What is the 1% Rule in Real Estate?

You can build wealth over time by investing in real estate. Real estate offers cash flow and is a great way to diversify your investment portfolio. However, investing in the right property is crucial to gaining profits. So, how will you know Which rental property is most profitable? How to determine if a rental property is worth investing in. You can determine the potential profitability of a rental property by applying the 1% rule. In this blog we have explained the 1% rule to help you understand and use it.  

Understanding the 1% Rule in Real Estate

Some real estate investors use the 1% rule to estimate the potential profitability of a rental property. The 1% rule can help you find the right home and determine what rent to charge for it if you want to make money in real estate. An investment property's worth is determined by its expected gross income, per the 1% rule. It suggests that rental properties generate at least 1% of their purchase price in rental income. The monthly rental income for an $800,000 property should be at least $8,000. 

Hence, if you are buying property for investment purposes, use the 1% rule to determine which property is the best to achieve your investment goals. If the property is unoccupied when you buy it, use this rule to determine monthly rent. Although the 1% rule provides a good starting point, there are other factors that you will need to consider when calculating the rent to charge your tenants. 

How to Use the 1% Rule?

Here is how to use the 1% rule to evaluate rental property profitability. Add closing costs, repairs, and renovations to the purchase price to determine the total cost of the property. Calculate the property's monthly rent. Use a rental estimate tool or compare the rental rates for similar properties in the area to estimate how much you should charge. Divide the monthly rent you can charge by the property's purchase price. As long as the resulting number is at least 0.01 (or 1%), the property meets the 1% rule. 

When does the 1% Rule Work?

It is an excellent pre-screening tool. When reviewing listings, apply the 1% rule to the listing price and compare it to the median rent in the area. If the neighbourhood median rent is much lower than 1% of the listing, drop this property from your list and look for more options. Any property that can charge rent equal to or greater than 1% of the purchase price passes the 1% rule. For instance, the 1% rule applies to a $200,000 property rented for $2,500. 

Situations Where the 1% Rule Does Not Work

The 1% rule has certain limitations. It does not include maintenance, insurance, operation expenses and property taxes, so you cannot rely solely on it. In some cities, property prices are too high, while the average rent in the area is lower than 1% of the purchase price. If the property's monthly rent is less than 1%, this rule will not apply to it. Likewise, if you purchase the $200,000 property, it was previously rented for $1800; in that case, the 1% rule does not work. If this is the case, look for a more profitable rental property or purchase the home for at most $180,000. 

Other Important Factors You Should Consider

There are other important factors which you should consider to evaluate the profitability of an investment property you wish to buy. One primary factor is the net operating income. A property might require some operational expenses; you should subtract these from the profit you expect to generate from the property. You should also consider the internal rate of return (IRR), which compares the property's future value to what it's worth today. 

Helpful Tips for Success Using the 1% Rule

The 1% rule can help you invest in real estate successfully; follow these tips to use it to your benefit: 

If you plan to invest in any property, research the local market, the property's expected rental income and the expenses associated with the property before investing. 

Consider other crucial factors, such as the property's condition, location, and potential appreciation, before applying the 1% rule. Also, take into account property management. 

Rather than being overly optimistic when estimating rental income and expenses, it's better to be more realistic. Focus on properties that are likely to generate steady rental income and appreciation in the future. This approach will help you choose an investment that will prove profitable in the long run. 

Work With Mike Bolger

Contact Mike Bolger to find profitable investment properties in Waterloo and the surrounding areas. Mike Bolger is an expert real estate agent with market awareness, industry knowledge and years of experience in the field. If you are looking for great investment opportunities in Waterloo, reading our informative blog “HOW TO SPOT A GOOD WATERLOO INVESTMENT PROPERTY”will help you.