A Real Estate Investor says the 1% Rule no longer applies, regardless of the Market.

By Elias DaSilva | August 30, 2024, 11:57 AM GMT+2

This 1% Rule is something that has disappeared,’ says John Smith, a veteran at closing deals under the 1% rule to acquire rental cash flows. However, Smith is still aligned with this strategy, even though it continues to change under current conditions, but with a long-term perspective.

Smith first entered the real estate sector to seek an additional source of cash flow, which would alleviate his unpredictable earnings, and it worked. A second source of income came from real estate. His real estate investment journey began in 2019 when he bought a residential property in Monroe, New York. Using the right approach of self-managing rentals and focusing on purchasing townhouses or condos in good condition, he was able to create an impressive portfolio within five years, with 4 investment properties and one primary residence.

Smith adhered to the ‘1% rule,’ a relatively accepted rule in the real estate market that uses the formula of ‘rental price = purchase price/100,’ which attempts to achieve positive net cash flow. In particular, one of his first properties was bought for around 200,000 dollars, which was rented for 1975 dollars monthly, giving him a rent-to-purchase price ratio of around 0.98 percent. For his second property, which cost 211,000 dollars, the rent was 2,100 dollars, with a ratio of 0.99 percent. The next property did even better with a ratio of 1.125 percent. Smith is not the only American who has been able to apply the 1% rule, but there have been exceptions to using this strategy. Smith mentions that for his properties, the rule has disappeared or rather ‘vanished.’ Smith’s first property, now valued at 350,000 dollars, still rents for 2650 dollars, thus there is a lower ratio of 0.76 percent. The second property, which is also valued at 350,000 dollars, rents for 2780 dollars, achieving a ratio of 0.79 percent. The third property has also seen its ratio drop to 0.89 percent.

Market Dynamics and Inflation Pressures 

The valuation of the property has gone way higher compared to how much the rent has gone. It’s not matching up,’ explains Smith. When asked if this trend is only happening within his portfolio, Smith responds that it is happening with all the properties he pursues. The normal perspective on why the 1% rule applies to provide sufficient income to pay the mortgage, HOA dues, insurance, and maintain the property is over since all these expenses have increased.

This change makes it difficult for new entrants in the market. According to Smith, his sister and brother-in-law, who are interested in purchasing a rental property in Upstate New York, lost interest after estimating their cash flow. Their cash flow projection template reflected a negative cash flow of at least 500 dollars against what they expected to bring in, something that new investors would not want to experience.

A Balanced View in Volatile Market Conditions

Despite these market challenges, Smith is not concerned and is not changing his stance. He emphasizes the importance of a long-term perspective and compares real estate investment to SIP investments, as market cycles are not unusual. ‘There will be fluctuations, but maybe you ride the wave,’ he says. Smith continues to seek new possibilities and would like to purchase a target deal if there is one. He raises some interesting points, giving the example that expanding the real estate portfolio may require a pause and perhaps this is the time to ‘take a bit of a breather.’ However, he does not advocate completely halting investment activity just because of how the market is.

While still maintaining a buy-and-hold strategy, John Smith believes that even under present circumstances, where it is not very favorable, the strategy will be fruitful over time.