Why The 1% Rule No Longer Works in 2024

Real estate investing can be a lucrative way to build long-term wealth, but the strategies that worked in the past may not be as effective today.

One such strategy is the 1% rule, which has been a popular guideline for evaluating rental properties for years.

However, as the real estate market evolves, it's important to reassess traditional wisdom and adapt your approach to maximize returns.

What is the 1% Rule in Real Estate Investing?

The 1% rule is a simple formula that states the monthly rent of a property should be equal to or greater than 1% of the purchase price. For example, if you buy a property for $200,000, the monthly rent should be at least $2,000 to meet the 1% rule.

This rule originated as a quick way for investors to screen potential rental properties for cash flow. The idea is that if a property meets the 1% rule, it's likely to generate positive cash flow after expenses.

Example of the 1% Rule

Let's say you're considering two rental properties:

Property A: Purchase price $150,000, monthly rent $1,300
Property B: Purchase price $250,000, monthly rent $2,700

According to the 1% rule, Property B is the better investment because its rent is more than 1% of the purchase price ($2,500), while Property A falls short at 0.87%.

Quick and easy: The 1% rule provides a simple way to analyze deals at a glance without getting bogged down in complex calculations.
Sets a benchmark: By aiming for properties that meet the 1% rule, you establish a standard for the types of deals you're looking for.
Helps filter out low-cash-flow properties: The 1% rule can help you avoid properties that may not generate enough rent to cover expenses and create cash flow.

Why the 1% Rule No Longer Works in 2024

Appreciation Outpaces Rent Growth

In recent years, home values have appreciated at a faster rate than rents. This trend makes it increasingly difficult for rental properties to meet the 1% rule, as purchase prices rise while rents lag behind. In markets with strong housing demand and limited supply, the disparity between home prices and rents is even more pronounced.

Low Interest Rates Drive Up Prices

The prolonged period of low interest rates has contributed to the rapid appreciation of home prices. As borrowing costs remain low, buyers have more purchasing power, which drives up competition and prices. This phenomenon pushes property values beyond what the 1% rule would deem feasible for investors, making it harder to find deals that meet this criteria.

Oversimplifies Property Analysis

Limited scope: The 1% rule fails to account for crucial factors such as operating expenses, vacancy rates, and appreciation potential, which can significantly impact the overall profitability of a rental property.
Ignores market nuances: By focusing solely on the ratio of rent to purchase price, the 1% rule overlooks unique market dynamics, such as high-growth areas where appreciation may outpace rent growth.
Short-term focus: Adhering strictly to the 1% rule may cause you to pass up properties with strong long-term appreciation potential, limiting your ability to build wealth through real estate.

What Matters More Than the 1% Rule?

As the limitations of the 1% rule become more apparent, savvy real estate investors are shifting their focus to factors that have a greater impact on long-term wealth creation.

Appreciation Potential

In a strong housing market, the appreciation of a property's value can significantly outpace the returns implied by the 1% rule. Investors who prioritize cash flow over appreciation may miss out on the opportunity to build substantial equity over time.

Look beyond immediate cash flow: While positive cash flow is important, it shouldn't be the sole focus of your investment strategy. Properties in high-growth markets may not meet the 1% rule but can offer significant appreciation potential.
Consider future value: When evaluating a rental property, think about its potential value in 5, 10, or even 20 years. A property that appreciates steadily over time can provide a much greater return than one that merely meets the 1% rule.

Total Return on Investment

To truly understand the potential of a rental property, you need to look at the bigger picture. Cash flow is just one piece of the puzzle. Appreciation, tax benefits, and equity paydown all contribute to your overall return on investment.

Appreciation: As the property's value increases over time, so does your equity. This appreciation can be a powerful wealth-building tool, especially when leveraged through financing.
Tax benefits: Real estate investors can take advantage of numerous tax deductions, such as mortgage interest, property taxes, and depreciation. These benefits can significantly reduce your tax liability and increase your overall return.
Equity paydown: As you pay down your mortgage, you build equity in the property. This equity can be accessed through a cash-out refinance or used to purchase additional properties, further growing your wealth.

How to Evaluate a Rental Property in 2024

In 2024, evaluating a rental property requires a more comprehensive approach that goes beyond the 1% rule. To make an informed decision, you need to consider multiple factors that impact the property's overall profitability and long-term value.

Estimate realistic rent: Don't rely solely on the 1% rule to determine the property's rental potential. Research current market rents for comparable properties in the area, taking into account factors such as location, property type, size, and amenities. This will give you a more accurate estimate of the rent you can expect to charge.
Factor all expenses: To get a true picture of the property's cash flow, you must account for all operating expenses. This includes vacancy rates, property management fees, maintenance and repairs, insurance premiums, and property taxes. Failing to factor in these costs can lead to an overly optimistic view of the property's profitability.
Project appreciation: While cash flow is important, appreciation is a key driver of wealth creation in real estate. Analyze market trends, economic indicators, and demographic shifts that can influence property values in the area. Look for markets with strong job growth, population influx, and infrastructure improvements, as these factors can contribute to higher appreciation rates.
Calculate total return: To make a well-rounded investment decision, you need to consider the property's total return, which includes both cash flow and appreciation. Use a comprehensive rental property calculator to model the property's expected cash flow, factoring in all expenses and potential rent increases. Then, incorporate conservative appreciation estimates based on market trends to project the property's long-term value. This holistic view will help you determine whether the property aligns with your investment goals and risk tolerance.

Is Investing for Appreciation Risky?

Investing for appreciation does come with its own set of risks. Unlike cash flow, which provides a tangible and immediate return, appreciation is less predictable and can be influenced by various market factors outside of your control.

However, this doesn't mean you should avoid investing for appreciation altogether. Appreciation remains a key driver of wealth creation in real estate, and with the right strategies, you can mitigate the risks and maximize your potential returns.

Choose markets wisely: Focus on markets with strong economic fundamentals and population growth. Look for areas with diverse job markets, low unemployment rates, and a growing population. These factors contribute to increased housing demand and can drive up property values over time.
Conduct thorough market research: Before investing in a property, analyze historical appreciation rates, market trends, and future growth projections. Look for indicators such as new construction, infrastructure improvements, and business expansions that can signal potential appreciation.
Use conservative estimates: When projecting appreciation, it's important to use conservative estimates to avoid overestimating your returns. Factor in potential market fluctuations and economic downturns that could impact property values. By using conservative estimates, you build a buffer into your investment strategy and reduce the risk of relying on unrealistic appreciation expectations.
Maintain financial reserves: Investing for appreciation doesn't mean neglecting cash flow entirely. It's crucial to maintain adequate financial reserves to cover unexpected expenses, vacancies, and market downturns. Having a strong cash reserve ensures that you can weather short-term challenges without jeopardizing your long-term appreciation goals.

The Shift Towards Appreciation Investing

In 2024, real estate investors are increasingly focusing on markets with strong appreciation potential rather than adhering to the outdated 1% rule. While cash flow remains an important factor in investment decisions, it is no longer the primary driver for many investors.

Prioritizing high-growth markets: Savvy investors are targeting markets with robust economic growth, population influx, and infrastructure development. These factors contribute to rising property values and long-term wealth creation, even if the properties don't initially meet the 1% rule.
Balancing cash flow and appreciation: Although cash flow is still a consideration, investors are willing to accept lower initial yields in exchange for properties with higher appreciation potential. They recognize that the long-term gains from appreciation can significantly outweigh the short-term benefits of higher cash flow.
Diversifying investment strategies: To maximize appreciation potential, investors are expanding their portfolios to include a wider range of markets and property types. They are exploring emerging neighborhoods, secondary markets, and niche property segments that show promise for future growth and value appreciation.

As you navigate the evolving real estate landscape in 2024, it's important to adapt your investment strategy to align with current market realities. While the 1% rule may have been a useful guideline in the past, it no longer holds the same relevance in today's appreciation-driven market.

To capitalize on the shift towards appreciation investing, conduct thorough market research to identify areas with strong growth potential. Look for markets with diverse job markets, population growth, and planned infrastructure improvements. These indicators suggest that property values in these areas are likely to appreciate over time.

When evaluating potential investments, use a comprehensive approach that takes into account both cash flow and appreciation potential. While a property may not meet the 1% rule, it could still be a solid investment if it's located in a high-growth market with strong appreciation prospects.

As the real estate market evolves, savvy investors are adapting their strategies to prioritize appreciation potential over outdated rules like the 1% rule. By focusing on markets with strong economic fundamentals, conducting thorough research, and taking a holistic approach to property analysis, you can position yourself for long-term success in the new era of real estate investing.

Ready to start building your real estate portfolio? Get started with Doorvest today and let our experienced team guide you through the process of investing in high-growth markets with strong appreciation potential. With our comprehensive approach to property sourcing, renovation, and management, you can enjoy the benefits of real estate ownership without the hassle.