One Percent Rule - Explained
What is the One Percent Rule?
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Table of ContentsOne Percent Rule DefinitionA Little More on What is the One Percent Rule WorksExample of the One Percent RuleKey TakeawaysThe One Percent Rule vs. Other Types of CalculationsImportant things to considerAcademic Research
What is the One Percent Rule?
The one percent rule is a rule that helps in ascertaining if the rent received per month from a property will be more than its mortgage payments per month. The objective of this rule is to make sure that the person will be receiving more or at least equal amount of rent so as to cover his or her mortgage payments. If the rent per month is equal to the amount of the mortgage to be paid, the investor will arrive at a break-even point. The one percent rule can offer premises for knowing the extent of rent that commercial real estate owners levy on the property space. This extent of rent is applicable for each type of tenants living in both residential and business based real estate properties. Investing in property or real estate involves a detailed analysis of many factors. The one percent rule is one of the techniques that enables an investor in measuring the risk involved, and prospective benefit that he or she may achieve with this investment.
How Does the One Percent Rule Work?
The one percent rule can be calculated by multiplying the purchase price of the investment property space plus repairs and maintenance expenses by 0.01 or 1%. The resultant value is a primary level of rent on a monthly basis. This amount is also compared to the prospective mortgage payment that the investor needs to make in order to give him or her a better idea of the amount of cash flow of the property. However, this rule is just feasible for steady calculations and predictions as it doesn't involve other expenses such as upkeep, insurance, taxes, etc. related to the property.
Example of the One Percent Rule
An investor is thinking of getting a mortgage loan on a rental property having a total payoff value of $200,000. By using 1% rule, the owner can calculate the rent amount that he or she will be receiving per month, which appears to be $2,000 (200,000 * 1%). Now, the investor knows that he or she should take a mortgage loan where he or she needs to pay no more than $2,000.
- The amount of rent to be charged should be either equal or more than the mortgage payment of the investor in order to at least achieve a break-even point on the property.
- The purchase price of the property when added to repair costs, should be multiplied by 1% for calculating the monthly rents base level.
- In ideal cases, an investor should go for a mortgage loan having monthly payments lower than the amount calculated by 1% rule.
The One Percent Rule vs. Other Types of Calculations
Through the one percent rule, the investor also knows about a base point that helps in emphasizing on other factors related to a property's ownership. The next significant calculation involves the gross rent multiplier that considers the monthly rent level to calculate the no. of years taken to pay off the mortgage. This can be calculated by dividing the total amount borrowed by the rent per month. For instance, the investor is investing in a real estate property of $200,000 and the monthly payment of rent appears to be $2,000. When $200,000 is divided by $2,000, the investor will know that he or she has 100 months or 8.3 years to pay off his or her mortgage. The gross rent multiplier is also used at the time of making payment schedule terms for the property mortgage. The 70% rule states that an investor should not incur any amounts beyond the 70% of the estimated value of the property
Important things to consider
While determining the gross rent multiplier, the investor should also research about the rental rates around the property's location. In case, the basic rent rate for the nearby properties tends to be lower than $2,000, then the buyer may have to lower the amount of rent for finding a tenant. The investor must also consider the maintenance costs associated with the property. Its the duty of the property owner or buyer to bear maintenance and repair costs. Though a deposit can be used for covering substantial costs, the buyer should also consider keeping aside a specific amount of rent as savings that he or she can use for maintenance purpose. This will give the owner two benefits: he or she can use these reserves for repairs and maintenance, and in case, there is no need to use those reserves or savings, it will be a profit for the investor. Investors who are willing to earn potential gains in the long run can consider real estate investments as a lucrative option. The base rent charged by the property owner creates a platform for payments that tenants need to make. Owner usually increase rent on a yearly basis because of inflation rates and other expenses related to the property. However, the base rate is a crucial parameter that ascertains the total returns an investment could offer.
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