2

The 1% Rule - The monthly rent earned on an income property should meet or exceed 1% of the total buying price of the property.

How accurate/important is this rule when it comes to personally investing in income properties? In my geographical area, that would be a ridiculous amount. The average 3 bedroom starter home (selling for $150,000) around here rents at $900 month. Barely over half of the "1% rule".

Similarly, a $300,000 downtown condo, would rent for about $1500/month. If local home prices/rents barely exceed half of this "1% rule" would that mean it is a poor area for income property investments?

  • 1
    $1.5K income on a $300K investment is only a 6% return, so yes I would say that it's a poor investment (given the risks involved). – D Stanley Feb 7 '18 at 17:53
  • 2
    Where on Earth do you actually get close to a 1% monthly rent? I'm looking at property values/rents in random places around America and nowhere is close. The average seems to be 0.2% - 0.75% at best. – WakeDemons3 Feb 7 '18 at 18:16
  • @WakeDemons3 There is a lot of money chasing investment returns anywhere that they can be found. I have seen rents higher than 2% of total value, but they were in small mining towns, so the risk of a value collapse if the mine slowed or stopped operations was pretty high. Most properties that I've purchased in the last several years were never publicly listed for sale (on the MLS) in the first place. There are deals to be had, but those deals will move quickly. You won't find them by looking at the average MLS listing (or on Zillow). – Nathan L Feb 7 '18 at 19:17
  • 2
    None of the rentals I've purchased satisfy the 1% rule, but that's typical of a high-growth area. These rules of thumb are pretty limited, also not that long ago it was a 2% rule. – Hart CO Feb 7 '18 at 19:30
  • "also not that long ago it was a 2% rule". I can't even imagine that... That's a $3,000/month rent for a $150,000 shack in the woods. – WakeDemons3 Feb 7 '18 at 21:00
5

I use a different rule. If market value is less than 10 times one year earnings, then it is a great rental market. If the market value is between 10-20 times one year earnings, then it is a reasonable proposition, but if the market value is greater than 20 times annual earnings, it is better to sell and find another rental elsewhere.

The 1% rule tries to encapsulate that because one year of earnings (12 months) * 10 is close to a month's rent minus expenses, but it is imprecise because taxes, insurance, and repairs, etc. can vary widely from one locale to another.

If you want to use the 1% rule to give you a ballpark estimate of whether a property is even worth considering, that's fine as a rule of thumb, but it's worth calculating in more depth what all the annual expenses are, and how many months of the year you think you are likely to have it occupied (also a number that varies with the market conditions of each locale). Subtract those numbers (and any management fees if you are using a management company) to determine what the annual return is, and if it is between 5-10% (price is 10-20 times earnings) then you are in a reasonable ballpark. Anything below a 5% return is a bad investment, and anything over 10% return looks pretty good.

  • 1
    @WakeDemons3 That might work if you're certain there will be someone occupying it every month, and you won't ever have to replace the sewer main-line, but that kind of thinking will land you with a bottomless money pit. – Nathan L Feb 7 '18 at 17:16
  • 1
    Also, I invest with cash, so that will explain why the word "mortgage" was never mentioned in my answer. – Nathan L Feb 7 '18 at 17:17
  • 2
    @WakeDemons3 Why? So you can eat up 4-5% of your return on mortgage interest? And risk foreclosure when you can't make the payments? – D Stanley Feb 7 '18 at 17:50
  • 3
    @WakeDemons3 To be fair, many people leverage everything they have to the hilt since borrowed money is "cheaper". But that completely ignores the risks, and many go broke as well. Leverage multiplies your returns, both positive and negative, so any loss can be catastrophic. Using cash is MUCH safer. – D Stanley Feb 7 '18 at 17:55
  • 1
    @DStanley I agree in regards to over-leveraging, but if you had $200k to invest, and were debating between putting it all in a rental property vs a down-payment and investing the rest in an index fund, I'd argue using cash introduces more risk, as all your capital is tied to a single asset. No argument that using the $200k as down-payment on 4 rental properties is definitely more risk than buying 1 with cash. – Hart CO Feb 7 '18 at 18:26
1

I haven't heard that one, but like any rule of thumb, I'd take it as, at best, well, a rule of thumb and not some absolute law of the universe.

If you've already bought the property, than the question is not, What is a profitable rent? but, What is the maximum rent that I can get away with charging?

If you are considering whether this property is worth buying, than if you are serious you will actually calculate your likely costs: What will you be paying on the mortgage, what maintenance expenses can you expect, how much are property taxes, etc.

The only use I see to a rule of thumb like this is for a quick guess at whether a property is worth investing in. If you could charge rent equal to 5% of the property value, I'd grab it quick. If 0.1%, probably pass. Maybe 1% is a reasonable medium, hard to say.

0

If you have a property that is charges 0.5% of its buying price in rent, then, appreciation aside, its maximum return on investment is 6%.

That does not include property taxes, mortgage interest / PMI, insurance, maintenance and repair costs, prepping costs between tenants, or the inevitable times when the property is untenanted and not returning anything. The lower the rate rent, the easier it will be for the rate of return to become negative.

Appreciation is a wildcard, but it is not something I would bet on in an area where the rents are already low in comparison to cost.

  • 2
    Your conclusion on appreciation seems backwards to me. The places with the highest price to rent ratios are often the ones with the most aggressive appreciation. – Hart CO Feb 7 '18 at 17:28
0

That would be an unheard-of return here. Almost everyone is aiming for 0.5% to cover the costs and relying on appreciation to make a profit. There is no capital gains tax in New Zealand, while there is income tax on net rental income, so this approach is tax-advantaged.

0

It would be impossible to purchase rental property in the San Francisco Bay Area on this format. Comparing newly-constructed condos to similar newly-constructed rental apartments, I see monthly rent is about 0.6% of the condo price. But you can do very, very well on appreciation.

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.