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Is the 1% Rule Dead in Today’s Market?

Is the 1% Rule Dead in Today’s Market?

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As a real estate investor, whether you are new or a lifelong investor, there has been a rule referred to as the 1% rule. The way it works is you simply take the monthly rent that you receive or want to receive for your property (or the median rent in a market) and divide that by the value of your property (or the median value in that market).

At one time this was a bellwether for how to be a landlord, or to establish pricing for a rental property. However, in most areas of the country the value of property has gone up much faster than rent rates.


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As an example, if you have a $750,000 property in a city on the west coast, the 1% rule says you need to rent it for $7500 a month when the actual market rate for your property might only be $3200 or $4000 a month. Conversely, you could have a property in east Texas, Louisiana, Arkansas, Kentucky, Mississippi, or a city like Memphis Tennessee, you could buy houses, fix them up, make them rent ready, and rent them using the 1% rule. Location is going to play a factor in whether this rule makes sense or not.

What is used to calculate this is referred to as the RTP, rent to price ratio. In most larger US cities, it would not be referred to as the 1% rule but the fractional percent rule, meaning your rent might be 1/2 of 1% of the value of the property. The bottom line, when you pick up a property to rent, you want to maximize your return by selecting a property in a great area, that people will want to live in. In some cities it doesn’t make a lot of sense to acquire a rental property that has good cash flow.

Here’s an example, there was a high-rise condo in San Francisco, close to Pier 32 that was for sale for $1.4 million. It was under 1000 ft.², with only one parking spot, and a monthly HOA fee of $1200. Plus, the HOA would have to approve any tenants. Another key factor isn’t just what you pay for a property, but it’s also, as previously stated, the HOA fees, property taxes, maintenance expenses, and in some instances, rental management. All of that must be added up and calculated into the true expense of maintaining a rental property.

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In short, this rule was created a long time ago when all the variables in real estate were quite different. There are still some markets where it might be applicable, however in general terms, the 1% rule is no longer a rule at all.

If you’re into math and you factor in the entirety of the United States, the rent to price ratio as it currently stands is just barely over .51%. In cities that are older and historic, like Philadelphia Pennsylvania, with a lot of marginal properties, the rent to price ratio is slightly over .77%. Rents in the United States have not kept up with the increase of prices so remember the one percent rule isn’t a rule at all, it’s more of a theory at this point.

One thing for sure, the FED will raise interest rates which will in all probability chill the market to some extent, and home prices could start to flatten out soon. As always stated, knowledge is power and the more you know, the more success you will have.

Areas of Review

Takeaway

Big picture takeaway points

  1. What is the 1% rule?
  2. Does this rule still apply?
  3. Not every market is created equal.

Reflection

Self-reflection questions to think more about the content

  1. Can I think of properties where the 1% rule makes sense? Why or why not?
  2. Have I taken into consideration the fluctuating market when analyzing a property?

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