What Is the 1% Rule and How to Use It in Your Real Estate Calculations
A lot of people believe that there’s a lot of complicated math in real estate, and while some transactions might be a little less straightforward than others, this isn’t usually the truth. The 1% rule, for example, might sound fancy, but it simply states that the total amount of the rent you ask from your tenants should be equal to or greater than 1% of the total purchase costs (including any additional expenses for renovation purposes) of the building itself. Now, depending on these expenses, it can get a little tricky to compare real estate transaction and rental costs, especially when both the rent and the price differs to a great extent.
Determining Which Real Estate Property Is More Profitable
Let’s say you have two real estate properties: one you bought for $100,000 and one that you bought for $75,000 but that you also invested an additional $50,000 in to make it livable. As at all times, in this case, the 1% rule pertains to the total investment costs associated with the properties. So, if you ask for $1,000 in rent in both cases, that would be exactly 1% of the first property’s cost, but it’s actually less than 1% of the second property’s total costs, even though if you only take the initial price into account, it would actually be more ($1,000 is 1.33% of $75,000, but only 0.8% of the total cost of $125,000 invested in the first property).
How Long Will It Take to Get Your Money Back?
Typically, if the 1% rule is met, you will require a total of 100 months or less to get your investment back. That means 8.3 years, give or take, depending on whether you increase the rent at a certain point in time, or you need to renovate the property a few years after you buy it. Of course, if you ask for a rental amount greater than 1% of the property’s price, then that time will shorten. A 1.5% rent would only require 66.6 months or 5.5 years, while a 2% value will get your investment back in just over 4 years.