What is the 1% rule in rental investment?

The 1% rule of real estate investing measures the price of the investment property against the gross income it will generate. For a potential investment to pass the 1% rule, its monthly rent must be equal to or no less than 1% of the purchase price.

rocketmortgage.com - Breaking Down The 1% Rule In Real Estate - Rocket Mortgage

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When it comes to real estate investing, the 1% rule isn’t the only method used for determining the best opportunities to buy a rental house. Other popular methods include the gross rent multiplier, the 70% rule and the 2% rule.

Gross Rent Multiplier

The gross rent multiplier (GRM) gauges the amount of time to pay off the investment. It’s the purchase price divided by the gross annual rent. The total you get is the number of years it will take to pay off the investment using just your rental income. The lower the GRM, the more lucrative the property may be. For example, you purchase an investment property for $200,000. You charge $2,500 per month for rent. Your annual gross rental income is $30,000 (2,500 x 12). $200,000/$30,000 = 6.67. The GRM of this property is 6.67, meaning it will take about 6.67 years to pay off the property using your gross rental income. Of course, you’ll need to consider other expenses when determining a property’s profit potential. These include repair costs, operating costs, maintenance and vacancy rate. You can use the GRM to compare different investment properties, too. If one property has a GRM of 6.67, while another has a GRM of 8.33, the one with the lower GRM (6.67) may be the better option since you’ll pay off the investment faster. When comparing properties, make sure they are in similar markets and have similar operating, maintenance and other costs.

70% Rule

The 70% rule is for those looking to flip a house, and it states that the investor should pay no more than 70% of the home’s after repair value (ARV), minus any repair costs. To calculate the 70% rule, simply take the estimated ARV of the home and multiply it by 0.7 (or, 70%). Once you have the total, subtract any estimated repair costs. This will be the amount you should pay for the property. Here’s an example: You are interested in a property that you estimate will have an ARV of $150,000. You estimate that you’ll need to spend about $30,000 on repairs in order to flip the home. $150,000 X 0.7 = $105,000 so $105,000 is the maximum amount you should spend on purchasing the home and making the repairs. $105,000 – $30,000 (repair cost) = $75,000. Per the 70% rule, you should pay no more than $75,000 for the property.

2% Rule

The 2% rule is the same as the 1% rule – it just uses a different number. The 2% rule states that the monthly rent for an investment property should be equal to or no less than 2% of the purchase price. Here’s an example of the 2% rule for a home with the purchase price of $150,000: $150,000 x 0.02 = $3,000. Using the 2% rule, you should find a mortgage that has a monthly payment of $3,000 or less and charge your tenants a minimum monthly rent of $3,000. As you can see, the 2% rule is more extreme than the 1% (basically doubling the monthly rent), but it can work in certain markets and provide a financial safety net if you have difficulty filling vacancies or need a major, costly repair on the property. No matter which rule you decide to go with, it’s important to run the numbers on a potential property to make sure you’re making an affordable investment.

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