THE 1% AND 2% RULES IN REAL ESTATE INVESTING?

You expect to make money when you invest. Rental revenue often accounts for a large portion of a real estate investor’s return on investment. When looking for a profitable acquisition, determining which property will provide a positive cash flow can be difficult. Fortunately, there is a method for swiftly determining an investment property potential. Learn how to apply the % rule and 2 % rule in real estate to help you discover the ideal investment property and decide the right monthly rent to charge for it if you’re looking for your own investment property to make money in real estate.

In certain cases, the 1% and 2% real estate investing rules can be effective tools for analyzing real estate investments. Investors can examine rental properties using simple math to see if any are worth pursuing further.

When it comes to buying investment properties, these real estate investing rules are all about applying income discipline. They are not, however, hard and fast regulations. The 1% rule is a simple way to assess if a property’s rent-to-value ratios are healthy or not. Following that, I’ll teach you how to calculate the 1% rule and when it might be useful.

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IN REAL ESTATE INVESTING, WHAT DOES THE 1% RULE MEAN?

The 1 percent rule is used in real estate to assess if the property’s monthly rental revenue is greater than or equal to one percent of the purchase price.

1% of the purchase price in monthly rental income

By reversing the 1% rule, you can achieve the same result:

[Maximum Purchase Price = 100 x Monthly Rent]

A quick calculation shows that if a property rents for $1,800 a month, the purchase price should be around $180,000. Keep in mind that rental values are determined by the rental market, not by the purchase price of a home.

How Does the 1% Rule Work?

To calculate, multiply the property’s purchase price plus any required repairs by 1%. Compare the outcome to your projected monthly mortgage to get a better idea of a property’s monthly cash flow if you’re financing. Additional fees such as insurance, taxes, and upkeep are not included.

Assume you’re seeking for a mortgage loan for a $300,000 investment property. Multiply $300,000 by 1 percent using the 1 percent rule. Your calculation yielded a figure of $3,000 as a result.

The 1 percent guideline informs us that your monthly mortgage payments should be no more than $3,000 per month. It will be tough to generate positive cash flow on the investment property if the mortgage is more than $3,000 per month.

If you are convinced that you can rent the home for more than $3,000 per month, you may make an exemption. In most circumstances, it’s a good idea for investors to go further into data than the 1% rule to see if they stack up and whether there’s a high chance for a positive return on investment.

IN REAL ESTATE INVESTING, WHAT DOES THE 2% RULE MEAN?

The 2 percent rule in real estate, like the 1 percent rule, can assist investors in determining the rent-to-price ratio. This rule of thumb is based on the same concept as the 1% rule. The 2 percent rule, on the other hand, recommends that a rental property is a smart investment if the monthly rent is equal to or greater than 2% of the purchase price. What is the value of the 2% rule? It’s almost completely obsolete these days, and it’s only used on rare occasions. The 2 percent guideline, on the other hand, may be used by investors buying distressed properties in D and F neighborhoods.

How Does the 2% Rule Work?

To use the 2 percent rule, double the property’s acquisition price by 2 percent, plus any necessary repair charges.

If a rental property does not fit the 2 percent criteria, it may still be a good chance to invest for gain, depending on what an investor wants to get out of it. You must choose whether your long-term objective is appreciation or monthly cash flow. You can decide whether or not to employ the 2 percent rule based on your real estate investing goals once you have a clearer understanding of your objectives.

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Please keep in mind that only a small percentage of investment properties adhere to the 2% criterion.

The 2 percent Rule in Action

Assume you purchase a $200,000 rental property. Multiply $200,000 by 2 percent using the 2 percent rule. The calculation yielded a figure of $4,000 as a result. This means that your monthly mortgage payment should not exceed $4,000 per month.

WHEN TO APPLY THE 1% AND THE 2% RULES

The 1% and 2% standards are really only effective for appraising real estate investments in the early stages. As a pre-screening tool, use the 1% rule. The 2% rule is no longer widely utilized as a screening method.

WHEN NOT TO USE THE 1% AND 2% RULES

Many real estate professionals nowadays blatantly violate the 1% and 2% regulations.

The markets with properties that fit the rule criteria aren’t always in the finest areas. And, in order to meet the 2% guideline, rental homes must be on the lower end of the market. Because the property is “cheaper,” an investor may be forced to pay more for repairs and maintenance.

Purchasing a home that fits the 2% criterion is not something we would advise our investors to do. That’s because it’ll most likely be in a D or F neighborhood, and it’ll be in bad shape.

DRAWBACKS OF THE 1% AND 2% RULES

When it comes to real estate investing, we are all aware that the 1% and 2% rules have a variety of disadvantages. While these principles can assist investors in determining if the market has healthy rent-to-value ratios, they should not serve as the only predictor of a successful investment property.

Some of the disadvantages of the 1% and 2% rules include the following:

• It’s just effective for determining a property’s rent to value; it doesn’t necessarily depict the full picture of investment potential.
• Other property costs, such as mortgage and purchase fees, closing charges, repairs and upkeep, insurance, property taxes, and so on, are not included.
• Do not provide information regarding the quality, location, net rental income, cash-on-cash (COC) return, cap rate, or appreciation of the property.
• In most marketplaces, meeting these standards may be impossible. If you wish to follow the rule(s), you have two choices: buy in other markets or lower your criterion (0.8 percent).

While the 1% and 2% rules are useful, they are far from ideal. One of the most significant flaws of the 1% and 2% rules is that they only consider revenues and ignore expenses. So, while a property may fulfill or above the 2% guideline, it may need extensive repairs and maintenance, and being in a terrible neighborhood may not be particularly profitable in the long run.

Furthermore, in today’s market, it can be difficult to discover houses that fulfill the 2% rule. So, just because a property doesn’t match the 2% rule doesn’t necessarily indicate it’s a terrible investment. Properties that do not fit the 1% rule, on the other hand, are unlikely to generate enough income to cover the investor’s expenses. In either case, investors should never use these tools to make a final selection, but rather to screen properties to see which ones are worth investigating further.

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