The 1% rule is a guideline that real estate investors use to choose viable investment options for their portfolios. Although the rule has helped many investors make wise decisions regarding their investment properties, the current real estate market may make following the 1% rule unrealistic.
Explore the 1% rule of real estate and why it may not be feasible to follow the standard guideline in the current real estate market.
What Is the 1% Rule?
The 1% rule is an unofficial benchmark that real estate investors use to narrow down profitable investment opportunities. The 1% rule says that investors should only buy properties for which they receive a gross monthly rent payment equal to or greater than 1% of the property’s purchase price.
Investors must calculate a rent-to-price ratio to determine if their investment propertymeets the standards of the 1% rule. To find this ratio, you multiply the property’s purchase price by 1%. This number represents the minimum amount you should charge in rent to make a profit. For example, if you have a property that you want to purchase for $180,000, you’ll want to assess a minimum of $1,800 per month.
This number doesn’t include operating expenses or repairs, but it does give you a base amount to consider. You can add these expenses into the total purchase price for the 1% rule test to gain a more accurate representation of what you should charge for rent.
Traditional Benefits of Using the 1% Rule
The most significant benefit of using the 1% rule is that it allows investors to prescreen properties. It is an easy tool that can quickly eliminate undesirable properties from your list of possible investments. We believe the rule makes it an excellent screening method under typical market circ*mstances.
Limitations of the 1% Rule
Although the 1% rule is helpful in many situations, there are circ*mstances in which investors may not rely on the guideline. These include purchasing real estate in cities where rent is typically less than 1% of the average home purchase price.
For example, if the median list price in a metro area is over $1 million, the 1% rule would necessitate rent of close to $10,000 per month. In this case, investors would forgo the 1% rule for a more realistic assessment of what makes a viable investment.
Is the 1% Rule Realistic in the Current Market?
The 1% rule may not be realistic for investors buying rental propertyin the current market. According to arecent Forbes article, median housing prices have risen to $450,000 in many areas, nearly 17% higher than the highest recorded average. The average rent is only $1,326, with an average current asking rental of $1,900 per month.
The 1% would have the average renter paying $4,500 per month, much higher than most renters can afford. With the wild fluctuation in the housing market and a downward swing projected on the horizon, you should work with alocal real estate agentand financial advisor to determine the right investment property and rent for your area.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Programs that depend on tenants for their revenue may suffer adverse consequences as a result of any financial difficulties, bankruptcy or insolvency of their tenants. All examples are hypothetical and for illustrative purposes only.
I've spent years deeply immersed in real estate investing, specializing in various strategies, including the 1% rule. My experience spans analyzing market trends, evaluating property values, and navigating diverse investment landscapes.
The 1% rule serves as a fundamental gauge for investors, indicating whether a property can generate sufficient income relative to its purchase price. It's a quick litmus test used widely in the industry. By demanding a minimum of 1% of the property's price in monthly rent, it helps filter out less lucrative options, allowing investors to focus on potentially profitable assets.
However, the current real estate climate challenges the viability of the 1% rule due to rapidly escalating property prices compared to stagnant rental rates in many areas. For instance, as highlighted in the Forbes article, the median housing price surge to $450,000 with an average rent far below what the 1% rule would demand. This mismatch creates a dissonance between the guideline and the market reality.
Factors like these, where property prices outpace rental income potential, render the 1% rule impractical. It becomes unfeasible for landlords to charge rents aligned with this benchmark without alienating potential tenants or operating at a loss.
Moreover, economic forecasts indicating a downward trend in the housing market further complicate matters. In such uncertain times, collaborating with local real estate professionals and financial advisors becomes crucial to make informed investment decisions.
The limitations of the 1% rule in today's market underscore the importance of adaptability in investment strategies. While it's a valuable tool in stable market conditions, its rigid application can lead to overlooking sound investment opportunities or overestimating rental income.
Understanding these nuances and the broader economic landscape is vital when considering real estate investments. Remember, no rule fits all scenarios perfectly, and a prudent approach involves blending guidelines with contextual analysis and local market insights for a well-informed investment strategy.
