciation market than a CF market). Contrary to some earlier comments, the most profitable deals I’ve done have actually had negative cashflow when I purchased them (due to being value-add projects where I was able to force appreciation quickly and increase rents to maximize overall returns, BRRRR strategy). So whether or not the 1% rule is a useful rule of thumb to consider really depends on what your individual goals are, what your market is like, and what your strategy is. If you’re looking to be as passive as possible, and your market doesn’t have a lot of historical appreciation, then yeah try to get as close to 1% as possible (markets like this actually used to follow a 2% rule by the way). It’s impossible to discuss the 1% rule without getting into the hackneyed debate of cashflow vs. appreciation which always comes back to what the individual investors goals are. If you want to replace your day job with landlording then by all means focus on maximizing rent to price ratio. If you’re looking for best overall return and building wealth, then initial cashflow is less important. My best cash flowing properties spin off about $400/door per month. That’s great and all, but the fact that they’ve appreciated at a rate of $1,000 PER DAY has had a much greater impact on my financial well being. Imagine if I had passed on those properties because they did not meet the 1% rule… In general, the best locations will have the best overall returns and cashflow is just one of the factors that contributes to overall return, with the others being appreciation, depreciation tax benefits, and principle pay down/ amortization. That’s why Location, location, location! is the golden RULE and the 1% rule is considered by many to be an outdated “rule of thumb” because it only pertains to cashflow and not overall return. This BP blog post by Dave Mayer from last year sums it up perfectly IMO: https://www.biggerpockets.com/blog/1-percent-rule-dead.

Jeff S. · Answer

@Scott M Dorau in some major cities you might have the 1/2 of 1% rule then the 50% rule on top of that. For example a condo I closed on last year was 450k and rents for $2400 per month which is which is slightly higher than 1/2%.

Then you use the 50% rule which says your return if paid in cash is $2400 x 1/2 = $1200 x 12 months = $14400 per year so $14,400/ $450,000 = 3.2% return or to use for debt service. This is better than a 10 year treasury and these returns are bringing money into these yields in my area driving prices up even more.

You really don't want debt service to be much more than 50% of your gross rent or in this case $1200 per month for P.I.

These down and dirty rules of thumb are for a quick analysis but also a realistic estimate of a cap rate. My cap rate here is at least 3.2.

Christopher Murphy · Answer

Hey Scott, congrats on starting your journey - I did so as well summer last year and have not yet closed on my first property. I have analyzed hundreds of deals and although it's called the 1% "rule", it's more of a benchmark as others have stated. In my opinion, it's a quick way for me to see if a deal is worth running the complete numbers on. So I would go through the MLS or Zillow, find a property and before I commit to analyzing the full deal, I will just look up the rent in the area for that home's build (I used BP rental calculator) and see if it is comparable to it's price. In the hot Dallas-Fort Worth market, I rarely saw deals that hit that 1%, but that didn't mean I never ran numbers. But after running several, I started to understand which properties were far overpriced for an investment and which would be worth looking into. Hope this helps.

What is the 1% rule for profitability?

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