The 1% Rule, a Quick Check

Simply put, the 1% rule suggests that a property’s gross monthly rent should be at least 1% of its total purchase price to offer a preliminary indication of positive cash flow potential.

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Sifting through countless potential investment properties can feel like searching for a needle in a haystack.

How do you quickly identify the gems – those with the potential for positive cash flow – from the potential money pits that could drain your resources?

Enter the 1% rule, a quick, rule-of-thumb guideline that helps real estate investors perform an initial ‘stress test’ on a property’s financial viability before diving into more complex analysis.

What is the 1% Rule?

When evaluating any single-family or multifamily investment property, it’s essential to assess its financial viability by applying tools like the 1% rule.

This quick, rule-of-thumb guideline helps investors gauge whether a property is worth further investigation before diving into more complex financial analysis.

The 1% rule suggests that the monthly rent of a property should be at least 1% of its purchase price to potentially generate positive cash flow.

For instance, if a property is priced at $200,000, you’d aim for a monthly rent of $2,000 or more.

Why the 1% Rule Matters:

1. Quick Stress Test: It’s a fast way to screen properties and filter out those unlikely to meet your financial goals.
2. Cash Flow Indicator: The rule highlights the relationship between purchase price and rental income, offering a snapshot of potential profitability.
3. Mitigates Over-Leverage: Helps ensure that rental income has the potential to cover expenses like mortgage payments, property management fees, taxes, insurance, and maintenance costs.

Diving Deeper:

• Close to or Above 1%: If the rent-to-price ratio is around or exceeds 1%, it warrants a closer look. This doesn’t guarantee a solid deal, but it’s a good starting point.
• Below 1%: It’s not necessarily a deal-breaker, but properties under this threshold might face challenges in generating sufficient cash flow. This may require more advanced strategies like value-add improvements or leveraging tax benefits.

Real-World Considerations:

• Local Market Conditions: In high-cost-of-living areas, the 1% rule may be harder to achieve but can still work if long-term appreciation is strong.
• Expenses & Debt Costs: The rule doesn’t account for property-specific factors like operating expenses or rising interest rates, which you mentioned earlier.

In conclusion, the 1% rule serves as a quick litmus test to evaluate the upside potential of an investment property.

If the numbers align, investors should dive deeper into underwriting, considering all income, expenses, financing terms, and market trends.

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• Top 5 Cities for Growth in Texas
• The Full Guide to Multifamily Syndication

Looking to expand your portfolio?

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Credit: Content for Financial Services

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