Evaluating properties is one of the processes we at First Gen Foundations feel strongly about. There are a ton of questions an investor can and should ask themselves, and others, when considering an investment property to purchase.
- How do I know the property I am looking at is “good?”
- How do I know if I am going to make enough money on it?
- Will this property become a money pit?
If you are anything like me, you don’t have a lot of time to be lazy. Between work, family obligations and a couple of mind-numbing activities we all have, there is not a lot of extra time at the end of the day. This means any new habits we pick up need to be efficient. At First Gen Foundations, we want to add value to your time. There are tools and tricks to help maximize your time when evaluating properties.
Enter the 1% Rule
These “rules” or “guidelines” help you know if a property has the likelihood of a positive cash flow (which is a good thing).
The 1% Rule states that your gross rents (rent collected before any expenses) equal 1 percent of the total purchase price of the property. You use this rule to quickly determine if you want to continue to analyze a property.
Let’s use this sample property for our calculations assuming a 6.5% interest rate with a 30 year amortization:
In this example, if you purchase a property for $100,000, the 1% Rule states you should be getting at least $1,000 per month in gross rents.
$100,000 x 1% = $1,000
The 1% Rule becomes clearer when you plug in all of your expenses. You would conceivably have roughly $132 of Pure Cash Flow.
The idea of the 1% rule is that you don’t have to fully underwrite a property to have a pretty good idea if your property will have a positive pure cash flow. This of course is if you can charge that 1% of the purchase price for rents.
How Do I Know How Much Rent to Charge?
Understanding the market that you are in is critical to this question. Here are some quick tips for finding some pro forma (estimated) rents.
- FInd a local property manager.
- FInd a local real estate agent.
- Enter the subject property address on www.rentometer.com.
- Enter the subject property address into the Bigger Pockets rent estimator.
Numbers 3 and 4 have a limited amount of times you can use them, but they give you a decent estimate of what you can expect for rents. You still want to have someone with intimate knowledge of the rents in a neighborhood which can change area to area even street to street.
We currently own a duplex where we collect $650 per door equaling $1300 per month for the property. I knew I was willing to at least entertain the thought of purchasing when I saw the asking price at $120,000. Ever the negotiator, we bought the property at $112,000 giving us better than the 1% rule. This property is currently cash flowing $275 per month.
I would have been able to stop evaluating this one and have moved on to the next property if the asking price was $160,000 because that would mean that I would need to charge $1600 per month for the combined doors to cash flow. The market does not currently support that, so I would have passed on that property.
There are more guidelines that real estate investors such as yourself use to understand if fully analyzing a property is the right thing to focus on. The 1% Rule is a guideline on if you have a chance to cash flow that property.
Some people are all right with purchasing a property that does not meet the 1% rule. That is ok. They might have a different strategy for the property. As conservative underwriters, we feel comfortable being in spaces that meet or exceed the 1% Rule. We might step outside of this guideline if we find a property in a great appreciating area.
I hope the 1% Rule helps you avoid doing long and tedious analysis on every property that you come across. Let us know your thoughts and how we can continue to help build your First Gen Foundations!
President and Co-Founder, First Gen Foundations
Proud to be a First Gen Investor