The 1% Rule is a handy formula for real estate investor to evaluate the potential profitability of any given deal, without pulling out a calculator or going through a complex financial model. Let’s take a look at the formula itself:

Monthly Income / Purchase Price * 100

Here is an example: For an investment property with an offer price of $150,000, it claims to a monthly rent roll of $1,000. In this case, $1000 / $150000 * 100 = 0.67%, so as a super quick Yes / No evaluation, this deal is a “No” as it fails the 1% rule. But if we were to spin it positively, instead of turning down this deal, another way we can leverage this formula is to use it to quickly determine what is a reasonable counter price, by tweaking the formula like so:

Offer Price = Monthly Income / 1%

Using our same example, this means $1000 / 1% = an offer price of $100,000. As you can see, based on the quick and handy 1% rule formula, we can determine the $150,000 was overpriced from an investment standpoint, and it maybe more reasonable if it is at the $100,000 price point.

One note of caution is that we at DoorInvestor do not recommend any real estate investor to vet a deal simply by using the 1% rule. We suggest using the 1% rule when you are engaged in a casual investment conversation, or as the first gate to filter out deals. The drawback about the 1% rule is that it only factors in income and not considering any expenses, which means you are only looking at half of the picture and ignoring the other half.

Before we make any decision, we should always do our complete due diligence, which includes running through all the incomes and expenses through our own financial model, and pay extra attention to the CAP rate when evaluating one deal with another. (Note: Please refer to our previous blog post here on CAP rate.)

Like many other formulas, the 1% rule has its reason for existence, and we feel that it is a handy formula for a quick yes/no evaluation of an investment property; and we use it for just that, not for our final purchase decision.