1% Rule & 2% Rule In Real Estate Investing How to Analyze a Deal In 5 Seconds
Today, we are going to be looking at the 1% rule in real estate investing as well as the 2% rule. This rule is a metric that other investors and I use to figure out if we should look further into purchasing a property.
This process will only take you 5 seconds to analyze your next rental property deal and will save you massive amounts of time finding your next investment property.
What Is the 1% Rule and 2% Rule?
The 1% rule in real estate investing is to help you analyze a property VERY quickly in order to save you time. The 1% rule is a property must rent for 1% of the purchase price if you are going to buy and hold the property as a rental. Doing this will gauge if you will make money every month is passive income.
Doing a full analysis on a rental property takes a good amount of time so this rule will help you be more efficient. If you want to learn how to invest in real estate, I wrote a step-by-step article to help you get started.
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Both the 1% rule and the 2% rule in real estate investing is to help you analyze a property quickly in order to save you time.
The reason why the 1% rule and the 2% rule are useful for investors like us is that it helps us to know, in a very fast time, what properties are worth spending more time analyzing all the numbers on the investment property.
When it takes 10 seconds to analyze property instead of 20 minutes, you save loads of time.
Usually, to analyze a property, you add up all the expenses and subtract them from the income to find the passive income amount and the break-even amount.
The problem with that is it takes a lot of time to calculate all the expenses as well as find all the expenses. With the 1% rule and the 2% rule, you can quickly find the good properties to do more investigation on.
The 1% Rule in Real Estate Investing
The 1% rule states that your monthly rent should be equal or greater than 2% of the total purchase price of the property in order for you to generate a positive cash flow on the property.
Now being that this is a general rule, you would need to further investigate the numbers to make sure that you will be making enough passive income each month.
If you purchase a property for $100,000, then you should be able to rented for $2000 per month. If you are able to do that then you will definitely be making money every month.
>> A $100,000 property should rent for $1,000 a month or more to meet the 1% rule.
>> A $200,000 property should rent for $2,000 a month or more to meet the 1% rule.
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The 2% Rule in Real Estate Investing
The 2% rule is designed to help you find properties that will make you money every single month in passive income. It is basically figured the same as the 1% rule but the outcome is different. It is also a way to screen out properties that might waste your time while you are analyzing it.
The 1% rule shows you if you’ll break-even, the 2% rule will show you if you’re a make money every month.
>> A $100,000 property should rent for $2,000 a month or more to meet the 2% rule.
>> A $200,000 property should rent for $4,000 a month or more to meet the 2% rule.
Analyze A Rental Property In Only 10 Seconds with the 1% Rule Real Estate
The question you need to ask yourself is, “Will the property that you are buying be able to rent for .01% per month of the total purchase price+rehab?”
If the property will rent for 1% per month of the purchase price+rehab, then this property is worth looking further into and run your numbers.
With the current interest rates, (4% for a 30 year note) you will more than likely make money and find investment properties that you can invest in.
As the interest rates rise, you will need to be more diligent in making sure your numbers work and you still make money by adjusting your offer price.
Build the Business First Before You Do the 1% Rule
Imagine if you have never driven before and you did NOT know how to drive.
Now, imagine I gave you the keys to the to a beautiful new sports car worth $80,000.
You now have access to an $80,000 sports car and you don't know how to drive. If you would get in the car and drive, you would most certainly get in a wreck and destroy the $80,000 car.
This is what it would be if you didn't actually know how to build, grow, and maintain a real estate investing business.
I want to fix that for you and invite you to my free investor workshop where I will show you how you can do the business right.
What Is the 1% Rule Real Estate and How Does It Work
The 1% Rule in Real Estate investing is used to analyze the profitability of a potential property in a VERY short amount of time.
Here it is in a nutshell: Any property that can rent for 1% of the purchase price, per month is a property that you should take the time to run numbers.
If you have a property that meets the 1% Rule then it will be worth your time to actually run the number on the property to see if it is one you should pursue.
Monthly Rent ≥ Purchase Price+rehab x 01%
$1,200 ≥ $110,000+10,000 x 01%
To apply this rule of thumb, you can use my how-to video that shows you how to use Zillow.com to find a property to invest in and my investment property calculator to analyze the property.
For example, if you can buy a house for $180,000, and rent the property out for $1800 a month then you are in a good area to start looking for deals.
Now in a place like Phoenix Arizona where I had been looking, I found that a property that sells for $180,000 house would only rent for $1200. As an investor, I would lose my shirt if I bought the property.
Here are the numbers:
Purchase price: $180,000
Monthly Rent: $1200
Monthly Expenses = $1481
5% – 30 year mortgage payment: $966
Property Manager: $180
Property Taxes: $250
Total Income: $1200
Total Expenses: $1481
Total Net Income (loss): -$281
If it fits the 1% rule, I should buy it?
No! Do not do that.
The 1% rule will tell you if you should spend more time evaluating the property.
Now, analyze the numbers, look at everything, and do your due diligence. The 1% rule is going to save you hours and hours, but don’t use it as your only rule to determine if you are going to buy a property.
Do not use only the 1% rule to buy a property!
If you are looking at a $100,000 property, it would need to rent for at least $1,000 per month to meet the 1% rule.
If you are looking at a $125,000 property, it would need to rent for at least $1,250 per month to meet the 1% rule.
You can easily see that you would lose $281 each month if you bought this property because of the interest rate and expenses.
Now imagine if you could rent that same property for $1800 a month. That would be 600 more dollars each month in income and turn your total net income into a positive cash flow rather than a negative one.
Total Income: $1800
Total Expenses: $1481
Total Net Income (gain): $319
If you could rent the property for $1800 a month you would make $319 each month in positive cash flow.
Practically Using the 1% Rule
Personally, when I am investing in real estate, I run the numbers for potential properties and I only look for properties that I can make a $300 profit each month in cash flow.
If I am not able to make a minimum of $200 a month on an investment property I will not buy it. Anything below $200 is too small of a profit to handle vacancies, repairs, and expenses that come with the property.
If the property is vacant for one month, you still have your expenses that you have to pay but you have no income. If you make $200 a month, that is $2400 a year increase in your personal income.
When you are looking for a new area to invest in, use the Investment Property Rule of Thumb for finding a good deal. Once you found a property you want to analyze further, you can use my investing property calculator to see if the property will be a good deal or not.
You can also watch this video that shows you how to use the investment property calculator and find a great deal on an investment property.
How to Use the 1% Rule on Zillow and the MPI Cash Flow Calculator
Why You Should Use the 1% Rule?
There are so many properties out there and your time is precious.
When I started, I had my job, my business, and my wife and kids. I needed a fast way to weed out properties.
If you are looking at 50 properties at one time, wouldn’t it be better if you didn’t have to analyze every single property? You would be able to look at 50 properties and know within 10 seconds of looking at each one which ones you should run the numbers.
Some people also use the 1% rule to see how long it would take to pay off the entire purchase price of that property.
If somebody buys a property for $100,000 and it rents for $1,000, you would multiply the $1,000 by the number of months it would take to pay off the property.
I don’t personally do this, but it isn’t a bad idea.
You and I as investors, we don’t care about paying off the property.
We invest for cash flow every month.
Invest for Cash Flow and Your Tenant Pays Your Mortgage
If I buy a $100,000 property and I use an FHA loan, which requires 3.5% down, it is $3,500 to buy one property. For FHA, you need to live in the property for one year, and after that you can get a renter in there.
This costs me $3,500 and the balance is $96,500, plus all of the interest on top of that. Your tenant is the one paying the balance, interest, taxes, and property management fees, which insures that you don’t have to work.
I don’t care how fast I pay off the property, all I care about is that extra $250 that is going in my pocket every month.
I have 30 plus properties and $250 is the bare minimum. You want to shoot $300, $400, or $500. I have some properties that are cash flowing $450 a month.
Imagine having five or ten properties at $450 or $500 a month! Wouldn’t it be mind blowing to just have one, let alone five properties?!
In my opinion, the 1% rule is all about saving you time. 1% of the purchase price is the rent, and if it beats that, then proceed with the numbers.
The 1% Rule Real Estate Is Best Used for Rental Property Investing
We don’t talk about wholesaling, flipping, tax liens, tax deeds, or anything like that. We talk about buying rental properties and keeping them long term. Investors like us, who buy and hold properties long term, are the ones that should use the 1% rule.
Flipping properties does not count on monthly cash flow since you will sell the house without ever getting a tenant. So that takes out one major portion of the equation. The monthly income in the form of rent is gone. So this would not work.
Same with wholesaling. When you wholesale, you are basically providing a service to the buyer and seller. You do this in order to make a commission when the transaction goes through.
You will never receive rents, have cash flow, or invest for long term growth. So the 1% rule real estate does not apply here. Same goes for tax leans and tax deeds. The only way for the 1% rule to work is to have long term tenants in your property paying you rent each month.
The 1% Rule Can Work For Commercial Investing Too
In the commercial property where I am moving my gym, I wrote in the contract that if the landlord ever sells the property, I have the first right of refusal to buy it.
I keep buying properties that are going to make me money and that I can pass down to my children.
In the same way with residential properties, income less expenses is your cash flow.
Now, there will be different expenses in commercial properties, but remember, this is a rule of thumb to go by. Not a law.
If you are going to buy a property for $300,000, it better rent for $3,000 or more a month, before you are going to waste any more time analyzing the numbers.
What Goes Into the 1% Rule?
Add up all of your expenses for the property you are evaluating. If you are going to make at least $250 in passive income, after all of the expenses are subtracted away from the rent, that is a good property to consider.
There are other things you will need to do, like inspections, but this rule will help you decide if you should continue to look at this property.
What if you find a property, but it is just below the 1% rule? For example, if they are asking $100,000 for a property and it will rent for $900 a month, it doesn’t fit the 1% rule.
Remember, $100,000 is the asking price. It is all about the purchase price. Talk them down by offering $80,000.
Always Negotiate to Get the Price Lower
They may come down to $90,000. Then you offer $82,000 and they may come down to $85,000. If you can work your way down to $90,000 or less, it meets the 1% rule.
You need to run the numbers after you make sure it meets the 1% rule, because there may be some extra expenses. Let’s say there is a homeowner’s association (HOA) fee that you didn’t know about at first glance.
You will need to add that fee into your numbers to make sure you will make at least $250 per month.
The 50 Percent Rule
There is also a 50 percent rule. Not many people have actually heard of this, but it is a general rule. These are not hard and fast laws.
This rule says whatever amount of money you can make a month in rent is cut in half to expenses.
For example, if you are making $1,000 a month in rent, half of that, $500, is going to be taken out to go to taxes, insurance, HOA, legal, property management fees, etc.
This does not include your mortgage.
This rule just shows you how much you will have in expenses without a mortgage.
What to do After the 1% Rule
After the 1% rule, you need to figure out if the property is worth buying. Pull up the calculator by going to https://www.masterpassiveincome.com/resources and click on the Cash Flow Calculator.
There you will find the Cash Flow Calculator. In this calculator, you can put in all of the numbers and see how much cash flow you will make per month.
Some of these expenses include property management fees, taxes, insurance, etc. Here are some examples:
- 5%: Maintenance of the property
- 10%: Capital expenditures like a roof or furnace
- 10%: Property managers
- 10% Property taxes,
- 5%: Insurance (depending on your area)
- 10%: Vacancy factor
These are the things you will need to take into account.
This is not an exhaustive list.
There could be more fees like HOA, water, sewer, and garbage, etc.
Potential Problems with the 1% Rule and the 2% Rule
First off, this is a general rule of thumb. You should not take this as the only way to find a good property. Also you should not take it as if you would absolutely make money on a property if it meets this criteria.
I have seen plenty of properties that meet this 1% rule but other factors come into play that throw it off.
High property taxes can really eat into your passive income.
Some areas have higher property taxes than others. Most areas of the country only have County property taxes which is good. But I have come across other areas where there are city property taxes, school property taxes, even jurisdictional fees hello.
Extensive repairs needed for the property will put your total dollar amount above the 2% rule.
Even though you are paying a low dollar amount to purchase the property, you are paying a lot of money to get the property rented. This increases the overall price of the home and cuts into your passive income.
High Interest Rates Will Lower Your Passive Income
The 1% rule and 2% rule take into account that you have a mortgage on the property. With interest rates being low, 4% to 5%, then this formula works out well. As interest rates go higher, that will eat into your passive income every month.
Back and they 80s and 90s, interest rates were 12%, 13%, 14%, or more, for conventional mortgages.
With interest rates being so high, your payments on the mortgage goes up. This is very problematic because your passive income depends on a lower interest rate with this rule.
A $200,000 property with a 4% interest rate is roughly $1,155 a month.
Paid $200,000 property with a 14% interest rate is roughly $2,575 a month.
You can see how this increase in mortgage payment will crush your passive income and make the 1% rule and 2% rule not valid.
The 1% Rule Summary
The 1% Rule Real Estate Investing is a terrific time saver but is not the end all be all when analyzing a property.
You want to make sure that you properly analyze the income, expenses, and any other costs that can be involved before you buy a property.
There is much more to rental property investing that you must do before you start investing.
Learn how to build your business by investing in your real estate education with my Ultimate Real Estate Investing System.
Check out my free workshop where I show you how I did it and how you can too.
Go to: http://www.freeinvestorworkshop.com
Let me know how you use the 1% rule real estate on an investment property in your area.
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