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In this lesson, you will discover an almost perfect method to screen for great real estate investment called the 1% rule; particularly when it comes to screening rental properties.
Let’s do some quick math.
Every other month, I hear the story of another person who just lost $30,000 in an attempt to invest in real estate.
I don’t know… but it seems like there is something negatively magical about the amount of $30,000 net loss and it’s no longer funny.
So these days, I just walk around telling everybody that it will cost them $30,000 to learn how to invest in real estate.
However, learning the 1% rule, as I am about to share in this lesson, can potentially teach them the same lesson absolutely for free.
So What Is The 1% Rule?
The one percent rule for real estate investment simply states that the gross monthly income from a rental property must be equal to or more than 1% of the purchase price.
There is more to determine if a deal is good or not.
But it’s a quick litmus test to determine if you should assess the deal further or not depending on what market you are targeting.
Real-Life Math Example Of The 1% Rule
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Purchase Price = $100,000.
In this case, you need to have at least $1,000 in monthly gross rental income to make this the ideal real estate rental deal to add to your portfolio.
What if the purchase price is $200,000?
You will need to have at least $2,000 in monthly gross income to make this the ideal real estate rental deal to add to your portfolio.
And for a purchase price of $425,000, 1% of that will be $4,250.
So in a situation where this is a 3-unit rental property; one rent for $1,200 and the 2nd rents for $1,500, what’s the minimum you need to rent the 3rd vacant unit for?
$4,250 rental income goal must be equal to $1,200 + $1,500 + X; where X is the proposed rental income from the 3rd unit apartment.
$4,250 = $2,700 + X
X = $4,250 – $2,700
X = $1,550… We need $1,550 or more in order to make this deal pass for the 1% rule.
Unfortunately, the 2 rented unit apartments are both 3 bedrooms and 1 bathroom while the vacant unit is a studio apartment that doesn’t rent for more than $800 in that market.
What do you do? Pass on the deal or look closer?
Is The 1% Rule Realistic?
In a real-life example, A real estate wholesaler just sent me a rental deal in a text message and I think we should assess it together.
Here are the numbers.
This is a 2-unit deal in Paterson, New Jersey with a purchase price of $269,990.
Unit 1: The tenant has been there for 8 years. He is paying $900 per month. The apartment is a one-bedroom and one bathroom.
Unit 2: For this unit, the tenant has been there for 5 years. She is a single mother who is paying $1,200 per month. This unit has 4 bedrooms and one bathroom.
That’s a total rent of $2,100.
With regards to the 1% rule and the purchase price of $269,900, that deal should be bringing in ($269,900 x 1%) which is equal to $2,699.
As you can see that deal is short on the rule by ($2,699 – $2,100) which is almost $600.
Is The 1% Rule Realistic?
Depending on the market you are targeting and your reason for targeting that market, and how soon you want to pick up deals, you may want to compromise.
If you want to take real estate investing a little more seriously, I want you to keep an open mind when it comes to locations and rules in general.
The 1% rule is extremely realistic in certain markets while it is precisely impossible in most busy metropolitan areas because of high demands and lower inventory.
The Exception To The 1% Rule
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Should I pass on that deal since I am short on $600? Not necessarily right?
An exception to the rule is, like I said, busy and metropolitan cities where it is sometimes okay to sacrifice $600 every month in exchange for extremely low vacancy rates.
Think about it.
If everything were equal, would you rather have an apartment sitting vacant for 5 months unrented because it passed the 1% rule or…
Compromise a little on the rule in order to have a vacancy rate of less than 1 month in 5 years across board?
Keep in mind that a 5 months vacancy on a $1,200 apartment will cost you a loss of $6,000 regardless of passing the 1% rule at screening of the deal or not.
And also keep in mind that $600 per month compromise on the 1% rule for fully occupied property does not negate the fact that you are building equity over time.
Just some food for thought.
Tell me in the comment area any questions you may still have about real estate investing, wholesaling, and finding profitable rental properties.
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