What is the One Percent Rule
The one percent rule is a rule of thumb used to determine if the monthly rent earned from a piece of investment property will exceed that property's monthly mortgage payment. The aim of the one percent rule is to have the rent be greater or equal to the mortgage payment, so the investor breaks even on the property at worst. The rule is used for quick estimation, as there are other costs associated with a piece of property that are not taken into account, such as upkeep, insurance and taxes.
BREAKING DOWN One Percent Rule
The one percent rule can provide a baseline for establishing the level of rent commercial property owners charge on real estate space. This rent level can apply to all types of tenants in both residential and commercial real estate properties.
Calculating the One Percent Rule
Purchasing a piece of property for investment requires thorough analysis of a number of factors. The one percent rule is one measurement that can help an investor gauge the risk and potential gain that could be achieved by investing in a real estate property. The one percent rule is a simple calculation that multiplies 1% times the selling value of the property to determine a base level of monthly rent. It is also compared to the potential monthly mortgage payment to get a better understanding of the property’s monthly cash flow for the owner. Take for example an investor looking to obtain a mortgage loan on a rental property with a total payoff value of $200,000. Using the one percent rule the owner would calculate a $2,000 monthly rent payment. In this case the investor would seek a mortgage loan with monthly payments of less than $2,000.
Considerations for Commercial Purchases
The one percent rule is a rule of thumb that also helps to give an investor a base level for which to consider other factors regarding the ownership of a property. A second calculation that is important in analyzing the purchase is the gross rent multiplier. The gross rent multiplier uses the monthly rent level to determine the amount of time it would take to pay off the investment. This calculation is achieved by dividing the total borrowed value by the monthly rent. In the case of the home buyer with a deal value of $200,000, the investor would divide $200,000 by $2,000. This gives them a 100-month payoff ratio which translates into 8.3 years. Investors can also use the gross rent multiplier in considering the payment schedule terms of a loan taken for the property.
Once the investor has a base understanding for the rent scenarios they can also consider other factors. The duration to payoff is a main concern for many investors. This is typically a main concern for the desired return on investment. All things equal, the buyer investing $200,000 in the rental home could potentially pay off the property in approximately eight years with the remaining payments after breakeven accumulating profits. This could present risks for the buyer if they need the money from the investment in less than eight years. The risk of achieving the desired rate of return is also a factor of the property’s expected longevity and maintenance requirements.
In calculating the gross rent multiplier, a buyer must also consider the rental rates in the area for which the property is located. If the standard rate for rent in the neighborhood is less than $2,000 for the buyer from the example above then they may need to consider decreasing the rent to ensure they find a tenant. Another important factor for consideration is the maintenance on the property. The property owner is responsible for upkeep and repairs. While a deposit may cover substantial damages, it is also important for the owner to budget a specified amount of the rent for savings. This can contribute to profits if unused and be available for utilization when any maintenance needs arise.
Overall, investing in real estate can be a good investment for long-term investors. The base rent that an owner charges on any type of property sets the level of payments expected by tenants. Owners may typically raise rent annually to manage for inflation and other costs for the property but the base rate from which they start at is an important level that determines their overall return from the investment.