The ‘one percent rule’ is a rule regarding purchasing investment homes and properties which states that the best investment properties will always return 1% of their purchase cost… after deducting expenses!
So, after finding the purchase price of a potential investment property, subtract the operating overhead. These are the expenses associated with running the property, such as utilities landlords must pay, trash, repairs, management and regular maintenance. It doesn’t include the principal and interest on your mortgage, but SHOULD include rental fees, the cost of finding a tenant, and etcetera.
For the sake of example, let’s say all those expenses come to $6,000 per year for a Nashville rental. If you rent a home for $1,200 a month, your finances should look like this;
Gross Operating Income: $14,000
Less operating overhead: ($6,000 per year)
Net operating income (NOI): $8,000 per year
Congrats, you know your net operating income, also known as “NOI.”
To find the cap rate, divide $8,000 (your NOI) by the total acquisition price of the house. Let’s assume your house cost $150,000, including closing costs and upfront repairs.
$8,000 / $150,000 = 0.05
Multiply your answer by 100 to convert it into a percentage. The $8,000 in cash flow you’re receiving translates to a 5% cash flow return on your property value.
Now, let’s assume you bought the house for only $100,000.
$8,000/$100,000 = 0.08, or 8%.
Much better! At that rate, you’re getting cash flow that exceeds most high-dividend stocks. And if your property value keeps pace with inflation (around 3 percent annually), your total return is around 11 percent per year, two-thirds of which come in the form of cash flow.
