What is the 1% rule in real estate investing?
Updated: May 11, 2022
What is the 1% rule in real estate investing?
The 1% rule is a quick way to assess if a property will be profitable in real estate investing. The rule states that the monthly rent generated from the property should be at least 1% of the purchase price. Although this is a good guideline, it is not always achievable in Canada due to high house prices. In other countries like the US, it is easier to find.
Example of the 1% rule
While the 1% rule can be a good guideline, it is not always easy to find. Take for example, a recent purchase in Toronto of a property for $1 million. The rent generated from the property would need to be at least $10,000 per month in order to meet the 1% rule! That is not realistic right now (especially because $1 million in Toronto will get you a very basic house nowadays.)
How to use the 1% rule in your own real estate investing
When you are looking at properties, you can use the 1% rule as a quick way to assess how profitable the property could be. For example, before we bought a single family home for about 190k last year and I did some research to find out how much rents would most likely be. I found that we could likely get about $1,800 per month so that is pretty close to the 1% rule (especially for Canada!) We analyzed it further and determined it was indeed a good deal and we bought it.
You too can use the 1% rule as a rough guideline when buying a property:
When you are looking for a long-term investment
When you want to quickly assess if the property will be profitable
If you're interested in cash flow
How to assess a property when the 1% rule doesn't work
If you're looking to invest in a property and the 1% rule doesn't work because house prices are too high or rents are too low, there are still ways to assess if the property will be profitable. You will have to find out by doing a fuller analysis of the property (which you have to do before buying a property anyway!)
First, look at the potential rental income that could be generated from the property. This can be done by researching average rents for similar properties in the area.
Assess other costs that will be associated with owning and managing the property, such as repairs, utilities, property taxes, property management fees, and insurance. These costs can significantly reduce the profitability of a property, so it is important to take them into account when making your decision.
Finally, you will need to calculate the return on investment (ROI) for the property. This is the most important metric to look at when assessing a property's profitability. The ROI is calculated by dividing the net profit from the property by the total cost of the investment. For example, if a property generates $10,000 in annual net profit and has a total cost of $100,000, the ROI would be 10%.
You can also think about the appreciation aspect - maybe it doesn't cash flow very well today but you know it's in a high appreciation area. Maybe you don't need the cash today and are more interested in the long term gains! Then the 1% doesn't matter to you.
In Summary...
When it comes to real estate investing, the 1% rule is a quick way to determine if a property will be profitable. Although this can be a useful quick guideline, it is often not achievable in Canada.
However, even if the properties you are looking at don't meet the 1% rule, you can use it as a way to quickly assess how profitable the property could be and if it's worth further analysis (ie. at a glance, how close is it to the 1% rule?)
This is just a quick overview of the 1% rule, when to use it (or not), and how to assess a property when this rule doesn't work.
If you want to learn more about real estate investing in Canada, please check out our blog or contact us for more information!