Real estate investing is one of the most effective ways that an average person like you or I can achieve true wealth in our lifetimes. But to do it properly, you really need to know how to analyze a deal or crunch the numbers. Luckily for you, experienced real estate investors have come up with a few simple rule of thumbs that they follow to quickly analyze a deal. If a house passes one of these rule thumbs, then they know hey, this house may have potential and we should crunch the numbers a little bit deeper.
1 Percent Rule
I'm going to share with you the three most effective rule thumbs to real estate investing. the first rule we're going to talk about is the 1% rule. with the 1% rule, you take the expected monthly rental income and you divide it by the value of the house, and ideally you get one or greater. If that number is one or more, then you know this property is probably going to be a really good deal. If that number is below one or really below one, then it may not be the best investment.
But the truth is, not all homes make good rental properties. There may be a section in your city where there's just not a big demand for rentals, the value to rent ratio may be really low. On the other hand, there may be a section in your city where there's a high demand for rent. Maybe there's a military base or a college nearby, and that rent to home value ratio may be much higher. the 1% rule is kind of a quick and easy way to see if a home would make a good rental property or not.
But as an example, if a home was worth $200,000 with the 1% rule, you'd want to get at least $2,000 a month in rent for that property. But here's the truth in today's current market, it's actually pretty difficult to find a home on the MLS that meets this 1% rule. But nonetheless, it's still a helpful benchmark to judge a property against. For example, maybe you find a property that doesn't rent for 1% of the value, but it rents for 0.09% of the home's value, or 0.08% of the home's value. That may still be a really good deal. the closer that you can get to this 1% rule, the better.
50 Percent Rule
The next rule I want to talk about is the 50% rule and this rule states that about 50% of a rental property's income is going to go straight into operating expenses. this is all the property's expenses, other than the mortgage. This is going to be things like taxes, insurance, repairs. On average, on a long enough timeline, about 50% of the income is going to go straight towards these expenses. this means that you really only have about 50% of your monthly rental income to cover your mortgage, as well as any profit that you want to make.
Let's say you rent a property for $2,000 a month, about 1000 of that on average is going to go towards all the operating expenses of that rental property. Let's say you want to make at least $100 cash flow profit every single month from that property, that means your mortgage has to be $900 a month or less. Based on that number, you can then determine what your maximum purchase price for that rental property should be.
Now the 50% rule is just kind of a rough estimate. if a property does come close to meeting that 50% criteria, then you need to crunch the numbers and go a little bit deeper. at this point, you'd want to look up what the actual property taxes are going to be it's a good idea to research real estate transfer taxes by state, as they can differ considerably. Maybe call me insurance companies and get an estimate for the insurance on that property. Maybe figure out based on how old the property is, how much you think you'd spend every single month in maintenance costs. Maybe actually talk to a lender and see what interest rates are at right now. If a property just comes close to meeting that 50% role, then you know that it's worth you investing your time and energy and more accurately analyzing that deal and crunching the numbers.
70 percent Rule
The first two rule of thumbs are really focused on investing in rental properties, but this third one is more focused on buying a fix and flip, and this one is the 70% rule. This rule states that you should only pay 70% of what you think the after repair value is of a property minus your estimated repair costs. if you think a home would sell for $300,000 after you fix it up, 70% of that would be $210,000 minus your repair costs of let's say $50,000. That means that your maximum purchase price for that flip would only be $160,000. the 70% rule is essentially saying that about 30% of your after repair value is going to go straight to your operating expenses. these are going to be expenses like your closing costs to buy and sell the home, your real estate agent's commissions, the holding costs to hold onto the property while you're doing the renovations, your utilities, taxes, etc.
By lumping all those expenses together, you really only need to figure out two main numbers in order to determine if a deal would make a good flip or not, and that's what you could sell that home for after you make all the repairs and about how much you think it would cost to actually fix up the property. Now the 70% rule isn't perfect and it kind of falls apart when you get into the two extremes. for example, if you're dealing with a one or $2 million property, the 70% rule doesn't really work out all that well. Again, if you're dealing with a $50,000 or $70,000 property, again, that 70% rule doesn't really work out. But the average home value in America is $350,000 and for that price range, 300, 400, $500,000, the 70% rule works pretty well.
If a home passes the 70% rule, now you know that you should crunch the numbers a little bit deeper and see if all your holding costs and operating expenses really do add up to 30% of the after repair value or not.
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