Help with the 1% Rule

6 Replies

I'm a newbie to rental real estate investing and I'm doing my research and education. I've read and listened to some books and podcasts, but I'm sorry I'm a little confused about the 1% rule. As I understand it, if the rent comes out to 1% or more of the purchase price, that is a short cut to assume it will be a profitable rental. I realize it's only a short cut and that all expenses should be calculated. I just want to be sure its the purchase price and not the loan amount that I'm to use in the equation. Meaning if the property is $100k and I put down $20k, the 1% is based off the $100k and not the $80k. When does this rule not apply? I am considering property in CA where if I bought a $500k, 3bd/2ba home, there is no way I'm getting $5,000/month. I might make a slight + cash flow, but I'm looking down the line to 5-10 years from now when this property appreciates, because of community improvements, and I sell it. Any input is greatly appreciated. Thank you.

Hi Summer,

I think I'll make a video to answer your question too but here's the quick scoop:

1.) Yes the 1% is the VALUE of the property not what you paid, so on a $100k house if it was a 1% it would be $1,000 a month rent.

2.) 1% houses are usually only going to be in the 100k-250k range because like you said you'll not likely find a 300k house that NORMALLY rents for 3k let alone a 500k house that rents for 1%.

3.) There are also 2% houses I do a lot of deals with them they are usually in the Midwest and ONLY in certain places like in Indy around the State Fairgrounds you can look on Zillow and see what I mean you'll see 30k houses renting for $600/mo the price is usually 30k-40k because you won't find many 50k houses renting for $1k but you WILL find 40k houses renting for 800/mo.

Usually your expenses will be half the cash flow, so if you get $1,000 a month it will cost for the first 3-5 years about $500 in various repairs, BS with tenants, etc. 

I can show you some more examples of deals I'm doing now that are 2% deals, 1% deals and .5% deals (the lower that number the better the area usually) if it will help you or somebody else.  

Hope that helps.  Thanks!  = ) 

You are correct @Summer Noyes , the 1% rule  (sometimes you'll hear it referred to as the 2% rule too) is the relationship between the monthly gross rent and the value of the property. From my experience with analyzing deals in the suburbs of Philly and Atlanta, the "sweet spot" is 1.5%.  When I start finding deals that look too good to be true (2% or 2.5%+) I start getting into issues with location where the tenant pool might not be of the caliber I'm looking for and therefore, risk goes up and possible costs due to poor tenants. 

All of this however, should be taken with a grain of salt and as you've mentioned, a proper analysis would involve itemizing all expenses and calculating / validating all the numbers of a deal.  the 1% rule is meant to be used as a "first line of defense" in quickly seeing if a deal is worth spending your time to fully analyze.

@Summer Noyes  Let me answer you with personal experience specific to Silicon Valley. You won't be getting anywhere near the 1% rule, maybe the .25% rule, and your planning horizon is way too short. At 5-10 years you may be headed right for a trough. I owned properties in San Mateo and Los Gatos they made money because I had held them for 30+years and they were paid for. Some investors that I knew in California ended up under water with their properties and ESP's (employee stock plan) at the same time, and they lost their shirts. Be very conservative and be way under leveraged in those markets or you won't do well. Being forced to sell in a down market is a disaster. The 1% rule applies to the purchase price. In order to see any cash flow you need to be more like 1.35% with regular financing. All the best!

1% is a good signal to dive deeper. In my market, even at 0.75%, I have okay positive cash flow. but really crunch the numbers. 

@Summer Noyes 1% rule is great starting point in some markets, not sufficient in other markets for cashflow and you won't see it in higher priced markets.

in San Diego, it depends what neighborhoods you are looking in and how much value add there is but generally a 0.7% or 0.75% are great as a starting point for further analysis.  I have purchased properties at those numbers as well as below.  Also, have purchase properties below those numbers and with value add have brought it up to those ratios/percentages.