Being in the midst of real estate investing feels a lot like being in the midst of a game. Those whose minds enjoy number-based contemplation surely win more often. Like in any other game, you have to follow some rules in real estate, as well. These rules are not written in stone but they can be of great assistance to those who are a novice to investments. One of them is the one percent rule.
The theory of the one percent rule
There are many rules when it comes to real estate investments. Some of them are presented as percentage values, such as 1%, 2%, 50%, and 70% rule. We might analyze all of them in the future, but at this point, we are going to start with the first one in line – the 1% rule.
This specific rule relates to the property value and monthly rent ratio. In theory, it is a very simple formula. In order to determine if the property you are aiming for is aligned with the one percent rule, you should:
Calculate the ratio between the monthly rent and value of the property, divided by 100.
The number you get is the ratio between the monthly rent and property value expressed as a percentage. According to theory, average monthly rent should be higher than one percent of property value.
The math behind the one percent rule
If we take the above-stated theory and put it into practice, things start to make sense. Still, this is not as simple as it may seem, because property value fluctuates and monthly rent can fluctuate too. That’s exactly what makes real estate complicated and exciting, as well.
Let’s take a look at the following examples:
Property valued at $70.000
Monthly rent $650
In theory, this property is not aligned with the 1% percent rule, since the monthly rent 0.07 percent lower than ideal.
Property valued at $65.000
Monthly rent $650
This is the exact match example to a 1% rule. The value of the property is exactly 100 times bigger than the monthly rent.
Property valued at $60.000
Monthly rent $850
The ratio between property price and monthly rent is around 1.42%, which is good.
Macro point of view
Although the one percent rule is useful and most of the time a necessary guide to determine whether an investment idea will end up being good or not, it is not smart to base decisions on this rule solely. Picking a property is a delicate decision-making process, and one must take into account various factors and the way these factors interplay side by side.
Macroeconomic aspects to an inexperienced investor might seem elusive at first, but it is not wise to make decisions without factoring them in after diligent research and analysis. What might seem like a perfect investment opportunity, could easily turn out to be a disastrous investment decision. To use a blunt example, if a country’s economy is on a downward spiral, and the country is at a brink of war, you probably should consider investing elsewhere, no matter how cheap property is at the moment.
Macroeconomic aspects that could suggest that the market you are planning to invest in is stable and reliable, include but are not limited to the stable political situation, steady economic growth, low unemployment rate,, decent fiscal policies, investments in infrastructure. Since most real estate investments are long-term, and macroeconomic crises happen across the world periodically, short-term challenges should be considered and analyzed. Experienced investors know how to discern a risky opportunity from a bad investment, and some are willing to take risks more often than others. It is not a secret that some made their fortunes by investing in real estate amidst the crisis.
Count in the micro
Microeconomic factors, however, seem to be more “tangible”. When it comes to real estate, micro factors should be understood as aspects that could in any way affect the community surrounding the desired property. Every state has its own rules and regulations, Property acquisition costs and taxations can vary drastically. For example, properties are cheaper in areas with higher crime rates, but only because nobody wants to live, work or contribute to the local community there. That’s why the one percent rule solely might trick you to make a bad investment decision.
Real estate investments require a 360° view
Let’s use the Example #1 again. Mathematically, this seems like a bad investment. Property is valued at $70.000, and monthly rent is roughly $650. Now, let’s look at other factors. Since this imaginary property is in the U.S., we can say that macroeconomic factors are stable and desirable, let’s not forget that the U.S. housing market is one of the most stable and certainly the biggest asset class in the world.
Furthermore, this property is located near a building site. Private investors are building a 1000-acre botanical park with artificial ponds. At the moment, this is not the most desirable location to live in. There is a lot of noise and dust, but in 12 months, initial building activities will be set, and in five years’ time, this location will be one of the most peaceful neighborhoods. Both, the value of the property and monthly rent price will go up in a few years’ time.
In the second example, monthly rent is exactly 1% of property value. However, due to the decreased number of inhabitants, the city government decided to shut down the nearby school and half of the shops in the local mall are already vacant. It is only a question of time when the mall will become a temporary home for local homeless people. In a few months’ time, there probably won’t be any renters, and property’s value will continue to decrease.
The third example of the one percent ratio brings a promising picture to the table. Stable economy, low crime rate, beneficial tax regulations, nearby schools, 10 minutes away from downtown. Most importantly, even during the times when this particular city was experiencing the worst economic downturn, the infamous 2008 crisis, monthly rent was stable and coming.
The risk and the one percent rule
Investors considered real estate ventures to be less risky than other investments. The first example in our imaginary world of investments is certainly the riskiest. High risk usually means higher dividends, but if something goes wrong, the loss becomes real. That’s why it is important to understand where do you stand as an investor, what type of risk you can absorb.
Predicting the future of the economy is charlatanism, but knowing how to read between the lines of macro and microeconomy is a knack worth pursuing. We have been perfecting the craft of investing in the U.S. market for years now and got pretty good at reading numbers, analyzing them. Discerning and mitigating risks became one of our expertise, and we know how to recognize those perfect, low-risk opportunities. The one percent rule is something will probably never break. And the third example is a real investment opportunity, it is above 1% rule investment in Detroit’s SFR market. You can find more information under the investments section on our website