See It In Action (Part 3): What is the 1% Rule in Real Estate?
Are you trying to determine if the rental property will generate enough money to cover the mortgage? The 1% Rule is a guideline that helps rental property investors find out whether the monthly income they earn from a rental property will exceed their monthly mortgage payment.
In general, the 1% Rule is a great way to assess a rental property's value and is especially useful for beginner investors who are just starting to invest in rental properties. It can help you avoid overspending on a property that won't generate enough income to cover your monthly mortgage, so you only invest in profitable properties.
How Do You Use the 1% Rule in Real Life?
To use the 1% Rule, simply take the property's monthly rent and multiply it by 0.01. For example, if a property is rented for $1,000 per month, multiply $1,000 by 0.01 to get $10,000. Therefore, your mortgage payment should be less than $10,000 per year or $833.33 per month.
Here's the formula:
(Monthly Rent x 0.01) = Maximum Allowable Mortgage Payment per year
(Annual Salary / 12) x 0.25 = Maximum Allowable Mortgage Payment per month
The 1% Rule is a helpful guideline when considering whether to invest in a rental property. However, it is essential to remember that there are other factors to consider when making an investment decision, such as the property's location, the property's condition, and the potential for future appreciation.
When is the 1% Rule Not Accurate or Applicable?
The 1% Rule is a general guideline and is not always accurate. Here are a few examples:
- - If a property is in an area with high vacancy rates, you may have months where the property is vacant, and you are not receiving any rental income.
- - If you’re investing in a market with high demand for rental properties, you may be able to charge more rent and still have your monthly mortgage payment be less than 1% of the rent.
- - If you are planning on purchasing a fixer-upper, your monthly mortgage payment will likely be higher than 1% of the rent while you fix the property.
- - If you plan on living in the rental property, your living expenses will be included in your mortgage payment as well.
In general, however, the 1% Rule is a helpful guideline when considering whether to invest in a rental property. As long as the property you're eyeing is in a good location and decent condition, following the 1% Rule can help you make a wise investment decision.
Is the 1% Rule Good to Assess a Rental Property’s Value?
In real estate, the 1% Rule is a great way to assess a rental property's value because it considers the mortgage payment, vacancy rates, and the median rent in an area. By using the 1% Rule, you can get a general idea of whether a rental property is a good investment or not before you commit.
For example, let's say you are looking at two different rental properties in the City of Detroit. Property A rents for $1,000 per month and has a monthly mortgage payment of $700. Property B rents for $800 per month and has a monthly mortgage payment of $1,200.
Even though Property A has a higher rent, it may not be a wise investment because you will lose monthly money due to the high mortgage payment. On the other hand, Property B may be a wiser investment even though the rent is lower because you will be earning a profit of $200 per month.
The 1% Rule is a great way to assess a rental property's value, but it is not the only factor you should consider when making an investment decision. You should also consider the location of the property, the condition of the property, and your personal goals and objectives.
What Alternatives are There to the 1% Rule?
If you are looking for alternative ways to assess a rental property’s value, you can try the following:
- * The 50% Rule: Take the property's monthly rent and multiply it by 0.50. For example, if a rental property is rented for $1,000 per month, you would multiply $1,000 by $0.50 to get $500. Your mortgage payment should not be more than $500 per month.
- * The 2% Rule: Take the purchase price of a property and multiply it by 0.02. For example, if you are looking at a property that costs $100,000, multiply $100,000 by 0.02 to get $2,000. This means that your monthly rent should not be less than $2,000.
- * The 20% Rule: Take the property's monthly rent and multiply it by 0.20. For example, if a rental property is rented for $1,000 per month, then you would multiply $1,000 by 0.20 to get $200. Your mortgage payment should not be more than $200 per month.
While the 1% Rule is a great guideline when assessing a rental property's value, it is not the only rule you should consider. There are many rules and guidelines that you can use, so do your research and choose the one that is right for you.
Ready to Start Investing in Real Estate?
The 1% Rule is one of the many other rules that guide you toward better rental property investments. As always, take these rules with a grain of salt and evaluate each opportunity according to your specific situation. Of course, the rules are sometimes meant to be broken—but only if it opens up lucrative deals for you.
Do you have any questions about real estate rules? Drop them in the comments below!