Today we’ll be talking about the rule of 1% and how to use it.
We use the rule of 1% mostly to do a quick analysis for a rental property to determine if it will be for a buy and hold. I conduct this analysis for all the properties I consider buying as it always indicates that you’re buying a suitable property. So, let’s provide an example of the rule of 1% using rentals. There are two quick formulas that I always employ when I am analyzing deals; it doesn’t matter if I’m going to do a fix and flip or a rental. The reason is that I want to be prepared if there is a sudden change in the market; I want to be able to convert my flip into a rental and know that it’s going to work out well. It takes a couple more minutes, so this will validate the numbers for both strategies.
The other reason I conduct this calculation even for a fix and flip is if I want to change or sell this fix and flip to an investor, especially in multifamily units. The numbers must work as you must present them professionally to an investor. So, the best rule of thumb for a long-term rental is the 1% rule. This rule is best used when using a five to 10% down payment for the numbers to be accurate. You don’t need to have the after-repair value, also called the ARV. The one thing you need to know is the fair market value rent for that comparable unit. If you have a three bedroom, you’d have to compare it with another three bedroom unit with similar bathrooms. You usually will have one bathroom in an apartment unit, but if you have a duplex, you probably will have one bathroom per unit. On rare occasions, you will have two of them, but the important thing is to compare the number of bedrooms. If you don’t have a mortgage on the property, the numbers will work even better; the more you have in your down payment, the better. So does it mean that it won’t be good if you have a property with less than 1%? Well, no. This is just a quick example to allow you to decide quickly if you want to spend more time analyzing this deal.
For example, we will use a triplex property with a purchase price of $180,000. This has nothing to do with the actual after-repair value; it might be worth more, or maybe you’re buying something completed and ready to go, and the fair market value is $180,000. In this case, we have a home purchased for $180,000 with a renovation cost of $80,000. You need to add those two figures, so the total acquisition is $260,000. The triplex consists of an apartment renting for $1370 a month, another for $990 a month, and the third unit rents for $830 a month. The gross value of the rent is $3190. So if you calculate 1% of $260,000, ensure that is the entire amount of money you have invested, including purchasing the property and renovating. You could have bought this property for $260,000 with the renovations completed.
So the 1% rate has to be calculated on the ready-to-go price, which in this case is $260,000, which works out at $2600. The total rents are $3190, which is higher than my 1%, which means this property is an excellent deal, even if I have a mortgage on it with five to 10% down. To figure out how much you’re going to be getting for rent, I would advise using this website called rentometer.com, especially if you’re new to the area or you’re analyzing a place where you would like to start buying properties. I have found that the rents given on the website are pretty accurate for the area, and they cover all the US. You can see how much you will get for your rental unit quickly. Check out my video on YouTube, link here, where I provide a step-by-step tutorial on how to use the website.
So there you have it, now you know how to use the rule of 1%. It’s important to remember that it is used with a property with a five to 10% down payment, and the more money you have for a down payment, the better the rule will work. Also, be advised that this is still a rule of thumb, so it is used as a quick indication to determine if the property is suitable to invest in. I always advise doing as much research as possible when investing in property, so if you require any help or assistance, I am always available to help. Until next time invest wisely.
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