There are many “rules” that I constantly hear used in real estate conversation. Investors that have been around for a while use them in day to day conversation, but many newer investors are not familiar with them and believe them to be rule rules. In this case though, rule is just a shorthand way of saying rule of thumb. These are aids for an investor to very quickly analyze a deal in a few seconds to decide if it is worth pursuing. We all know that real estate is local and different markets are in different states of recovery, failure, or somewhere in between, which means these rules may not apply or even work in some markets. Let’s define the most common rules:

• The 1% Rule: The rent of a property per month should be 1% of the value of that property in order to be profitable. For example, a $100,000 property should rent for $1,000 per month to cover all of its expenses and make you “acceptable” money
• The 2% Rule: This is the same as the 1% rule, only it’s 2%. This rule is usually met in cheaper, rougher neighborhoods where you can find inexpensive housing. For example, a $50,000 property should rent for $1,000 per month. A key concern about this rule is that you typically find these types of properties in “war zone” style neighborhoods and while the numbers on paper usually look great it can be difficult finding management and you may have more damages, higher turnover, and more vacancy/evictions
• The 50% Rule: The expenses of the rental will consume around 50% of the rent. This does NOT include your principal/interest payments, but does include the taxes, insurance, repairs, management, vacancy, etc. For example, if you charge $1,000 per month in rent you would expect that $500 will be used for expenses, which leaves $500 for your principal/interest payment and profit
• The 70% Rule: This rule applies to buying a property. Using the 70% rule, you would not pay more than 70% of the ARV when purchasing a property. This ensures that you do not overpay and provides you a large margin for error, or a large margin for profit. For those doing rehab work, you would include your rehab budget in this number. For example, If the ARV is $100,000 and the unit needs $20,000 in repairs, one would not pay more than $50,000 to acquire this property
• Maintenance Rules Maintenance is a tough one for many new investors because you generally cannot know what will break before it breaks. There are a couple of rules of thumb for helping estimate, but again, these are rules of thumb. The age of the property, maintenance over the years, part of the country (weather conditions), and other factors will all change the reality. It is important to know, maintenance is not capex. That should be figured in addition to maintenance. I use these formulas:
  • $1 per square foot per year: Self-explanatory. Using this rule, a 2,000-sq. ft. property should expect around $2,000 per year in maintenance
  • 1% of the price per year: Expect that 1% of the purchase price will be spent on maintenance per year. For example, a $100,000 property should expect $1,000/year in maintenance

These are the main “rules” you may encounter when discussing real estate at a high level without actually analyzing a deal. I hope you had a great Christmas and an amazing new year! If you aren’t stretching, you aren’t growing! Get out of your comfort zone because “what got you here won’t get you there.” – Marshall Goldsmith