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Have you ever heard of the One Percent Rule when it comes to real estate investing? I hadn’t either until recently. I had been researching real estate investing as a possible new income stream when I came across this concept.
It turns out, the one percent rule can be a quick way to search for rental properties that have the potential to be cash flow positive. We like cash flow positive investments here on The Money Sprout, so we need to investigate this rule a little further.
What is the One Percent Rule?
As a general rule of thumb, the monthly rent on a rental property should be greater than or equal to one percent of the purchase price. If it is, then there is a good chance the monthly rent will be able to cover all required expenses and be cash flow positive. On the other hand, if the required monthly rent is less than the actual rent received for the property, then there is a good chance the investment will be cash flow negative.
Here is a look at this simple calculation –
Required Monthly Rent = Sale Price of Home x 1%
Does This Property Meet the One Percent Rule?
Let’s take a look at a couple examples. After searching for available homes for sale in my area I came across the following 2 properties –
- Home – 1,656 sqft, 3 bedroom, 1.5 bath
- Asking Sale Price – $150,000
- Estimated Monthly Rent – $1,123
If I wanted to quickly screen this potential investment, I can run a calculation of the one percent rule.
$150,000 x .01 = $1,500
In this scenario, the one percent rule is telling me that I would need to collect at least $1,500 in monthly rent from this property in order to cover all costs. Based on the actual monthly rent estimate ($1,123), this doesn’t appear to be a good investment. I would actual be cash flow negative of -$377 each month.
$1,123 – $1,500 = -$377
On the surface, this doesn’t look like a good investment.
- Home – 1,314 sqft, 3 bedroom, 1.0 bath
- Asking Sale Price – $69,500
- Estimated Monthly Rent – $772
Now that we have removed property 1 as a potential investment, let’s move on to property 2. Running a quick one percent rule calculation, I came up with the following results –
$69,500 x .01 = $695
In this scenario, the one percent rule is telling me that property 2 has the potential to be cash flow positive. Based on the actual monthly rent estimate ($772), the property could generate $77 in positive cash flow each month.
When looking at these figures and calculations, it is important to keep things in perspective. For example, I am using estimated monthly rents for each property provided by Zillow.com. There is absolutely no guarantee that I would be able to charge $772 a month in rent for property 2.
I also discovered that some investors use the actual sale price of the investment, while others take out the down payment from the equation. Taking out any down payment from the sale price would actual move many properties to the cash flow positive side.
Final Thoughts on the One Percent Rule
It is a tool used by real estate investors to filter out potential investment properties.
If the monthly rent of a property exceeds the result, then there is a good chance it will be cash flow positive.
If the monthly rent is lower than the result, then it would signal a potential cash flow negative investment that should be avoided.
Do you use the one percent rule to screen out potential rental properties? What other criteria do you use to find cash flow positive investment properties?