The 1% rule in real estate: What to know before investing

Imagine you’ve decided to start investing in real estate. You’re hoping to buy a rental property, but you’re worried about failing to generate an income or winding up underwater. All investors need to be able to run the numbers before making a deal to calculate whether they can cover their expenses and turn a profit.

The 1% rule¹ is a popular rule of thumb that can give investors an idea of whether they can earn a return on investment in a rental property. It states that in order for a property to produce a return, it needs to rent for 1% of its purchase price each month.²

We’ll break down the 1% rule, how to use it, and other ways to decide if a real estate investment may be a good opportunity.

What is the 1% rule in real estate?

The 1% rule is a popular rule of thumb that real estate investors use to decide whether a property might be a good investment opportunity. It suggests that for a real estate investment to succeed, the investor needs to be able to charge 1% of the home’s price for monthly rent.

Keep in mind that you should also account for the cost of repairs and renovations when doing this calculation.

This rule is popular for a number of reasons, including that it’s easy to use to get an idea of how much you’d need to charge in rent, and it’s a good safeguard against not being able to cover your mortgage payment.

Many investors use it as a pre-screening tool to focus their search for rental properties. For example, if you know that homes in a neighborhood rent for about $1,100, you probably want to pass on a nearby property selling for $150,000.

Some investors go more conservative and use the 2% rule, aiming to charge 2% of the home’s purchase price in rent.

Example of the 1% rule

Here’s an example of how the 1% rule works.

Imagine you’re hoping to buy an investment property. You find a home selling for $270,000. It does not need any major renovations or repairs.

According to the 1% rule, this may be a profitable investment if you can charge 1% of the home’s price for rent each month. $270,000 x 0.01 = $2,700, so you would typically need to charge $2,700 per month in rent to make a profit.

You look at nearby properties and see that they’re advertised for rent at $2,900 a month. Because that more than meets the 1% rule, you can feel relatively confident that this is a good investment opportunity.

Additional considerations

It’s important to keep in mind that the 1% rule is only a rule of thumb. It is not a guarantee of profit, and it does not account for a number of factors that influence the success of a real estate investment, including property taxes, insurance costs, property management fees, or maintenance costs.

It also ignores your mortgage’s interest rate. Lower rates mean lower monthly mortgage payments, so you can charge a lower rent while still turning a profit. A higher rate would mean you’d have to charge more to earn a profit.

You should also be aware of potential problems when purchasing an investment property in the most expensive cities, where homes are pricey, but the average rent is much lower than 1% of the typical purchase price.

For example, the median list price for a home in San Francisco is about $1.2 – $1.3 million. Using the 1% rule, you should charge $12,000 or $13,000 as your minimum monthly rent.

Despite this, the average rent in San Francisco is close to $3,100 per month. To match the 1% rule to the median rent in San Francisco, you’d need to find a $300,000 property, and that’s only a quarter of the median list price in the city.

Other investment rules in real estate

The 1% rule is a popular rule of thumb for analyzing real estate investment profitability, but it’s not the only one. Many investors use other metrics when buying rental properties.

Gross rent multiplier

Gross rent multiplier (GRM) is another metric that investors use to screen for good real estate investment opportunities. The GRM of a property is the ratio of a property’s market value compared to the annual gross rent it produces.

For example, if a home is worth $400,000 and it produces $26,500 in rent each year, its GRM is:

$400,000 / $26,500 = 15.09

The GRM reflects how many years you’d need to rent the home out to earn as much money as you’d get from selling it. Note that this is different from how long it would take to pay the home off, because GRM doesn’t account for operating costs.

There isn’t a single rule for what makes a good GRM, but in many places, a score between about 4 and 7 is a good deal. Instead, it’s useful for comparing different properties in the same market. The lower the GRM, the more income a property produces compared to its value, and the better it is as an investment.

70% rule

The 70% rule is a real estate investment rule of thumb for house flippers rather than people buying homes to rent out. It states that investors should aim to spend no more than 70% of a home’s expected after-repair value on a home. That includes the purchase price and any expenses incurred as part of repairing it.

The formula for the 70% rule is:

(After-repair value x 0.70) – repair costs = maximum purchase price

For example, if you see a home that you think you can sell for $300,000, but know it will need about $35,000 in repairs to get it into sellable condition, you should pay no more than:

($300,000 x 0.70) - $35,000

$210,000 - $35,000

$175,000 = maximum purchase price

The bottom line: Know the rules of investment properties

Finding good investment opportunities is one of the hardest things to do as a real estate investor. The 1% rule states that for a property to be a good investment, the monthly rent it generates must be at least 1% of the home’s purchase price. This is not a guarantee of profit. Investors should carefully consider the purchase of any property before moving forward.

This rule can help investors quickly screen investment opportunities and decide whether the property is worth further research.

If you’re looking to buy a home either as an investment or to live in yourself, you can get started by applying for a mortgage with Rocket Mortgage®.

¹ The 1% rule does not guarantee return on investment profit and only suggests the property may cash flow if typical costs fit within a rough cap rate band.

² This article is for informational purposes only, and is not a substitute for professional advice from a medical provider, licensed attorney, financial advisor, or tax professional. Consumers should independently verify any service mentioned will meet their needs.