Understanding the 1-percent Solution in Real Estate Investment

In real estate investing, coming up with a plan to determine what property to acquire is important if you want to avoid financial loss. According to Ali Ata, most returns on investment in real estate come from rental income. For this reason, you will need to check a property's potential to generate a positive cash flow from possible rentals. The numbers may be difficult to crunch, but some real estate investors follow the 1% solution.

Following the 1% solution is done by measuring the gross income that a property will generate in a given month against the total purchase cost. If the ratio exceeds 1%, it passes the 1% solution. If the property is currently unoccupied, then you can also apply the rule to determine how much you should charge the next tenant.

In some instances, you would also need to include the cost of the necessary repairs you will incur and add that to the purchase price when making your calculation. For example, if a property is listed at $200,000 and has historically charged a $2,000 monthly rent, it passes the 1% solution. If, however, the property immediately required $25,000 in repairs, then the property no longer meets the 1% criteria.

Of course, there are other types of calculations or investment rules, says Ali Ata. Some of those are the gross rent multiplier and the 70% rule. What you opt to use depends on the circumstances surrounding the potential real estate purchase.

Most real estate investors use the 1% rule only as a prescreening tool, helping them narrow down their choices when faced with plenty of properties to select from.

It is best to not solely rely on the 1% solution when a prospective property has several other cost streams that may be incurred upon purchasing it, such as fix-up costs, financing costs, high property taxes, and other operating expenses.

Ali Ata has a degree in Chemical Engineering and is now actively involved in the real estate development business. Subscribe to this blog to