There are around 20 million rental properties in the United States. Investing in rental property can be a foolproof way to turn a profit. However, it must be done thoughtfully and strategically. For real estate investors who own rental property, their profits are largely dependent on rental income. With that being said, buying a rental property can pose some risks. How can you make sure you’ll generate positive cash flow? How do you know how much to charge tenants? In this article, we will discuss the method of the 1% rule and how you can use it to purchase a successful rental property and determine the best price for rent.
The 1% rule of real estate investing measures the price of the investment property against the gross income to be generated. The gross income is your monthly rent. In order for an investment property to pass the 1% rule, the monthly rent must be equal to or greater than 1% of the purchase price.
Formula: Property Purchase Price × 1% = Monthly Rent ($100,000 × 1% = $1,000)
With the formula above, given $100,000 for the sale price, you need a property with a mortgage of $1,000 per month or less. And you need to charge your tenants at least $1,000 in monthly rent to meet the 1% rule.
For a more simplified version, move the comma in the purchase price to the left two spaces.
The 1% method is widely used by investors and has proven to be extremely helpful in securing passive income. However, other factors must also be taken into account when purchasing a rental property and determining the price of rent.
Repairs must also be taken into consideration. If you purchase a rental property for $100,000 that needs another $100,000 in repairs, (because let’s be real, that’s usually what a property selling for $100,000 needs), you need to first combine the purchase price with the cost of repairs for the formula to be applied correctly.
Example: $100,000 + $100,000 = $200,000
Now, complete the formula using $200,000 as your property purchase price.
$200,000 x 1% = $2,000
In order for this property to meet the 1% rule, a minimum of $2,000 per month must be charged for rent. The reason you need to add in the cost of repairs is because you want all of your invested money to be accounted for. Doing this the right way ensures you turn a profit.
Beware of purchasing a rental property that has historically not met the 1% rule. If a property is listed for $200,000, and charges tenants $1,800, it probably isn’t the property for you. Chances are the current owner was able to obtain the property for a lower price and is making a decent profit, but the list price just isn’t compatible with the price for rent. However, if you can purchase the property for a maximum of $180,00, the 1% rule is met and you’ll be more likely to generate positive cash flow.
The 1% rule is an excellent formula, however it does have limitations. It does not take into consideration maintenance, operating costs, property taxes, and insurance.
Make sure you’re doing adequate research to determine exactly how much money needs to be put into the property to make it livable and attractive to tenants. The area of town matters as well! You can have the most beautiful rental home that meets the 1% rule, but if it’s in the middle of nowhere, you might not find tenants.
The 1% rule also won’t work as it should for some markets. For example, the median list price in Austin, TX is about $574,000. Applying the 1% rule at this price, you should charge a minimum monthly rent of $5,740. However, the median rent in Austin is $2,327 per month. To match the 1% rule to the median rent in Austin, you’d have to find a property listed for about $230,000 – less than half of the median list price for the city.
I’m not saying it’s impossible to buy rental property in Austin. Austin has a booming real estate market and there are those hidden “gems” that just need a little sprucing up to turn into the perfect cash cow. But overall, you cannot rely on the 1% rule alone when making decisions about rental investments.
The whole purpose of investing is to make a profit. Don’t waste your time and money diving headfirst into a real estate investment without doing your research! I am passionate about helping my investors succeed in the long game with real estate. With over 10 years of experience, I offer some of the best tricks and tips available. To learn the best three ways to create wealth with real estate investing, check out my YouTube video here.
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