Why 1% of monthly gross rents Rule purchase price?

Question

Im interested in knowing why the purchase price needs to be 1% of gross months rent to make sense. Can someone explain this?

Greg M. · Answer

Why? Because someone said so and it stuck. There are also lots of other "rules" that other people pulled out of their *** and repeat like it's gospel. Like most rules, they exclude a lot of necessary data and they may or may not work in your area.

BTW, it's the other way around, the rent needs to be 1% of the purchase price.

Nathan Gesner · Answer

If anyone is preaching it as "gospel" then they have a serious misunderstanding. The "1% rule" is a guiding principal used to quickly determine whether a property is worth investigating further. Instead of analyzing 100 houses, you use a rule of thumb to eliminate properties that you know are unlikely to be a good investment. Then you focus your attention on the few that look promising. In my market, the average property on market would bring a .7% return which doesn't cash flow. If I use the 1% rule, I can quickly see whether a property may cash flow. It prevents me from wasting time analyzing every property.

There are a lot of articles on this. Here's one: The 1% rule

Mike McCarthy · Answer

@Brian Bonetta if you analyze 10, 50, 100, 200 of your own properties, you’ll figure out whether your area and your investment strategy fits into a 1% rule, 2%, or something else.

Regardless, it’s just a quick ‘back-of-the-envelope’ calculation. Before I (or you) but anything, you should be doing a more in depth projection to confirm you’re making a good purchase.

Max T. · Answer

@Brian Bonetta

In my experience the 1% rule is the minimum (or close to) for the rental income to pay for all expenses of the property over time, including big Capex if it is saved properly along the way. Obviously this doesn’t take into account the varying levels of deferred maintenance you might be dealing with at acquisition, so let’s assume “fair” condition (whatever that means).

If you can get to the 1% rule or better in an appreciating area then IMO you have a solid deal. Of values are largely stagnant you’ll be okay long term, but for many investors that is not worth it. If you’re getting under 1% you better be seeing good appreciation and be ready to come out of pocket for some big/irregular expenses.

Jay Hinrichs · Answer

I think the other thing about these rules..   is what are the baseline returns and equity needed to hit the rules.

so when someone is thinking 1%  they are looking for a property after all expenses and reserves extra that will cash flow positive and create a return of 10% COC  with  20% down.. Any thing will cash flow when you increase the down payment or pay cash.

the metric I see on BP is:

20% down

10% COC

50%  of rent for all in reserves maintenance PM etc etc  ( some maybe less but thats a general rule)

Deduct mortgage payment  ( mortgage being 80% of purchase price)

and you are left with positive cash flow that equates to a 10% annual return on your Cash into the deal.   So 20k down 1% rule

they want to get 2k a month NET after all costs.. although I think as we have seen in this pandemic cycle.. that many investors really under estimate how much reserves they will need .

Chris London · Answer

@Brian Bonetta it's interesting, where I live in Raleigh/Durham it is difficult to find properties that hit the 1% rule. I'd say we're more at .6%. However, we experience 3-5+% annual property appreciation.

About an hour from me is the town of Greensboro where you can certainly find properties that hit the 1% rule, however from what I can see they have extremely limited annual appreciation.What separates a house as an investment compared to say a stock is that you have 3+ different ways to make money on a house (an investment property specifically).

1) Appreciation. Paper wealth that you don't realize until the house is sold and all fees/taxes are paid.

2) Cash flow. This is why people chase the 1% rule

3) Principal Paydown. The amount that the tenant puts toward the equity (principal) that becomes the owner's equity.

+) Tax advantages.

So, the 1% rule is great if monthly cash flow is your primary goal, however, don't forget to look at appreciation also to see more of the whole picture.

Bill Goodland · Answer

@Brian Bonetta because it’s unlikely to cash flow well unless it hits the 1% rule. If you are renting out a former primary residence or built a lot of equity with a BRRRR there can be some exceptions though

Landon Reigelman · Answer

It's not necessary or practical in all markets, but I find it works very well in my market. It kind of just works like a screening tool to find properties that are more likely to give you a decent ROI.

Why 1% of monthly gross rents Rule purchase price?

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