The 1% rule in multifamily investing is a general guideline that investors often use to quickly screen potential rental properties, including multifamily units. According to this rule, the monthly rent of a property should be at least 1% of its total purchase price to consider it a good investment. This means if you’re looking at buying a multifamily property for $500,000, the combined rent from all units should be at least $5,000 per month to meet the 1% rule. [Source:Investopedia.com]
This rule has functioned as a quick way to estimate whether a property is likely to generate positive cash flow, taking into account the mortgage payment, property taxes, insurance, maintenance, and other operating expenses. It’s important to note that while the 1% rule can be a helpful initial filter, it’s a very simplistic measure. Investors should conduct a more detailed analysis, considering all expenses, the local rental market, property condition, and potential for appreciation or depreciation, before making an investment decision. I would posit that the 1% rule is no longer effective in today’s real estate climate.
Has the 1% rule for real estate investing lost it’s effectiveness?
The effectiveness of the 1% rule in today’s real estate investment market can vary greatly depending on a number of factors including location, property type, market conditions, and investment goals. Here are some considerations to keep in mind:
- Market Variation: In some markets, especially those that are highly competitive or have experienced significant property value increases, it might be challenging to find properties that meet the 1% rule. In high-cost areas, the rental yields (rent as a percentage of property value) may naturally be lower, making the 1% rule less applicable.
- Property Type and Condition: The type and condition of the property can also impact the applicability of the 1% rule. Properties in need of significant repairs might meet the rule initially but could require substantial additional investment to become rentable, affecting overall returns.
- Investment Strategy: The rule is more suited for cash flow-focused strategies rather than those focusing on capital appreciation. Investors in areas with strong growth potential but lower rental yields might accept lower initial returns for the prospect of significant property value increases.
- Economic and Interest Rate Environment: The broader economic environment, including interest rates, can affect the feasibility of the 1% rule. Rising interest rates, for example, can increase borrowing costs and affect cash flow calculations, making it harder for investments to meet the 1% threshold while still being financially viable.
- Alternative Metrics: Savvy investors often use a range of metrics to evaluate properties, such as the cap rate (capitalization rate), cash on cash return, and NOI (Net Operating Income). These metrics can provide a more nuanced view of an investment’s potential than the 1% rule alone.
While the 1% rule can still serve as a quick screening tool for rental properties, its applicability and effectiveness varies widely in today’s diverse and dynamic real estate markets, making it far less reliable than it use to be.
What About Using it for Nashville Real Estate Investment?
Here in Nashville, TN, particularly in Davidson County, the 1% rule will be challenging to apply effectively as a primary method of evaluating properties for several reasons:
- Nashville Real Estate is a highly competitive market. We have seen that property prices remain higher than the surrounding areas, which can make it difficult to find properties that meet the 1% rule. A combination of high demand and unrealistic seller expectations have kept purchase prices high, reducing the likelihood of achieving the 1% monthly rent relative to the purchase price.
- Flattening or Decreasing Rents: With 30,000+ apartment units scheduled to come online in the next two years, Nashville property managers are pulling out all of the stops to get heads in beds [WKRN-ARTICLE]. Sometimes offering 2 or 3 months free to get tenants to sign leases. If rents are stagnating or declining while property prices remain stable or continue to rise, achieving the 1% rule becomes even more challenging. The rule relies on strong rental income relative to purchase price, and flattening or decreasing rents can negatively impact potential investment returns.
- High Interest Rates: With interest rates above 6%, debt servicing costs are higher, which can significantly affect cash flow and the overall return on investment. High interest rates mean higher mortgage payments, reducing the net income from the property and making it harder to achieve positive cash flow, especially if you’re aiming for the 1% rule as a benchmark.
Given these market conditions, relying solely on the 1% rule in Nashville’s Davidson County might not be the most effective strategy. In fact, it may never be a metric investors should use in Nashville ever again. Using additional metrics like the cap rate, cash on cash returns, and NOI can provide a more nuanced understanding of the property’s potential as an investment.
How to find Nashville Real Estate Investments without the 1% Rule
Even if the 1% rule doesn’t neatly apply to real estate investments in Nashville, especially within Davidson County, it doesn’t necessarily mean investors should look elsewhere. There can still be viable and potentially lucrative investment opportunities in our area; it just requires a different approach or set of criteria to identify them. Here’s why investing in Nashville can still be smart and how to approach it:
The condition of a property will have a large impact on the property’s ability to meet the 1% rule. In which case you must consider the total cost of renovations in order to achieve market rents.
1. Diversification of Investment Strategies:
- Value-Add Properties: Look for properties that may not meet the 1% rule initially but have the potential for significant value increases through renovations, upgrades, or repositioning in the market.
- Development Projects: New construction or redevelopment projects can offer good returns, especially if you have insights into emerging trends or areas poised for growth.
- Short-Term Rentals: Given Nashville’s popularity as a tourist and event destination, short-term rental properties can yield higher returns than traditional long-term rentals, although they come with different regulatory and operational considerations.
2. Capital Appreciation:
- Nashville and its surrounding areas have seen significant growth and might continue to do so. Properties in high-growth areas may not meet the 1% rule but can still be excellent investments due to appreciation in value over time. There are pockets of Nashville that are on the verge of re-development. For example Madison, TN will see enormous growth over the next decade thanks to major infrastructure improvements that are slated for 2026 and beyond.
3. Research and Patience:
- Detailed market research is vital. Look for undervalued areas within Davidson County that have growth potential. This requires patience and thorough analysis but can lead to finding hidden gems. Patience is key as you will inevitably have to sift through countless properties to find the right one. But be ready to act as soon as you find the right property. In Nashville’s crowed real estate investment market there are dozens of other investors out there looking for the next good deal.
4. Creative Financing:
- Exploring alternative financing methods can improve the deal’s structure and its returns. Seller financing, lease options, or partnering with other investors are ways to mitigate the high interest rates and upfront costs. In some cases even Fannie/Freddie loans are transferable. In the right scenarios these may be an excellent way to find a good deal.
5. Networking and Local Insight:
- Building relationships with local real estate professionals, joining investment groups, and staying informed about local market trends can lead to opportunities that are not apparent through basic metrics or online listings. We cannot emphasize this enough. While real estate investing is something that is open to anyone, it often comes back to knowing the right people. Local meetups and networking events are often free and provide a great service for new investors.
6. Keep a Long-term Perspective:
- Real estate should often be viewed as a long-term investment. Nashville’s growth trajectory suggests that investing in real estate, even at current prices and rents, could yield significant long-term benefits. Buying a property that meets your required debt service coverage ratio, may be where you start. Holding the property for 5, 10 or even 15 years will pay off in the long term, even if it isn’t producing the “Mailbox Money” the investor gurus told you it would.
Conclusion:
The 1% rule is just one tool among many for evaluating real estate investments. In markets like Nashville’s, where the rule may not apply broadly, investors should consider a comprehensive approach that includes multiple evaluation criteria and strategies. With the right approach, Davidson County can still offer attractive investment opportunities, even in a competitive and evolving market. Want to learn more about property valuation so you can be prepared to launch your real estate investment journey right here in Nashville? Schedule a FREE Consultation with one of our multifamily experts. Multifamily real estate is a ALL we do. You will not find a firm more dedicated to this market than us.
