What it means
Property investors look at hundreds of listings, so they need a fast way to discard weak ones. The rule gives a single test: divide the monthly rent by the price, and see whether the result reaches 1%.
If it does, the property goes onto a shortlist for closer analysis. The logic is that a rent of 1% a month adds up to 12% of the price each year before costs.
After property tax, insurance, repairs, vacancies and management, a sizeable part of that is used up, but enough should remain to cover a mortgage and leave some profit. A property that rents for much less than 1% is likely to need rising prices to make money.
The rule works better in some markets than others. In cities where prices are high compared with rents, almost no property passes, and investors who insist on the rule would never buy there.
In lower-priced areas many properties pass easily, but they may carry higher risks of vacancy, repair costs or tenant default. It is important to see the rule as a screen and not as a valuation.
It ignores interest rates, tax, local running costs, the condition of the property and the chance of price growth. Experienced investors follow it with a proper calculation of net operating income (rent less running costs) and the return on the cash they invest.
A different 1% rule is used by some traders, who risk no more than 1% of their capital on any one trade. That is a risk management rule and has nothing to do with property, so it is worth checking which meaning someone intends.
In this entry, the property meaning is used.
In practice
Real-world examples.
Example
A first-time landlord looks at a flat listed at $150,000 that rents for $1,650 a month. The ratio is 1.1%, so it passes the screen. She then checks the building fees and local taxes before making an offer.
Example
An investor in a high-priced coastal city finds that no property reaches 1%. Instead of lowering his standards blindly, he uses a lower target and focuses on areas where rents are rising, accepting that returns depend on future growth.
Example
A small property fund creates a spreadsheet of 60 listings and filters by the rule before sending an analyst to visit. Only 9 pass, which saves the team from visiting listings that were unlikely to produce acceptable income.
Formula
Calculation
Monthly rent needed = 1% x purchase price
Rent-to-price ratio = monthly rent / purchase price
Suppose an investor is considering a house priced at $300,000. The rule requires monthly rent of 0.01 x 300,000 = $3,000. The local market rent is $2,400.
Rent-to-price ratio = 2,400 / 300,000 = 0.008, or 0.8%, which is below the 1% target, so the property fails the screen.
Annual rent is 2,400 x 12 = $28,800. If running costs are 40% of rent, they are 28,800 x 0.40 = $11,520, leaving net income of 28,800 - 11,520 = $17,280, or 17,280 / 300,000 = 5.8% of the price.Case study
Seen in the real world.
Wren Property Partners is an illustrative, fictional company that buys small rental houses. It adopted the one percent rule to cut down the number of listings its two analysts reviewed each week.
In the first quarter, the rule rejected most city centre properties and passed several in smaller towns. The firm bought four houses at $120,000 each that rented for $1,300, which is above the 1% target.
Later, the finance director found that two of the houses had high repair bills and long vacancies, so their actual return was lower than the rule suggested. She changed the process so the rule was used only for the first screen, followed by a full budget for repairs, vacancy and management. The illustrative lesson is that the rule is a good filter and a poor decision maker.
Watch out
Common mistakes.
- Treating the rule as proof of a good investment, when it ignores costs, financing and the condition of the property.
- Applying it in every market, when in expensive cities nearly every property fails.
- Confusing the property rule with the trading rule of risking 1% of capital per trade.
Questions
People also ask.
What is the one percent rule?
It says that monthly rent should be at least 1% of the purchase price, so a $250,000 property should rent for $2,500 a month.
Does the rule include repair costs?
No, it looks only at rent and price, so repairs, vacancy, tax and insurance must be analysed separately.
Is a property that fails the rule a bad investment?
Not always, because high price growth, low costs or cheap financing can still make it attractive, but it needs a stronger case.
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