Real estate is one of the most thriving industries. Recent statistics indicate that the global real estate market size was estimated at USD 3.69 trillion in 2021 and may expand at a remarkable compound annual growth rate (CAGR) of 5.2% from 2022 through 2030.
The real estate industry is also relatively easy to penetrate. Contrary to popular belief, you don’t necessarily need significant funding to set up a real estate venture. In most instances, you require moderate capital, a willing lender, and credible resources to get started.
So, if you’ve been considering taking your chances in the real estate industry, there’s no reason to tarry any longer.
However, as with any business, the success of your real estate venture requires implementing specific fundamental rules. One such rule is the real estate 1 percent rule, and in this post, we explore what this concept is all about.
Factors to Consider Before Investing In Real Estate
There are numerous factors to bear in mind before setting up a real estate venture.
For starters, you’d want to invest in properties located in reasonably accessible locations. The homes should be situated within a reasonable distance from public transport networks.
Proximity to social amenities is another essential factor to consider while scouting for the best properties to invest in. Healthcare facilities, educational institutions, and recreational centers should all be within reach.
However, cost implications are perhaps the most significant consideration before investing in real estate. It doesn’t matter how appealing the property is. You’ll only be able to purchase it if you match the seller’s asking price.
Most importantly, you’ll need to understand the duration it would take to begin reaping returns on your investment. And that’s where the 1 rule real estate comes in.
What Is The 1% Rule in Real Estate?
Before purchasing an investment property, ensuring it will generate enough profit within a reasonable duration to cover the initial purchase price and any other costs associated with preparing the property for renting is prudent. One way to accurately make these evaluations is by using the 1% rule.
The 1 percent rule real estate is an investment guideline used in the real estate industry to help investors quickly estimate the minimum monthly rental income to charge to break even on a certain property. According to this rule, the rental income earned from an investment property should equal or exceed 1% of the property’s purchase price.
The 1% rule is a valuable metric in determining whether a property’s listing price is worth the income it’s expected to generate. It also estimates the duration before the property investor breaks even.
Now, the 1% rule used to be the fastest way to determine whether a property was worth investing in. If the figures looked promising, the prospective investor would analyze the other factors highlighted above, such as the property’s proximity to public transport and social amenities.
Illustrating The 1% Rule
Now that we’ve familiarized ourselves with the 1% rule, the next step is understanding how to calculate the 1 rule in real estate. And how best to do that than by using illustrations!
Assume you’re considering purchasing a rental apartment priced at $200,000.
First, you must apply the 1% rule in finding a suitable broker. The good news is that numerous brokers provide friendly mortgage options for first-time home buyers. Ideally, the best mortgage broker under these circumstances would be one that charges a monthly payment of $2,000 or less.
After finding the broker, apply the 1% rule to set a minimum monthly rent of $2,000. In this case, the apartment’s rental income matches its monthly mortgage payment. So, you’ve successfully applied the 1% rule to make a sound real estate investment.
However, it could happen that the property you’re considering buying requires extensive renovations to the tune of, say, $10,000.
In that case, you’d need to factor the renovation costs into the home’s purchase price. This would bring the total cost to $210,000. The implication is that your mortgage lender would need to charge monthly payments of $2,100 or less, and the minimum monthly rental income would have to be $2,100 or more.
You can also use the 1% rule in real estate to determine if you should invest in a property already generating monthly income.
For instance, a residential apartment is priced at $300,000. The property charges a monthly rent of $2,000.
Using the 1% rule, you’d evaluate the property’s suitability for purchase as follows;
$300,000 X 1/100 = $3,000.
It’s evident that the rental income in this case ($2,000) is less than 1% of the property’s purchase price ($3,000).
So, based on the 1% rule, this property isn’t worth investing in.
How Reliable Is The 1% Rule?
Having conclusively answered the question, ‘What is the 1 rule in real estate,’ you’re probably wondering how reliable this metric is.
The profit motive is the primary reason people set up business ventures in the first place. Any aspiring investor would want to know whether an investment they’re about to make will generate reasonable returns besides simply breaking even. The 1% rule is a reliable formula for novice property buyers unsure whether their investments will yield returns.
Another excellent thing to love about the 1% rule is that it’s not only based on a property’s current listing price and potential rental income revenues. You can also apply this rule to determine if you should buy a property based on its historical rent.
Due to its timelessness, the 1% rule can be useful in gauging whether the current rental income generated by a piece of real estate property is its actual potential in an ideal environment. This can provide investors with even more insights into picking the right properties to purchase.
Is The 1% Rule Cast In Stone?
The 1% can be invaluable in helping you determine whether 2024 will be an excellent year to buy a home. But as with other real estate concepts, this rule isn’t cast in stone.
The 1% rule only provides a general guideline. Whether you’ll buy a real estate property depends on a host of other factors.
It’s important to note that the 1% rule itself doesn’t consider all the metrics that influence the decision to buy real estate property. For instance, the rule may not work in a market with skyrocketing inflation. It would also be unreliable in a post-real estate market crash scenario.
Exceptions to The 1% Rule
The 1% rule is undeniably one of the most reliable metrics for investing in real estate. However, this formula is not without its limitations.
We’ve just mentioned high inflation rates and the housing bubble as the two noteworthy scenarios in which the 1% rule would be inapplicable. But as you shall find, there are many other similar instances. That underscores the significance of working with a trustworthy real estate and mortgage broker.
In fact, the challenges faced by many aspiring property buyers explain the rising demand for mortgage agents. Be sure to acquaint yourself with how to become a mortgage broker. This information will especially come in handy when scouting for a suitable lender.
Below are additional costs typically not covered under the 1% rule;
1. Maintenance Costs
The 1% real estate rule may factor in the initial repair costs. However, it typically excludes ongoing maintenance costs, such as HVAC repair, lawn maintenance, and pest control.
Indeed, property owners usually markup rental fees after factoring in the rate of ongoing maintenance. But the metric may prove unreliable if you consider the 1% rule as the sole indicator in determining whether to purchase a property.
2. Loan Terms
The interest rates your lender charges may also invalidate the 1% rule. This is usually true for lenders charging exorbitant mortgage fees.
Now, it may be tempting to factor in the mortgage cost while setting your monthly income. However, the final figure could be higher than the market average. This could consequently render your property unrentable.
Therefore, it’s best to work with an experienced digital real estate broker to help you find lenders with reasonable mortgage fees.
3. Homeowners Association Fees
Many real estate properties exist in communities managed by homeowners associations. Sadly, only a few sellers will factor in homeowners association fees while listing their properties.
If these fees are significant, they might prolong the duration it takes for your investment to break even. In that case, simply relying on the 1% rule will not help you make a sound purchase decision.
4. Taxes and Insurance
Real estate earnings attract taxation like any other income. The 1% rule may be inapplicable in cities with high rental income taxes, such as New York and San Francisco.
Last but not least, there’s the aspect of homeowners insurance to consider. The higher the premiums, the longer it will take for your investment to break even.
The 1% rule is essential in determining whether a real estate investment is worth it. But as we’ve seen, this formula doesn’t work in isolation.
The only way to make the most of the 1% real estate rule is to use it as a general guideline while also considering other factors.