The One Percent Rule is a guiding formula used to ascertain if the monthly rent earned from an investment property will cover or exceed the property’s monthly mortgage payment. The primary aim of this rule is to ensure that the rental income is at least equal to or, ideally, greater than the mortgage payment, ensuring a break-even scenario if not outright profitability.
Key Insights:
- The rental income should be at least equal to the investor’s mortgage payment to ensure a break-even point.
- To determine a base rent level, multiply the property’s purchase price, including necessary repairs, by 1%.
- Investors should ideally secure loans with monthly payments that are less than the 1% figure.
This rule acts as a baseline for establishing rental rates on various types of properties, whether commercial or residential.
Purchasing investment property necessitates a detailed analysis of several components. The One Percent Rule offers a preliminary tool to help investors evaluate the potential risk and reward associated with their investment.
How the One Percent Rule Functions
To put it simply, this rule multiplies the property’s total purchase price plus any necessary repairs by 1%. The result offers a base monthly rent amount, which is then compared to the monthly mortgage payment to provide a clearer picture of the property’s potential cash flow.
It’s crucial to note that this rule is a quick estimative tool and doesn’t account for all associated costs like upkeep, insurance, and taxes.
Example: Applying the One Percent Rule
Consider an investor looking to secure a mortgage for a rental property valued at $200,000. Using the One Percent Rule, the target monthly rent would be $2,000 ($200,000 multiplied by 1%). In this scenario, the investor would strive for a mortgage with monthly payments below—preferably well below—that target rent figure.
Comparison: The One Percent Rule vs. Other Calculations
The One Percent Rule offers an initial assessment point but works in conjunction with other critical calculations. Another essential metric is the Gross Rent Multiplier (GRM), which computes the time it will take to recover the investment based on rental income. Calculated by dividing the property’s total cost by monthly rent, GRM gives a perspective on payback periods.
For example, for the same property worth $200,000, dividing this value by a $2,000 monthly rent results in a GRM of 100 months, or slightly over 8.3 years.
Additionally, the 70% Rule advises that investors should not spend more than 70% of the property’s after-repair value, excluding repair costs.
Special Considerations
While calculating the gross rent multiplier, taking into account the standard rental rates in the targeted area is crucial. If local rents are considerably less than the calculated $2,000, adjustments might be necessary to attract tenants.
Maintenance is another vital factor. The property owner shoulders the responsibility of regular upkeep and repairs. Having a budget for savings from rental income for maintenance can not only cover potential repairs but may also contribute to profitability if unused.
In summary, real estate investment holds significant long-term potential. Setting a base rental rate is crucial in managing tenant expectations and handling inflation and other incremental costs. Understanding and applying the One Percent Rule alongside other financial metrics can greatly improve the overall returns on your investment.
Related Terms: gross rent multiplier, 70% rule, maintenance expenses, mortgage loan.
