The “1 percent rule,” has served buy-and-hold investors particularly well for quite some time. Because its ability to serve as a baseline for establishing a rental property’s profit potential, landlords have come to rely on this particular rule to help gauge their interest in an asset.
In its simplest form, however, the 1 percent rule is really a tool; one intended to help today’s investors gauge the risk and potential of a particular rental property. The ability to simultaneously calculate and intemperate the 1 percent rule may prove invaluable, which is why we have created this guide. The following information should give you insight into the 1 percent rule, why it should be used, and how to properly use it.
The 1% rule is simply one of the many guidelines an investor can use to determine if a rental asset is worth buying. More specifically, however, the 1% rule discloses whether or not the asset will produce enough cash returns to cover its respective mortgage.
It has developed a reputation for helping investors find worthwhile assets that will—at the very least—help them break even. In determining the approximate difference in a rental property’s rental income potential and monthly mortgage obligations, the 1% rule will also suggest how much the investor will need to rent the property out for to cover impending costs.
It is worth noting, however, the 1% rule is not designed to provide an exact answer, but rather a quick estimation. Since the 1% rule does not account for additional costs—like upkeep, insurance, and taxes—it is meant to serve as an educated guess instead of an objective answer. Investors need to take the resulting variable “with a grain of salt.” While it will give investors a good idea of what to expect, it’s merely an estimation.
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How The 1% Rule Works
The way the 1% rule works is relatively simple: multiply the purchase price of the real estate asset (accounting for any necessary repairs that need to be completed) by one percent. The resulting answer is then used to determine the base level of monthly rent.
Investors will then know how much they need to charge in rent every month to at least cover the cost of homeownership. From there, investors may adjust their asking prices to increase profits.
An Example Of The 1% Rule
Let’s say, for example, an aspiring buy-and-hold investor is in the market for a new rental property to add to their portfolio. After conducting their own due diligence and market research, the investor negotiates with a seller and decides to buy a subject property for $100,000.
However, before the investor commits to buying a home, they would like to find out how much they would need to rent the home out for if they want to cover the ensuing monthly mortgage payments. That way, they will at least be able to break even on their investment, or perhaps even make a monthly profit.
That’s where the 1% rule comes in.
Once the investor knows their loan amount, they simply need to multiply it by one percent. In this case, the investor will multiply $100,000 by 0.01 (which equals $1,000). As a result, the investor would need to find a mortgage loan with monthly payments of less than $1,000 if they hope to make any sort of profit each month.
When To Use The 1% Rule
The one percent rule is reserved for passive income investors who need to do two things: determine the amount they would need to rent the property for each month and assess impending risk. Therefore, the one percent rule is meant to be used prior to purchasing a rental property. Calculating the one percent rule at this time will factor into whether or not the investor will follow through with the acquisition.
When Should I Not Use The 1% Rule?
The 1% rule should not be used when investors need to determine the exact monthly mortgage obligations (and immediate repairs to make the home livable). Again, the 1% rule is an estimation, and not to be taken as gospel; there is room for error built into the equation. At the very least, there are a number of costs left out: upkeep, insurance, and taxes—just to name a few.
How To Make Money Using The 1% Rule
In its simplest form, the one percent rule is a form of risk mitigation.
By practicing the one percent rule before buying a rental property, investors will increase their likelihood of securing a profitable deal. Again, the one percent rule should identify whether or not a home is worth buying to rent out.
Therefore, simply using the one percent rule to identify a profitable exit strategy should lead to more profits, or at least point investors in the right direction. When all is said and done, the concept behind the one percent rule has more to do saving money than making it.
The 1 percent rule is one of the easiest equations for today’s investors to comprehend, but don’t be fooled by its simplicity. While it’s no more than a simple multiplication problem, the 1 percent rule can help investors determine whether or not a deal is worth pursuing—in relatively no time at all. As a result, this particular strategy is yet another tool for investors to mitigate risk and tip the scales in their favor.
What strategies do you prefer to use alongside the one percent rule when evaluating a rental property? Please share your thoughts in the comments below: