Hey, I have a question for you.
You buy a rental property. Congrats. How long will it take before the property pays for itself?
“Uhhhh…. ??”
Okay. I thought so.
By the end of this article, you’ll know how to calculate this figure.
In the process, you’ll understand why the One Percent Rule matters … and how, and when, to use it.
The Gross Rent Multiplier
Let me introduce you to a close friend. This friend isn’t a person. It’s an equation. It’s called the Gross Rent Multiplier.
The Gross Rent Multiplier (GRM) tells you how many months it takes for a property to “pay for itself” through top-line revenue.
It’s the ratio of a property’s price to gross rental income.
“The ratio of what-the-what?”
Let’s break this down:
Let’s say you’re comparing two properties — one that collects $2,000 in rent, and another that collects $1,500 in rent.
You’ll need to contextualize those numbers. How much rent will you collect relative to the property cost?
If both properties cost $200,000, the property that rents for $2,000 is the better deal. (We’re assuming equivalent risk and similar overhead. More about those topics here.)
But what if:
- Property A costs $200,000 and rents for $2,000 per month
- Property B costs $100,000 and rents for $1,500 per month
Which is better? Property B.
How do we know this? Let’s look at the GRM.
- Option A: $200,000 property / $2,000 monthly rent = 100 months
- Option B: $100,000 property / $1,500 monthly rent = 66 months
Since we want the property to “pay for itself” as quickly as possible, 66 months is better than 100 months. Therefore, Property B is better.
Run the numbers yourself using this free GRM spreadsheet:
The GRM helps you make apples-to-apples comparisons. If you’re familiar with stock investing, think of GRM as the price-to-earnings ratio (P/E ratio) of a rental property: it starts the conversation, but it’s not the final word.
The One Percent Rule
How does this relate to the One Percent Rule of Thumb?
First, a refresher: the One Percent Rule states that the gross monthly rent should be at least one percent of its final price.
- A property that costs $100,000 should rent for at least $1,000 per month
- A property that costs $200,000 should rent for at least $2,000 per month
- A property that costs $300,000 should rent for at least $3,000 per month
When I talk about a property’s price, I’m referring to purchase price plus urgent repairs. After all, you might buy a $100,000 house needing $175,000 in immediate renovation.
If a property meets the One Percent Rule, it’ll take 100 months for the property to recoup its cost.
Example:
- $100,000 property / $1,000 monthly rent = 100 months
- $200,000 property / $2,000 monthly rent = 100 months
- $300,000 property / $3,000 monthly rent = 100 months
- $400,000 property / $4,000 monthly rent = 100 months
What timeline are you aiming for? A reasonable goal is 100 months or fewer. That’s 8.3 years.
“Wait … why?”
Let’s turn our focus to another rule-of-thumb. This is called the 50 Percent Rule, and it states that roughly half the revenue gets spent on operating overhead over the long term.
You won’t spend 50 percent every year (as you can see from my monthly cash flow reports). You might enjoy super-low-bills for five years. Eventually, though, you’ll replace the roof, gutters, garage door, siding, electrical panel, A/C unit and windows. The 50 percent estimate is a long-term average.
(By the way, if you talk to an investor who claims “I only spend 20 percent of revenue on operating costs!,” ask how long he’s been in the game. Nine times out of ten, he’ll reply, “Two years, and I haven’t made any repairs yet!” That’s the myopia of an ill-informed novice.)
(Ignore those puffed-up claims. You’re in this for the long-haul.)
That said, the 50 Percent Rule holds obvious limitations:
- Operating overhead varies depending on local labor and material costs, insurance rates, property taxes, and more.
- Overhead and rental pricing are independent variables. If you raise your rent by $100, your operating costs don’t rise by $50.
This rule is a generalized estimate — but a popular one. Investors regard this as an aggregate average, useful for back-of-the-envelope estimates.
You’ll need to examine every property’s specific overhead in the deep due diligence phase. But we’re not at that step yet. First, we need to narrow our property search.
This brings us back to the 50 Percent Rule.
Let’s assume long-term expenses consume half of gross revenue. Let’s apply this assumption to three scenarios:
Scenario A:
- Price: $200,000
- Rent: $2,000
- Rent/Price Ratio: 0.01, which is one percent
- Payback: 16.6 years for the cash flow to pay for itself.
Sounds like a long time, huh? Keep reading …
Scenario B:
- Price: $200,000
- Rent: $1,500
- Rent/Price Ratio: 0.0075, which is three-quarters of one percent
- Payback: 22.2 years for the cash flow to pay for itself.
Scenario C:
- Price: $200,000
- Rent: $1,000
- Rent/Price Ratio: 0.005, which is half of one percent
- Payback: 33.3 years for the cash flow to pay for itself.
(These figures don’t adjust for inflation. But guess what? These figures also don’t include interest payments. This assumes you bought the property in cash. If you have a mortgage, the final payback period — after interest — is years longer. We’d need a huge spreadsheet to calculate these interest and inflation variables (rate, term, etc.), but for the moment — for simplicity’s sake — let’s view these scenarios as a relative comparison against each other.)
Back to the essential concept:
Why does the One Percent Rule matter? Because you want your earnings to cover the price in a reasonable timeframe.
Like 16 years, instead of 33.
“But doesn’t the actual payback period depend on specific operating costs?”
Of course! That’s why you need to calculate overhead with ruthless specificity.
“Okay. So why eliminate properties that fall short of the One Percent Rule? What if these have cheap overhead?”
Here’s your game plan: Eliminate first; scrutinize second.
When you search for an investment property, you’ll view hundreds, if not thousands, of options. It’s impossible to calculate specific returns en masse. Due diligence takes a sh**load of time and money.
You need a sorting mechanism. When you’re sifting through piles of potential properties, you need a yardstick by which to say “no, no, maybe, no, no, maybe, no, no, no, no, and no.”
Enter: the One Percent Rule.
If a property passes (or comes close to passing) the One Percent Rule, mark it as a “maybe.” It merits further consideration.
That doesn’t mean that you should buy every property that meets this standard. It means efficient use of your time comes from eliminating properties that don’t.
Once you cull the candidates, you’ll hold a smaller, manageable list. Let’s say you’re left with 12 properties. Now you can dig.
- What condition are these properties in?
- What are the repair estimates?
- What are the operating costs?
- What’s the cap rate?
- What’s the neighborhood risk profile?
- How quickly can we close?
Use these questions to eliminate your choices to 3-4 properties. (Or send a dozen low-ball offers and see who responds. That’s a lengthy controversial conversation for another day.)
Once you’ve narrowed the list (and perhaps signed a purchase contract with a 10-day inspection period), double down on due diligence.
You’ve curated the contenders. It’s time to get intimate with the finalists.
THIS is when you’re beyond using rules-of-thumb. You’re perusing tax records, water bills, zoning maps and rental rates. You’re calling contractors and meeting neighbors. You’re scrutinizing ceiling water spots and slithering through the crawl space, cobwebs clinging to your eyelashes.
(Okay, that part is optional.)
This takes days. That’s why the One Percent Rule is an efficient culling device. You don’t want to waste dozens of hours — and thousands of dollars — inspecting properties with a low likelihood of yielding strong returns.
Let me note that if a property is darn close to meeting the One Percent Rule, it’s okay to stick that property in the “maybe” pile.
If a property costs $205,000 and rents for $2,000, it’s a rounding error away. That’s fine, as rental pricing itself is an approximation. A property that “rents” for $2,000 could be priced between $1,900 – $2,100 depending on the season/weather, lease term, photos/advertising quality, and many other variables.
Rent is a range. There’s no such thing as a property that only rents for precisely $2,000.00, with no variation. Even at that price, a GRM of 102.5 instead of 100 won’t murder your returns.
But if a property costs $205,000 and rents for $1,400, skip it. You deserve better.
Use the One Percent Rule (and accompanying Gross Rent Multiplier) as a sorting tool, in the same way that many stock investors use P/E ratios. It’s a culling device. It’s not the final word, but it’s a strong start.
And if you’re a new rental investor, starting is the most critical step.
___________________________________________
This is an excerpt from Your First Rental Property, the property investing course I’m developing. Join the free VIP List to be the first to get updates about this upcoming course.
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I have a rental house and a duplex and I’m hoping to start buying at least 2-3 more duplexes before I quit the 9-5. As I’m the path to building up my portfolio, rules of thumb like this on great to have in the back pocket.
Thanks for this one!
— Jim
That’s awesome, Jim! Congratulations! 🙂
I’ve only dabbled in real estate but I always love the great rules of thumb coupled with “ruthless specificity.” The 1% rule was probably the first real estate rule I learned, in quickly evaluating properties, and it’s served us well so far.
If the breakdown sheet is the tires (where the car touches the road) then the 1% is the best quick and dirty way on analyzing a property in under 5 seconds. It’s not everything though some locations such as Chicago have super high taxes (about 2x the average of everywhere else) so someone would be like whoa Chicago is awesome but then it comes more in line when the Cashflow analysis is done.
Great rule of thumb. A big pet peeve of mine is when people think real estate is a great investment just if the rent covers the mortgage and real estate taxes. “The mortgage pays for itself!” they say, when in reality once you crunch the numbers it’s not as great as it sounds since they have a ton of cash tied up in equity or don’t consider repairs and maintenance.
Oh, that’s a huge pet peeve of mine too. “The rent covers the mortgage! Plus another $100!” That’s an obvious signal that the person hasn’t done their homework. 🙂
It all depends on the property. I have three condos that I paid cash for ($24,000 to $36,000 per unit), and I rent them for $800 – $900 per month. Even after paying the association fees and other expenses, I’m making a few hundred per month on each unit. I’m in Wisconsin though, far from some of the hottest real estate markets.
I know what you are saying but need a rule of thumb for property value Jen. I had a condo 124K and rented for 1,000 but sold it 2 years later for 225K. Probably luck but some areas are going up and is their a way to figure this or only in hind site…….
If you applied the 1% rule in this instance, you would only need to charge $240 to $360 a month. Assuming there are no lurking expenses or problems $800 for a $24,000 investment is hitting 3.3%, which would be very good indeed.
I use 2,5% rule for my family. But the principal is pretty much the same
Hi everyone
I need help with 1% rule and the UK market if you can offer any advice?
I live in Cambridge. Housing market here is interesting as you are competing with cash buyers and houses are coming and going off the market in less than 24 hours.
I bought a house with my partner for £250,000 in Dec 2015. It is a tiny 3 bed and our mortgage is £761 per month. The house next door has just been let for £996 per month excluding bills (condition of property is ok but in need of care, ours is mid renovation).
I doubt we could hit 1% rental income, based on rental in the area but we hadn’t originally purchased the house with rental in mind. Then I find this website and now I want to build a portfolio!
If I wanted to go about starting in the property business, is it worth trying to rent this current house or do I need to take a different approach?
The house in December 2016 is now valued at £290,000 (without taking j to account completed renovations).
I feel like i am late to the party as this is my first house at 25 🙁
If you didn’t have “rich” parents, relative or friends explaining these concepts, then you had to stumble across them like most people. Don’t beat yourself up over this. You own a house..GREAT. Start where you are… If you don’t have the funds partner with people who do until you can stand on your own. This is not easy, BUT if it was there would not be the kind of income you seek to have.
Ummm, not entirely true. As an investor I have borrowed to purchase a house, not using any money of my own. After paying interest on loan and monthly carrying costs it makes me 600$ per month. The house didn’t meet the 1% rule. Good investment or bad? Im clearing 600 per month using no investment of my own.
I like that you explained it in terms of months. I also do the same because 1% can be tough to understand what it means exactly.
It’s also really easy to calculate – however much the house costs, drop 2 zeros. That’s the minimum you want it to be able to rent for each month.
In my area (Montreal, Quebec, Canada), the typical triplex sells for 600 000 and rents 3000-4000 per month. I’m pretty sure there are virtually no properties here that meet the 1 % rule.
@Fred —
#1: “Pretty sure” tells me you haven’t verified that assumption. Test your assumptions. What’s the typical percentage-under-retail that foreclosures are priced at during auctions? How does this discount rate change between single-family and multifamily homes? How about short sales? Can you get better deals through courthouse auctions or online auctions? If you haven’t explored these avenues, you haven’t looked.
#2: If you methodically verify your assumptions and they’re correct, what other areas could you invest in? There’s no law stating that your rentals need to be located next door. Name five other areas with better price-to-rent ratios. Then describe the pro’s and con’s to investing in those places. List these on a spreadsheet, so you can see your options in one place. Among these five alternative areas, which one will you explore first?
#1 I’ll just tell you that I did verify, and let you go on Centris.ca if you insist on telling me I’m wrong. I haven’t checked for foreclosures, no, I was talking abut typical properties.
#2 I also took the time to specify the area in which my comment applied, and never said anything about other areas.
@Fred —
#1: I don’t “insist on telling you you’re wrong.” I asked you to test your assumptions.
#2: I gave you helpful, specific, actionable advice to you empower you to invest in other areas. There’s no reason that you’re confined to only investing in one area.
Are you committed to finding a profitable investment property? Are you going to focus on problems, or look for solutions? The choice is yours.
Right now I’m just telling you that according to your one percent rule there is virtually no good deal in Montreal (or that 1 in 1000 properties will respect the 1 % rule and that if most people followed that rule no one would ever invest in rental properties in my area or in a radius of around 100 kms).
Just stating a fact.
They buy foreclosures. Short sales. Distressed sales. (Do you think experienced rental investors pay full retail??) They buy fixer-uppers and create forced appreciation.
Your “fact” is myopic.
Foreclosures in Canada don’t work like they do in the US. There are laws about this and that. Here’s a good primer: http://www.justinhavre.com/blog/canadian-foreclosures-are-not-as-lucrative-as-foreclosures-in-the-us.html The result is that foreclosures aren’t that much cheaper than regular houses.
I haven’t seen any really decent short/distressed sales in my searches here in Canada either. My suspicion is that (a) similar laws govern these sorts of sales, and/or that (b) realtors snatch them up before they appear in the usual channels. No hard info on that though.
One option is municipal tax auctions — in Canada the city is allowed to sell your house if you’re delinquent for a certain amount on your property taxes. The trouble is that the winning bidder has to put a down payment which is then locked up for an entire year in which the property owner is given the chance to pay off their taxes. Bit of an opportunity cost there.
In Fred’s defense, it’s extremely hard to find something coming close to that 1% mark, unless you’re a realtor perhaps. Note that I didn’t say ‘impossible’, although in my experience it’s almost as good as impossible: my wife and I have been looking for a while as well, and we haven’t found anything really good, either nearby or far away. House valuation is pretty inflated in most markets. Fred is not as myopic as you might suspect.
We eventually did find something that had better returns than the stock markets, over the long term, but nowhere close to the 1% mark.
(Just to clarify: I don’t mean that ROI was nowhere near 1%; it was considerably more than that over a decently long period. I just mean that the property doesn’t meet the 1% rule. Neither does any property I’ve ever seen in my searches.)
I see the same thing in Seattle’s strong markets….. Seattle, San Fran and New York city are all about .5 because somehow people are making you pay for future appreciation. Show me a town with low appreciation I will show you the 1.5% rule…….. Detroit where you can get a house for 15,000 will probably rent for 500 a month.
.5 to .75% rule in Canada looks more realistic
Yep. I’m in Vancouver, BC and there is nothing remotely near 1% anywhere in BC. Plus, as you suspected, realtors (and real-estate lawyers) snap up anything really good since they find out about it first. But they still aren’t getting 1%.
Right now, shitty old 400 sq ft apartments in Vancouver’s West End, (50 years old and never upgraded, no insuite laundry and no parking), are going for 400+K.
There is no way you’d get anywhere near $4000 a month for that, no matter how ridiculous our rental market has become.
I find it fascinating that there are markets where this 1% rule is actually possible.
Being a naysayer will never lead you to success. Find the “how” instead of an excuse.
I should also take the time to mention that I’m talking about 1 to 4 apartment buildings. Obviously the more apartments the more profitable it generally becomes.
The average in Montreal is around 0.05 and sometimes it creeps up to 0.07.
1% is pretty much unheard of in this category of rental properties.
I am no expert but I think it would be more likely that it would be harder to achieve the 1% rule trying to purchase the apartment buildings you are looking at simply because the owners of these are most likely investors as well and they are making all of their buying/selling decisions based on numbers not emotions. If you want to try to find deals on properties like single family homes your more likely to run into people who will make decisions on emotions rather than numbers….maybe they acquired the property through heirship and are trying to get out from under the property, maybe they had to move because of a job, maybe they can not afford their mortgage anymore etc…..these things happen everyday to regular everyday people and that is where an investor can scoop up a good deal. I don’t think the big shot apartment investor faces the same possibilities hes focused solely on analytics. Just my 2 cents on 1 percent 🙂
Colby – it actually works the other way around. Larger properties are bought on the numbers (they have to work). The investor buys it that way and when they go to sell they know the only way they can sell is to another investor (who presumably runs the numbers).
In single family and even up to 4-plexes you are dealing with home buyers who might be looking for reasons unrelated to financials (it’s a great neighborhood, great schools, cute house, “surely we can afford the mortgage”, etc.).
For what it is worth in seller’s market like these days the 1% rule is extremely hard to achieve in most markets. Not impossible, but it takes finding off-market or under marketed properties. I also like the idea of fixers.
Your defeatist attitude is not going to help you find a deal. I know plenty of real estate investors in Montreal that are finding great deals. Be creative. Don’t state “facts” and say why you can’t do something. Figure out ways around it.
please don’t put “facts” in quotes if you are not going to put some other facts that prove the guy wrong.
I did a quick research and I can confirm Fred’s words.
if you know others who do great deals – do you also know how they do it? if so, dare to share? 🙂
Interesting to hear what is happening in Montreal. I also live in Montreal and had been wondering whether this is a possibility. I do have a bit of a feeling that it is tough to find a great deal, but it’s not impossible. You definitely cannot do it through the usual method of realto/market value listings. The whole point is to find the thing that is not market value.
I’m in the greater Denver/Boulder Colorado market looking for my first investment property 🙂 I’m also finding it difficult to meet the 1% rule. What is up with financing for foreclosures, short sales, distressed properties, auctions? I look for these type of opportunities, but was under the impression these are mostly cash deals, or at least you’d have to put a lot more cash down. Thanks!
Although it’s not impossible certain places have lower rent to value ratios. And unfortunately the places with landlord friends are not the place where all the cool kids want to live such as Seattle, SF, LA, New York.
Most areas are not great for investing. In most areas, you can only find good deals if the property is seriously distressed and you can add a lot of value. You should look in new geographic areas to invest. There are maybe 8-10 good markets where the average sfr is a good investment.
I never invest even at 1% as it barely breaks even and even loses money most of the time.
A 100k home getting 1k rent with 500 expenses will have a mortgage >$400 (at these crazy low interest rates with 20% down). So, you’ll ‘net’ less than $90 most months. You can sneeze and find $90 worth of expenses to drain your money away.
I don’t even look at a property unless it’s over 1.5%. Most people try to follow a 2% rule when searching.
Keep up the search, you’ll find something!
hey Fred,
Soo agree with you and actually wanted to say exactly the same thing!
I am also from Montreal and I have really hard time imagining a $100,000 property bringing in $1000 a month.
I do not think it exists in our market.
A condo that costs, let’s say, $200,000 can be rented out for $750-850 maybe if it is next to a metro.
Duplexes are sold for $400-500,000 (checked the prices yesterday), and they probably bring in $850 x 2 = $1700 (currently looking for a pat to rent and know the prices). It is about 4-5% and not 1% :((((
Hi Nadya,
I agree that the market in Montreal is hot, but will say that in many areas of Montreal you cannot rent a duplex unit for less than $1200 + utilities.
Also, what Paula said, if you are willing to go out to surrounding towns you’d be surprised at the lower prices and depth of the rental market.
I realise that it’s been a while since these posts. I just discovered this blog from Millennial-Revolution, itself from MMM, and felt like I had to add my 2 cents!
I’m from Montreal too, I own 60 doors over 15 properties, all types of properties from condos to 20 apartments building. I’ve been a real estate investor for 10 years now, full timing since day 1.
Totally true that the 1% rule can’t apply to Montreal, and probably not Toronto, Vancouver or other big cities either. Deals can always be found, but 1% is a very very long shot.
You want to wait for the perfect property that fits in the 1% rule? Good, my tree will grow while you’re still searching for the perfect spot to plant it.
Word of warning to the new investors though : make sure to make a good financial analysis of the property you are looking to buy, with the right expenses, especially in the “vacancy, repairs, management” columns. If the cash flow is negative, as it will probably be in big cities, make sure you have a strategy to turn the situation around and positive-cash-flow it within 1 to 3 years. If not, it’s your salary that will compensate. Ask yourself how much negative cash flowing property you can own vs. how much positive ones? Infinite.
It’s also true that the 1% rule could be found in other area near Montreal, like Lachute, Sainte-Agathe, Shawinigan, etc. but not only will it be harder to find good quality tenants, these cities doesn’t have at all the same appreciation as Montreal. It would be good cash flow, but slow growth in it’s value.
And as the saying goes : we don’t get rich with cash flow!
I feel like value growth is something I haven’t read a lot about in this blog?
@Paula Pant : Please, what are your thoughts on this?
Bon succès!
I’m in your same boat Fred but in Bend, Oregon. If we stuck with the 1% rule, nobody would ever buy an investment property here. You can’t find a property under $200,000 and if you do, it’s practically a tear down and you’d be lucky to get $1000 in rent. I do think this is a really valuable tool though and I always have it in my back pocket.
Ditto the Toronto area where condos are $1000/sq ft. You might spend $500k for a one bedroom condo and get $2500 a month rent. There’s no way the 1% rule works in every market. I have three rental properties and we’re just happy if they break even or make a couple hundred a month. The capital investment is what people rely on here. Your property can go up a couple hundred thousand in just a few years.
Great info as usual, Paula. I’m irked by unrealistic real estate advice that’s overly optimistic. It’s so nice that you keep it real.
I realize the inflation and interest variables are too much to get into in one post (or comment), but if these rules of thumb apply, does that mean inflation and interest can potentially average out? Assuming you get a good rate and maybe a 15-year or shorter term? It seems like the rules of thumb wouldn’t be very applicable otherwise.
Thank you Kalie! I appreciate that!
As the inflation and interest:
The impact of the interest on the loan depends on (1) fixed, adjustable, balloon, jumbo?; (2) primary residence? second home? investor loan? portfolio loan? hard money? private loan? — because those may relate to the following — (3) how many upfront points? at what cost? (4) APY?
After that, the following questions include: (5) term length?; (6) is the loan amortized or are the payments interest-only (e.g. many loans with balloon payments); (7) if the loan is adjustable, how often does the rate adjust, by how much, and what’s the cap?;(8) do you make any prepayments? if so, how much?; (9) do you refinance? how often? at what rates? with what loan origination and closing costs? …. and a whole bunch more.
That’s why it needs a massive spreadsheet. 🙂
Here’s the simple, short, extremely-oversimplified answer:
From 1971 to 2015, mortgage interest rates (APY) stood between 6 to 10 percent for the majority of those years. The full range spans from a low of 4.6 percent to a high of 16.63 percent during that term.
Here’s the chart: http://www.freddiemac.com/pmms/pmms30.htm
Meanwhile, from 1971 to 2015, the average inflation rate stood at 4.12% per year.
Here’s that chart: http://www.in2013dollars.com/1971-dollars-to-2015-dollars
If your APY was 6 to 10 percent (historically, 1971-2015) and inflation was 4.12%, then no, those numbers don’t balance out.
But if you happened to catch the wave at the low point of that historic range (4.6% APY), then those numbers might balance out. But that depends also on whether or not you paid upfront points, the term, fixed or adjustable, etc.
So …. it depends. 🙂
Thanks, Paula!
Making money on a rental property takes a ton of time – and that actually assumes that you bought the right place. Making money on investment properties can definitely happen, but like you said, you really need to be in for the long haul instead of hoping that you’re one of the few that just so happen to buy the right place at the right time and immediately jump up $100k in appreciation in a couple years.
We have a rental property at the moment that we are getting ready to sell. Honestly, we can’t sell that place fast enough…I want that mortgage gone, and then we’ll be 100% mortgage free. I am definitely not cut out to be a landlord. 🙂
Hi Paula, I’m thinking of renting an apartment to rent out on Airbnb/vrbo. I’m hoping to get your advice on this. I plan to do this in the Seattle metro area. I have heard of a few companies doing this on a larger scale (they have a few properties they rent out), which makes me think it could be a lucrative business. I haven’t done much research apart from looking at vrbo and air bnb occupancies in the area, but in general, would you advise against it?
Thanks for this post! As someone who is new to real estate, it gives me a great place to start. I’m wondering if you have ever purchased a property that you personally planned to live in for a few years before renting out and if you forced yourself to stick to this formula for that scenario as well. Keep the posts coming. I’m addicted.
Hey Paula,
Right on with this one. I think the gem you distinguished here was between:
1. Sifting and sorting deals
2. Due diligence after a contract
The process of buying a good deal is, well, a process:) And these rules of thumb like the 1% rule are super-handy as long as they’re used early in the process. People seem to get into trouble when they take the rules to the bank and don’t follow-up with the “cob-web in eyelashes” (lol) due diligence.
Thanks for sharing.
I have said it a few times before and I am saying it again:
Love the style you write, the info you provide and how down to earth
and simple your figures and calculations are, Paula.
Glad we joined your new venture and cannot wait for the actual results!
Go Paula, GO!
Interesting. It seems that the potential for appreciation in the price is something that’s altogether eliminated, whereas I would think that might enter the equation at some point. After all, if your rent payments are just covering the mortgage, taxes, and repairs but not generating any tax revenue, the immediate response is to say that the benefit of you owning that property is zero, but what if the property goes up in value from $200,000 to $300,000 in a few years. That increase, plus the decline in the mortgage balance from your payments, is a net gain to you as the owner. True, that doesn’t get realized from a cash flow perspective until you sell, but from an overall return on investment review, that could be a better situation compared to someone who might bring in $300 per month from a cash flow perspective, but not see any gain if the property doesn’t appreciate in value.
Many (if not most) “buy and hold” real estate investors stick to a cash flow first model.
The problem with counting on appreciation is it is really hard to predict when it will go up vs down, not to mention that historically home prices basically keep pace with inflation.
So the calculations are (usually) done without inflation to see if it works.
Any appreciation is icing on the cake – and you are right, that is some pretty sweet icing!
Another great post, Paula!
Using the 1% rule to quickly cull through options is great. How are you determining whether the 1% represents an accurate rental rate? Do you work off of experience in certain areas or a “gut feel” for the sake of saving time researching each one in the preliminary stages?
I have the same question. Maybe I am being too obtuse but it seems that you need to do a deeper-level analysis in order to determine if the property passes the one percent rule, which is contrary to what this article is saying.
What about condos and strata fees? In terms of accounting for repairs and maintenance. If the depreciation report is appropriate and the contingency fund is health and they do gradual increases instead of special assessments?
Is this the cost to own after subtracting the down payment?
Hat about factoring capital gains?
What about if the rental is part of your house? A basement suite/ a mortgage helper?
If you’re considering a property that has an HOA, it’s useful to back the HOA fees right off the top and then look for the 1% rule.
While HOAs provide valuable services, they can also destroy returns since upkeep will still be around 40-50% of gross rents (as always, your mileage may vary, but that has been my experience and the experience of other people in the same market).
I won’t invest in properties with HOA. The restrictions and added fees are not valuable to me.
Where on Earth does this one percent “rule” actually exist?
You’d be lucky getting 0.5% in any decently populated area on the east or west coasts of the US.
If you could actually get 1%, the rental market would be near non-existent as many of the renters would just be buying their own homes.
One method?
Find a property with a fixable defect so you can negotiate the purchase price below market value, fix it so that you force some additional appreciation and rent at the going rate for your area.
Basically, it takes work.
bought a completely redone sf house in the n. Oak Cliff section of Dallas. New appliances, roof, kitchen,bath, hardwoods etc. Am getting about 1% of rent. Rent is $2,200/m.
Just bought and am living in another house right in the heart of Dallas. And when we do end up renting it, it should be right at 1% as well. (assuming $500/bedroom in rent)
Two examples bought in the last 18 months in Dallas (one of the hottest real estate markets in the country), both houses are within 3-4 miles of downtown.
It can be done, you just have to look. If it was easy, everyone would be doing it.
I feel that 1% just breaks you even. On $100k or less I look at a $200/mo profit. $1200/mo rent for $100k property. If financed need 20%+ Cash-on-cash return.
Well put. I’m with you Curtis.
Hi Paula, thank you for great article and awesome podcast – The Money Show (I listened all the episodes)! I am wondering about 50% rule also apply to investing in apartments (rather then houses). In general in apartment there is less things that can be broken (e.g. no roof, no garage). I keep reading your blog even though I plan to invest in my home country – which is Poland. Unfortunately it looks like the real estate markets are so different that most of “the rule of thumbs” does not apply to properties in Poland. Good luck with your blog!
Hi Paula!
Thank you again for the great insight! I am beginning to search for properties in northern California (San Francisco Bay Area to Sacramento area) and I know that I currently don’t have a lot of cash to spend. I’ll probably have to find ways to do low down investing.
1) How do you factor the mortgage into the one percent analysis?
2) Do you include it in your initial yard stick analysis or afterwords?
I am worried that I might find some properties that fit the rule based on operating expenses but the mortgage will keep throwing this off. Making it less likely to find a deal. Do you or any other experienced investors have any advice on this?
Thank you and greatly appreciated!
Have you found any information about this? I also have the same questions.
Thanks!
Hey Paula!
I stumbled upon you and your website listening to Stacking Benjamins and have really enjoyed your content. We see pretty much eye to eye on most things I’ve read and heard so far so I have a quick question for you. What is your opinion on turnkey rentals (It would be a great blog post, hint hint)? I own two rentals and love real estate to balance my equity portfolio. I’m trying to figure out how to best acquire more properties but I have a career and side hustle that I love and a young family so putting the time into finding a optimal rental like you do is difficult. For that reason I like the turnkey model, they easily hit the 1% rule. I know I sacrifice optimal for good, but given my other constraints I’m pretty happy with good for now. Is my logic flawed?
In my city (Bengaluru, India), it is tough to apply this rule. City where the land price itself is much appreciated there is virtually no chance of getting property falling under 1% rule.
Same is true for my city – Mumbai, India. The GRM in Mumbai of the Building in which I live is 37!
It’s interesting how people have such different goals when buying investing properties. Some are speculators, some are looking for cash flow, some are looking for a tax write-off, others want cash flow and growth. Some folks are just looking to diversify!
Does the 1% rule apply to all of these different types of real estate investors, or just the cash flow mavens?
This is a very comprehensive explanation, Paula. The practical mathematical illustrations are very useful. If the rest of your property investing course is this helpful, it is sure to be a success.
Hi Paula!
I love the 1% rule, I use it as a super quick test to see if I will spend anymore time evaluating a property. If it is 1% or over, then I dive in and really dig into the actual numbers to use for calculating cash flow and stuff.
In super popular cities it is almost impossible to get 1% but im totally on board with you going outside your area if you have to for finding deals. I started buying rentals outside of Austin after I spent 6 months getting outbid on multiple houses here. LOL.
There’s this rule that is social proof; we see the rental income model working for many others and we figure that it ought to work for us, so we dive.
1% rule is a quick rule to run the number on the top of your head while searching the deals. We should also take other factors such location, demographic into consideration. For most, rental is not completely passive at least in the beginning. From time to time, you run into the issue like this.
This is the conversation I had with my tenants this Saturday. Not what I would prefer for the activities on a Saturday!
Mind you, this is not the worst tenants we have encountered!
How do you see how much a house is renting for?
rentometer is good place to start to see how much rent you will get for the location.
I think all the ratios are important and finding the right deal can be hard. In my area taxes are such a cash flow drain that it is really hard to find deals. That’s why many people just do fix and flip. Taxes average between 7K and 15K annually depending on the area.
Advice on a deal…
Multi Fam – U1: 2Be/1Ba, U2: 3Be/1Ba
Purchase Price: $105,000
Repairs Needed (New Roof, Furnace): $13,000
Location: Next to schools and downtown area of up coming city.
Rents: U1: $750, U2: $900 ($1650)
Loan would be $100,000 on 3.5% interest FHA as I would live in Unit 1 for the first year.
Any advice appreciated.
Is this information FREE. Or is there a subscription cost. I can’t find a cost anywhere. I would be grateful or the information. Thak you.
Agreed, all the houses I’ve bought I’m all grossing 1%+. This is very hard to do in major cities and expensive metro areas. I actually did the calculation for my condo in Chicago and I’m getting 0.93% a month. So we’re close but for a nice area in Chicago we know thats a great return.
I’ve been enjoying the posts and have very similar rules, and results too.
Thanks,
Keep it movin’
As someone reading a lot about real estate specifically, I have often found myself doubting the specificity that the 1% rule brings along with it.
Great info Paula P. The 1% Rule was shocking for me when I from heard you mention it because my current rental gets no where near 1% . This was a home that turned into a rental so I don’t feel as inexperienced as I would have if this was initially an investment property. After hearing your rule, I researched the neighborhood and area where my rental is located and found that none actually receive 1% so my curiosity peaked as to how many investors, novice or experts, actually get 1%.
Hi Paula,
Great blog!
About the 50% rule, do you think it needs some adaptation for condos, apartaments buildings?
These kind of property have a lot of shared spaces. And the eficiency of the management of the condo fees plays a big role here.
Did you think about the long term cost for this kind of property?
I did some calculation and I am tending to think that 50% is a little over.
If someone has any consideration to share, I would love to know about.
I feel like there are almost 0 houses in the Northeast that meet the 1% rule, excepting those in really low income areas. In the South, especially Florida where I grew up, you can find them in abundance. I think the wealthy just want the real estate in NY and CA for the appreciation potential and drive everyone else out, including small time investors!
I did a toastmaster speech on the rent to value ration. Its just a freaking rule (sorry)… its like Tinder for investing. There are thousands of properties that you look at as investor and the 1% rule is simply one want to see who “you are going to date”. We aren’t talking about marriage and yes of course some of those we swipe left can be good suitors too.
Sorry Paula I backlinked this article on my website because you said a lot that needed to be said.
Haha — I like that analogy!! 🙂
BTW Seattle is 0.5% RV ratio and many parts of Asia its 0.25%
Thanks for a great article. One question though. Once the goal of that first propriety is achieved, how does one make the move to property number two if all equity is tied up in the first property. Regardless of how good the next deal seems, it may take years before the equity stream is replenshed. Am I missing something here?
Thanks
Great question. I have the same! Following…
I have never herd of the 1% rule before. This article makes perfect sense. Thank you for explaining it so clearly, I will use this for the rest of my investing life.
When you refer to the 1% rule, is that with or without the overhead costs associated with a rental such as taxes, insurance, vacancy rate, maintenance, etc?
Great article! I’m also looking to enter into the rental market and I read a lot of useful info here. I have a question though: does the 1% rule equally apply for single houses and apartments? I assume with apartments you could calculate with less operating costs, or am I wrong?
Hi Roadrunner –
I use the 1% rule for all residential rental properties — which is defined as anything with 4 or fewer units (4-plexes, triplexes, duplexes, and single-family residences (SFRs)).
Multifamily residential rentals (like triplexes and 4-plexes) have some ‘economies of scale’ that reduce operating costs. You’ll only need to replace one roof, for example.
But multifamilies could also hold certain costs that SFRs don’t. For example, we include more utilities — including water, sewer and lawnmowing — for the tenants in our triplex. Our SFR tenants, by contrast, have to pay for their own water/sewer and mow their own lawn.
That’s why I use the 1% Rule for both SFR’s and residential multifamily (duplex, triplex, 4-plex).
Once you start getting into large apartment complexes (e.g., one of my friends owns a 250+ unit apartment building), the rules of the game REALLY change. At that point, you have full-time payroll employees, etc., and there’s a chance that there are also multiple investors participating in the deal. Those Big Big Deals — e.g. huge commercial apartment complexes — have their own playbook.
Living in LA, I can definitely relate to those expressing difficulty finding properties in their local market that meet the 1% rule. I’m still new to real estate investing but here is my track record:
* In 2012, I financed a condo for $150K and rented for $1290. This was enough to cover the mortgage and HOA. Within 2 years, I sold the property for $250K.
* The profit from my first deal allowed me to finance a duplex for $610K in 2014. I’ve raised the rent once and it’s now at $3430. Market rates would justify at least another $500 in rent and I plan to raise soon. Now in 2016, comparable property sales value my duplex at around $725K.
I hadn’t heard of the 1% rule until reading this article. Honestly, I didn’t even realize that kind of return was possible in LA. Luckily, I’ve been able to ride a wave of good appreciation in LA and come out on top. I will definitely scrutinize my next set of properties more aggressively and try to find something in LA that meets the 1% rule. If anyone has been able to pull this off in LA recently I would be really interested in the details; what area, what type of property, price and financing, etc. Not having enough capital to bring all-cash offers seems to make those really low price deals much more difficult to find.
I’m about to buy a property for 65k that has 5 rentals on It renting at $425 per month ($2125) total. Also there is. 3 1/2 acre wooded lot on it that I plan to sell to get a 15k-25k off the purchase price 🙂 always look for hidden value my friends
The flip side to this is convincing clients to evaluate portfolio holdings against one another. Some clients will hold onto that $200k property that rents for the same as one we helped them acquire and manage that cost $55k ! Evaluate your holdings annually, then compare with what else is out there. Broker dad taught broker son this years ago. ‘What will you do with the $’s once you sell it?’
in canada the 1 % rule doesnt really work because if you buy a house for 450k the mortgage on that (with zero down payment) is 2K a month . 1% rule says you should charge $4500 a month .
No smart person would pay $4500 rent when they can OWN the house for half the money
I have 2 condos in Florida for which I paid around 100K each, 3 and 6 years back.
The first condo has gone up in value to around 175K, it is rented for 1400 USD, the other one is valued to be around 130K and rented for 1300 USD. So, I am wondering if I should think about selling the first condo?. I am not USA citizen but my sisters lives there and manages the property, her husband is a real state agent. If I sell it, I would probably put the money in index funds.
I like reading this website. I did not meet the 1% rule, but I still made over 430% from my DP in 3 years, here in Norway. I got extremely lucky. I utilized tax free income by living in the rental property for 3 years. I had water damage from copper pipes, and the insurance covered all of my pipeline and bathroom upgrades. So the appreciation came from both rental and from appreciation. Now I moved out and I have to pay tax from the rental income, It then doesn’t cover the 1%rule, but I can sell the property tax free within 2years after moving.
There are new rules in Norway, so I cant borrow more than x5 my income anymore, my best option is to buy preselling projects at 5% DP, then sell it at turnover. This has more risk, but in the long run it’s a lot easier. Im going to buy 1bedroom, convert it to 2-3bedrooms and list them at turnover. I then get to have better credit rating incase I want to borrow money to buy a car or fix something. Here the interest rates are 1.9-2,3%. With low interest, low unemployment and many immigrants, housing prices are most likely rising.
Curious what are your thoughts are in high priced areas like LA, SF, and NYC. It’s hard to see how traditional metrics (GRM, cap rate, 1% rule, 2% rule) apply to these environments. How would you go about evaluating these kinds of properties (assuming you would, but I know you wouldn’t because the price to pay is just so darn high and why bother if you can obtain a better cash flow elsewhere)?
Did you ever find an answer? Live in the NY/NJ area. No way we’d meet the 1% rule. Would have been nice if she answered this one.
I like that you bring up the 1% rule. That is forgotten a lot when newcomers are looking at their first rental investment.
Thanks for this one, Paula. Very clearly put–and really drives home how you have to factor in ongoing expenses when considering a rental property.
You, Paula, are a rockstar!!! You are the only person I need to follow and you have all of my attention….. #1%Rule I’m starting to feel more in control – Thank you brilliant beautiful one! #feelingthemomentum 👏
I am finally entering the game of real estate rentals this summer. I have identified an area where houses are cheap and rent is more than the 1% rule (closer to 16%). these houses are in a moderately depressed area near a major city. Crime isn’t too bad, but not a war zone either. My first purchase will be cash, followed by equity to buy more once it is rehabbed. I am fortunate that I used to be a contractor, so most rehab work will be done by me.
Do you know of people who dance on the edge of depressed areas for their rental property? I can see the area recovering if enough houses were rehabbed. My goal is to start that trend when I go in and start buying property.
Great article. I utilize the 1% for fundamental screening as you propose, yet I’m shooting for that after all conceded support thing speculations are finished.
Thank you very much for all the information you provide Paula.
I would love to see a list of locations in the United States where the 1% rule is possible.
On your podcast you mentioned Montgomery, Alabama. Do you have a list of other locations?
Thanks
Hi,
What is your recommendation for evaluating the following situation:
Bought our house for 222,000 in 2009. Switched to 15 year loan in 2012. Have 143k remaining on the loan.
Could rent for 2,200 a month. This would cover P,I,taxes, insurance with 100 remaining for maintenance per month.
The house will have all the maintenance expenses you mentioned above coming up in the next 3 to 5 years.
Thank you
Hi Doug – you might have a better chance of getting an answer if you submit your question as a voicemail for Paula to answer on her podcast. You can do that here, if you’d like: https://affordanything.com/voicemail.