[ad_1] The post What is the 1% Rule in Real Estate? appeared first on Millennial Money. When you’re investing in a property, the thing that probably matters most to you is making money. You’re not getting into this business to have fun or to get a place where you can visit sometimes and let your friends rent at a discount. You’re in it for the net income, period. That being the case, it’s very important to understand whether a rental property is capable of generating a strong return on investment. One way to do this is to apply the 1% rule. What is the 1 percent rule? The 1% rule is a calculation that lets you quickly determine if the monthly rent on a property will be more than the monthly mortgage payment. Why the 1 percent rule is important The 1% rule is important because it tells you if you’re in a position to break even from an investment or profit from it. Before entering a real estate market — whether that’s San Francisco, New York City, or Keokuk, Iowa — you need to know what kind of investment you’re getting into. Some investors go into a property comfortable with breaking even for a certain period of time — that is, until market conditions change or they’re in a position to refinance their mortgage. However, both options are risky. Economies don’t always change for the better, and refinancing is not always possible. Plus, unexpected upkeep costs can pile up, putting a bigger dent in your bottom line. In either case, it pays to have a general understanding of what you’re getting involved with as a starting point before you dive in and buy a property. How to apply the 1 percent rule in real estate investing The 1% rule says that the rental rate you charge tenants should be equal to or greater than the mortgage payment you make every month. To figure that out, simply multiply the purchase price of the property in addition to repairs and other fees like closing costs by 1% (or 0.01). For example, on a house valued at $360,000, you would want your total monthly payments to be $3,600 or less. Which means you’d want to charge tenants $3,600 or more per month. The 1% rule is fine for a quick approximation upfront, akin to a prescreening. But the truth of the matter is that it doesn’t factor in any other economic factors (e.g., property manager expenses and interest rates). With that in mind, here’s a more comprehensive way to go about the process to get a better estimate. 1. Find a property you like First, find a commercial rental property that you’re interested in purchasing. The property should be in a profitable location. It should also be in decent enough condition to either rent outright or fix without spending too much on capital upgrades. Further, it should be affordable enough to not go too far into debt when buying it. Work with an agent to find an ideal property that aligns with your goals and looks like it could be a profitable investment. CrowdStreet With a CrowdStreet account, you will be able to invest in individual commercial real estate projects. You can also invest in a Portfolio of dozens of properties to diversify your holdings. Create Your Free Account 2. Determine the average monthly payment price Next, take the property’s sales price and have your agent or lender break it down into monthly mortgage payments, factoring in approximated property taxes, insurance, and interest. This is important because it gives you a sense of what you can expect to pay each month in total payments. It’s also important to factor in any additional fees that you can expect to pay — including homeowners association (HOA) fees, parking, and utilities. You should also consider property management fees and even a general budget for unplanned upkeep costs. Some people choose to factor in the 1% rule based on the mortgage alone. But that is not an entirely accurate assessment when it comes to determining a likely cap rate. When taking the above costs into consideration, the monthly cost of your investment property could easily double. 3. Figure out how much you can rent it for Once you get a better sense of what your place will cost you on a monthly basis, you’ll be in a better position to make a judgment about whether you can afford it. The next step is to figure out how much you can rent the place for. As a landlord, you’ll most likely have the option to charge whatever you want for rent. That said, you definitely don’t want to guess or pull a number out of thin air. Otherwise, you could wind up scaring away renters and finding yourself needing to deal with vacant property. For the best results, talk with your lender and ask for a home valuation report on the property you’re looking at. The lender should be able to provide you with an expected monthly rental amount based on the property value and the location. Run this number by your agent to get their opinion. They may tell you that the suggested rental price is too high or too low compared to what you could actually charge. 4. Consult with a contractor about repairs Next, bring in an experienced contractor to see if you can potentially make upgrades to the property to increase the rental value. By making a few small upgrades here and there, you may be able to significantly increase the amount you can charge to renters. Keep the agent involved in the process to get their opinion as well. The more opinions you can get, the better off you’ll be. It’s worth noting that expensive upgrades or repairs will cut into your profits. However, they could be well worth it in the long run. Run the numbers, figure out a course of action, and stick with it. 5. Compare your estimated expenses
