What is the 1% Rule?
The one percent rule (or 1% rule) is a rule of thumb that determines whether an investment property provides value. It calculates if the monthly rent generated from a piece of real estate is higher than its monthly mortgage payment. If the rent is more than the mortgage payment, it means the property owner is generating a profit in rental income.
The one percent rule stipulates that monthly rent should be equal to or greater than one percent of the price an investor paid for the property (and any repairs). Mortgage payments should be less than that number. For example, if a property costs $500,000, monthly rent should equal $5,000 a month, and mortgage payments should equal less than that amount. If the investor can generate that much rental income and pays monthly mortgage repayments that cost less than the rent, that property is considered a good investment.
Here’s how to use the one percent rule: First, multiply an investment property’s purchase price (and any repairs) by one percent. The resulting number equals the minimum monthly rent you should charge tenants. Then compare that number with the potential monthly mortgage repayments on the property. If those repayments are less than the minimum monthly rent, you will generate a profit in rental income on the property. If mortgage repayments are equal to or more than the minimum monthly rent, you won’t be able to generate a profit.
There are some problems with the one percent rule. This calculation doesn’t consider other outgoings associated with an investment property, such as maintenance, taxes, and insurance. However, investors like you can use this metric to determine the value of a real estate investment and how much you should charge tenants for rent.
1% rule case study
An investor in a hot property market wants to determine if an investment property will generate a profit in rental income. The property in question has a value of $300,000 and requires no repairs. Using the one percent rule, the investor works out the minimum monthly rent for the property—$3,000. The investor’s monthly mortgage repayments are $2,000. Therefore, the property will generate a profit of $1,000 every month in rental income.
The bottom line
The one percent rule (or 1% rule) is a calculation used to determine the value of an investment property. By multiplying the purchase property (and any repairs) by one percent, you can figure out the minimum monthly rent you should charge tenants who occupy that property. If monthly mortgage repayments are less than that amount, you can consider the property a good investment. The one percent rule doesn’t consider the costs of maintenance, taxes, and insurance, so you might want to use other metrics to determine property value.