What Is the One Percent Rule in Real Estate?
Learn a simple rule for evaluating potential rental property investments, and understand why a complete financial picture requires more than just one metric.
The “one percent rule” is a widely recognized guideline in real estate investment. It serves as a preliminary screening tool, helping investors quickly assess if a property might generate sufficient gross monthly income to warrant further financial analysis. It is a starting point, not a definitive measure of an investment’s profitability.
Understanding the One Percent Rule
The one percent rule suggests that the monthly gross rental income of an investment property should be at least one percent of its total purchase price. This includes the initial acquisition cost plus any immediate repair expenses. For instance, if a property is acquired for $200,000, the rule indicates that the expected monthly rent should be at least $2,000 to meet this benchmark.
Calculating the One Percent Rule
Applying the one percent rule involves a simple calculation. You multiply the property’s total purchase price, including any necessary upfront repairs, by 0.01 (which is 1%). The resulting figure represents the minimum target for monthly gross rental income to satisfy the rule. For example, if a property costs $250,000 and requires $25,000 in immediate repairs, the total investment is $275,000.
To meet the one percent rule, the property would ideally need to generate at least $2,750 in monthly rent ($275,000 x 0.01). If the anticipated monthly rent for this property is less than $2,750, it would not pass the one percent rule. Conversely, if the market rent is $3,000, it passes the rule, indicating it might be a suitable candidate for deeper financial review.
Considering Other Important Factors
While the one percent rule is a useful initial filter, it does not encompass all financial aspects of a real estate investment. Investors must analyze several additional factors to determine true profitability and cash flow. Operating expenses are a significant consideration, typically including property taxes, insurance, maintenance, and property management fees.
Property taxes, for example, can vary significantly across jurisdictions, often ranging from less than one percent to over two percent of the property’s assessed value annually. Homeowner’s insurance costs also fluctuate, with national averages ranging from approximately $2,100 to over $3,300 per year for $300,000 in dwelling coverage. Additionally, a budget for maintenance and repairs is crucial, often estimated at one percent of the property’s value annually or $1 per square foot. Property management fees, if using a service, commonly range from 8% to 12% of the collected monthly rent.
Investors also need to account for potential vacancy periods, where the property generates no income. A healthy vacancy rate is typically considered to be between 5% and 8% of potential gross rent. Financing costs, such as mortgage interest and loan terms, directly impact monthly expenses and overall cash flow. Ultimately, the goal is positive cash flow, meaning that all income exceeds all expenses, including debt service.