How to Quickly and Easily Evaluate an Investment Property: “The 1% Rule”

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When analyzing a potential real estate investment property, it is very easy to over-complicate the process.  It’s actually really quite simple.  “The 1% Rule” is your simple cashflow formula!  When using the 1% rule, a good cash flowing rental property will bring in at least 1% of it’s total value each month.  So you simply multiply one month’s rent by 100 to arrive at a ballpark valuation.

For example, lets take a property we have for sale on our website.  Lets use the duplex in Detroit, 1407-1409 Chalmers St.  This property is rented for $800 a month.  The tenants pay all utilities.  That means that this property is worth a maximum of $80,000 by using the 1% rule.  ($800 rent x 100 months = $80,000 valuation)

That DOES NOT mean that if you pay $80,000 you can automatically get $800 in rent each month.  Some $80k houses will only rent for $500, leaving a negative cash flow.  You need to learn the rental market first.  Know how much rent you can get BEFORE making an offer on anything.  If it’s already rented, then the work is already done for you.

The 1% rule is for average neighborhoods.  Here’s a breakdown.  Subtract any owner paid utilities from rent before calculating.

  1. Middle Class neighborhoods (white collar professionals) pay 100 to 120 x’s the monthly rent.
  2. Lower Middle Class neighborhoods (blue collar / young white collar mix) pay up to 100 x’s the monthly rent.
  3. Low Income Areas (minimum wagers, move around on occasion from job to job, some HUD mixed in) pay 75 x’s the monthly rent.
  4. Slum Areas (no one has a job, area may have drugs, gangs, guns, etc. NOT A PLACE YOU WANT TO BE!) pay 20 – 50 x’s the monthly rent.

Higher class areas almost always have negative cash flow and are harder to rent, especially in bad economic times.

My preference is to concentrate on *Lower Middle Class and *Low Income Areas for the highest possible cash flow properties.

Of course, this 1% rule is to help you buy smart.  You will find that many sellers and realtors will list properties at 10 times their annual income.  This makes their “asking price” equal to 120 months of rent vs. our 100 months.  A whopping 20% difference.  But the “asking price’ and the actual “selling price” are rarely the same.  They are usually off just a bit.

Remember, don’t over-complicate this!  If a property meets the 1% rule, then you can further evaluate it and know that it has a tremendous cashflow potential!