When I first began looking into real estate investing, I spent a lot of time trying to figure out what criteria I would use in selecting which property to buy. I have built many Excel spreadsheets with mind-numbing calculations and data, all geared to finding that perfect investment property. Having now purchased four rental properties over two years, I’ve developed a much easier way to evaluate whether a property will generate positive cash flow or not. I call it the 1 percent solution, and it works like this–
Will the property generate monthly gross rent equal to at least 1 percent of the total cost of the property?
The total cost of the property includes four things: (1) purchase price of the property; (2) fix-up costs; (3) financing costs; and (4) carrying costs from the time of purchase until the first tenant moves in. Of course, this requires making a reasonable estimate of what the rent will be and the cost to fix-up the properties. With enough experience and research, I’ve found that these estimates can be made with good accuracy.
On estimated rent, for example, I usually estimate within a range of $100 and calculate the 1 percent using the mid-range of this estimate. Because my investment properties are all in the same area, I’ve got a very good idea of how much rental income a given property will generate.
A note of caution. In many areas of the U.S., finding a property that meets the 1 percent rule is next to impossible. I invest in the mid-west, and given the high rate of foreclosures, have been able to find properties that generate rents at or near 1 percent of total cost. I am able to finance nearly 100% of the total cost on a 30-year fixed rate mortgage that enables me to generate positive cash flow immediately, even after factoring in an allowance for repairs and vacancy.
I’d be interested in hearing if anybody else uses this or another guide to evaluate potential real estate investments. But I’ve found the 1% solution to be a great way to make profitable real estate investments.