Morris Invest: What is the 1% Rule for Real Estate Investing?

How to understand the 1% rule
for real estate investing, and what does that mean for your
passive income every month– that's today's show. Let's get to it. Hey everyone, I'm
Clayton Morris. Welcome to the Investing
in Real Estate show. This is the show where we focus
on building passive income. And how we do that is with
buy and hold real estate. We find great real
estate that's going to give us an enormous
return on investment year after year after year. And the idea is that we hold
it for the rest of our lives. That's what we focus on
this channel specifically. So if you're looking for
other real estate talk, if you want to learn about
mobile home investing and giant commercial properties and
investing in REITs, R-E-I-Ts, and all that other
kind of stuff, or if you're interested
in flipping houses, that's not what you're
going to find here. We want to hold
on to real estate in order to create
great cash flow and increase our net worth
for the rest of our lives.

Today I want to talk
about a strategy that– I know it's something
that my father-in-law uses to great effect. And a lot of real
estate investors use this as the
standard by which they invest in real estate. And that is the 1% rule. So I want to dive
into this today and help you understand a little
bit about what this exactly means and what the 1% rule is. Now, let me preface this by
saying that you should never use this as the entire metric
for your investing strategy. So what I mean by that
is, yes, it's a good way to kick-start an idea, and look
at, and say to yourself, OK, that sounds like it's
going to be a good deal. Let me dive deeper. So you only want
to really use this as a jumping-off point
in which to figure out your real
estate-investing journey. You don't want to just
say, yep, that's it, I'll buy that property,
sold, after you understand the 1% rule.

Again, it's just a
jumping-off place. So let's dive into it. What exactly is the 1% rule? Well, at the basic
level, it just means that when you purchase a
rental property or you purchase a piece of real
estate, that it should cash flow, every
month, 1%, up to 1% of the purchase price
of that property. Now, in round numbers,
let's make it super simple. So let's take, for
instance, $100,000 property. When you look at a
$100,000 property– that's the purchase price– what are you going to get? Get out your handy
little calculator. Can anyone help me with
the math real quick? Ding, ding, ding. It's going to be $1,000 a month. So the 1% rule on a
property of $100,000 in cost is $1,000 a month. That's what it needs to
cash flow in order for you to basically break even and make
sure that your investment isn't a bust. Now, I know that many people use
this to decide whether or not they're going to
invest in real estate. You may use this
as your baseline metric deciding whether or
not a deal is good or not. I'd like to go a little
higher than that, but that's because I'm
going after cash flow.

But for a lot of
investors, 1% is exactly where they want to be. I've heard it on podcasts. I've seen it from real estate
experts who I've witnessed– I've been sitting in the
audience, listening to them. And these are
millionaires who own lots of properties around the world. They follow the 1%
rule to make sure that their property is going
to cash flow 1% of the purchase price of that property. So you can use that
in your arsenal when you're deciding
whether or not to buy a rental property, the 1% rule. Now, in terms of
feasibility, this is my process when analyzing
a set of properties. What you want to look at,
though, is not just the 1%.

So if it doesn't
meet that 1% rule, then I'm not going to buy it. I'm going to walk away. Now, a lot of investors
I speak to– you own a rental property that
maybe you had in the family, you lived in that
property and then you move to another
property and you kept it. I'm sure there's probably a
lot of you listening right now, raising your hand,
saying, yep, that's me. I have this townhouse
that my wife and I had as our first property, and
we moved, and we kept it. And I'll ask them, what is
the return on investment? And very often, they
can't answer that. Well, is it even
hitting the 1% rule? You bought it for $100,000
or you bought it for $80,000. It's paid off. Great. And it's only cash flowing maybe
$100 above what you owe on it. You have to take in your
expenses and your taxes and all of the other
things that you're paying. Don't forget to
include your home– your Homeowners' Association. So if you've got a
townhome or a condo, your HOA is going to
eat into that 1% rule.

That's why I mean, again, the
1% is just a jumping-off point. When you want to take
it a step further and start to analyze
that property and really get into
the nitty-gritty, we need to look at taxes,
we need to look at the HOA, we need to look at your
insurance costs as well and your property
management costs. So all of those things need to
be figured out before you just raise your hand and say, yep,
I want to keep that property. So if it does meet
that 1% rule– so when you're quickly
analyzing a property, if it does meet that 1% rule, great. Then move on from there and run
the numbers on the property. I want you to start to check out
what that cash flow will look like once you start to add
in things like insurance and property taxes
and things like that. So again, the 1% rule can be
a really valuable mechanism to help you figure out, just
as a back-of-the-envelope quick calculation, is this property
going to work for me? I'm telling you,
though, if it doesn't– if, for instance, on
that $100,000 property, it's only going to cash flow
$800 a month, walk away.

Run for the hills. Because guess what? When we start adding
in taxes, when we start adding in other
factors, repairs, property management, who knows what
else you're going to be adding into that property,
then it's going to start to dwindle it down
to $0, next to nothing. At least with a 1% buffer,
you know that you're probably going to be coming out on top. And then you can analyze
the deal from there. Some investors like
to go up to 2%. Now, if you go up
to 2%, chances are you're going to have a lot of
other things to experience. You're going to have a lot
of other things to fix up. Now, typically it's
going to be on properties that are a little bit less
expensive, like the ones that I like to buy.

So you get properties
in the $40,000, $50,000 range, well, yes you're
going to probably have to put $20,000 into them. And that's what I do. So $15,000, $20,000 of fixing
up, and then the total cost is $50,000, $45,000. So I might acquire the
property for $25,000. And then I've got to put
$20,000, $25,000 into it. So OK, great. Now can I hit the 2% rule,
meaning will the monthly rent be about 2% of the purchase
price of the property? And then you move into those
higher territory numbers. These are incredibly
difficult to find, these types of
properties, and you've got to have a lot of
smart pieces in place in order to make a
2% rule work for you. We try to do that on
every property that I do, but it's incredibly

And by the way, these properties are very
hard to find, especially in the good neighborhoods
where you're going to have stable
tenants, good job growth, and you're not going to
have any headaches to worry about, you're not buying
them in a war zone, right? I had somebody email
me the other day and say, hey, I found
a $3,000 property. He was on some college
campus somewhere. I don't know what state. And he just wanted some advice. And I said, well, I need some
more details than that, right? If it's $3,000 and
it's been sitting there on the market for a long time
and it's been publicly seen by people, chances are that
thing should just be torn down.

I mean, $3,000, what are
you paying for, really? Probably just the value
of the land at that point. So yeah, that may sound
like a great deal, but then when you realize
you've got to put $50,000 into the house because all it
is is a bombed-out fire shell of a house– I mean, there are houses
in New Jersey near my house that I've seen that
are literally shells. They're shells. They've burned inside, and
it's like a candy shell. You might as well just
knock the whole thing down, because it's worthless. So when you're looking
at those numbers, yes, you can find 2% properties. They're very hard to find,
and they require a lot of work and they require
a lot of education in order to make them get
you that type of cash flow. So if you're at 1%, good. If you can be at a 1.5%, great. 2%, yes, that's great. But you really have to take into
consideration a lot of factors. Again, these are
just rules of thumb. These are good
jumping-off places. And it's a good way for you to
quickly do a quick analysis.

When someone throws you
a property and says, hey, I've got a property for
$150,000, it cash flows $1,000. I'm going to throw that
out to you right now. Is that a good one? Here's the property. You're going to buy
it for $150,000. It's going to cash
flow $1,000 a month. Ding, ding, ding, ding. No. I'd walk away from
that in a heartbeat. $150,000 house that's only
going to cash flow $1,000? No, thank you. I'd rather buy three properties
that are going to cash flow $700, $800 a month,
and I'll nearly triple that amount of cash flow.

So again, just a quick
back-of-the-book analysis, then it enables you to dive in
a little bit more deeply and do some deeper research
about the cash flow, about the history
of the property, the Homeowners' Association
if there is one. You know my feelings on
Homeowners' Associations. I've got a whole series on why I
don't like condos and townhomes and those types
of things, because those special assessments
by the Condo Association can come out of the blue and
charge you an additional $2,000 to fix the roof on the whole
complex, which happened to me.

So I'm not a big fan of those. But again, that is the 1% rule. It's a tool that a lot of
investors use to great effect in order to buy a
rental property. I know my father-in-law did it. And when he found out that he
could get great deals at 1% or above, he was able to jump on
those deals and invest quickly. It's a tool in your
arsenal in order to help you invest in
rental properties quickly. I hope you found this useful. These are things that we
don't learn right away when we're investing in real estate.

But once you understand
the things like 1% rule, then it's always something
you can keep in your pocket, in your purse, in your
wallet, that you can pull out in a moment's notice in
order to analyze a deal and then take it from there. I hope you found this helpful. I know I found this helpful
when I was first starting in real estate investing. If you have any
questions, I would love to hear your thoughts. If you're watching
this on video, please leave some
comments in the thread below and ask any questions.

We always respond. I try to respond very,
very quickly to questions. And thank you so much for
subscribing and leaving all of your kind reviews as well. I really, really appreciate it. We publish this show multiple
times per week, everyone. We really try to help you go
out there, become a real estate investor. We really want
you to take action and to build legacy wealth
for you and your family. We want you to have all the
tools here in order to do that. Much love to you all. We'll see you next time here
on the Investing in Real Estate show. Bye, everyone..

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