The 1% Rule for Rentals Is Dead in Most Cities — Use This Instead

A rental bought at the wrong number can cost you $9,600 a year for as long as you own it – paid out of your own paycheck, every month.

A two-bedroom condo lists at $400,000 and rents for $2,400 a month. The 1% rule wants $4,000, so the deal reads as a fail before you have looked at a single bill.

But the 1% rule was never a profitability test. It compares gross rent to price and stops, blind to vacancy, HOA dues, insurance, maintenance and management.

The replacement is two numbers, not one: cap rate – net operating income against price – held against a floor you set yourself, then cash flow after the actual loan payment. You can pull a listing, run collected rent through operating costs to NOI to cap rate, and decide pass or pursue before you book a tour.

The 1% rule is a price-to-rent shortcut

The 1% rule is a price-to-rent filter, and that is the only question it answers. It says monthly rent should land at 1% of the purchase price. Run it on a $400,000 condo and the demand is $4,000 a month.

Now look at the listing. The two-bedroom asks $400,000 and rents for $2,400 a month. Divide $2,400 by $400,000 and you get 0.6% of price. The rule's verdict writes itself before you tour: $1,600 a month short of what the shortcut wants.

Here is what that arithmetic touches. Gross rent against price, nothing else. Vacancy never enters it. Neither do HOA dues, insurance, maintenance or a manager's fee. Two properties with identical rent and identical price score exactly the same, even if one carries $300 a month in HOA dues and a $2,400 repair year while the other runs lean. The rule cannot tell them apart, because it was never built to.

What broke the shortcut is the market itself. Purchase prices outran rents for years, so a fixed 1:100 ratio now fails listings whose real operating numbers still work. See where buy vs. rent math flipped before assuming ownership wins or loses in your market. Same in reverse: it waves through plenty that cannot carry itself after costs. Either way, the rule stays silent on whether a deal makes money.

So when the 0.6% comes back, it tells you this listing is not cheap relative to its rent. That is a real answer, and it is the whole answer. It says nothing about what the $2,400 leaves behind after the bills, which is the number that decides whether the property pays you or you pay it.

Test	What it compares	Example result	What it misses
1% rule	Gross monthly rent vs. purchase price	$2,400 rent is 0.6% — fails the 1% threshold	Vacancy, HOA, insurance, maintenance, management, tax
Cap rate	Net operating income vs. purchase price	$16,488 NOI ÷ $400,000 = about 4.1%	Every mortgage payment; how the buyer pays
Cash flow	NOI minus the actual loan payment	Set by the lender quote at today's rate	Long-run rent growth and appreciation

Use the cap rate instead

Net operating income is what the property keeps after vacancy and operating costs, and dividing that by the purchase price gives the cap rate. It is the collected rent, minus the months nobody pays, minus what the building costs to run, before a single mortgage dollar is considered. Then you divide.

Because vacancy and those costs come out first, the cap rate prices the building as a business instead of pricing its rent tag. Two condos at $400,000 with the same $2,400 rent can land at very different numbers once one carries a $300 monthly HOA and the other does not.

On the example: $16,488 of NOI divided by $400,000 comes to roughly 4.1%. That single figure tells you what the property returns on its price if you paid in cash and slept well.

The floor you measure it against is yours to set, and it has to exist before you open a listing. Pick the minimum cap rate that pays you for the risk and fits your local market, write it down, and leave it alone while you shop.

Six percent is the illustration here, for this $400,000 example only. It is not a universal target, and a different city or a different risk appetite can justify a different number.

Once the floor is written, it does the deciding. A listing's cap rate either clears it or it does not, and you know which before you tour, before you negotiate, and before you talk yourself into a neighborhood you like.

Run it on the example listing

Holding the formula is not the same as running it, so here is the example built line by line. Start with the rent the lease calls for: $2,400 a month, or $28,800 a year. Assume one month of vacancy a year, which costs the full $2,400. Collected rent drops to $26,400.

Now the operating costs, the lines the 1% rule skipped. Maintenance and repairs at $2,400 a year. Insurance at $1,800. HOA dues of $300 a month, which is $3,600 a year. Management at 8% of collected rent, or $2,112. Add those four and you get $9,912.

Now the subtraction. NOI is $26,400 minus $9,912, which leaves $16,488 a year.

Divide $16,488 by the $400,000 price and the cap rate comes out around 4.1%. Against the illustrative 6% floor, the example misses by roughly 1.9 points of cap rate.

Translate that gap into dollars and it stops being abstract. A 6% cap rate on $400,000 demands $24,000 of NOI. The property produces $16,488, so closing the gap means finding $7,512 a year of extra net income, from higher rents, lower expenses, or some of both.

One line is still missing from all of this: property tax. It is not in these figures, and it is not small. Pull the current county tax bill and add it to the operating costs. NOI falls, and the cap rate falls with it.

Cap rate does not cover your mortgage

Cap rate prices the property, not your plan for paying for it, so it stops short of what you pocket each month. That is by design. It treats the $400,000 condo as a business and judges NOI against price before a lender is ever involved. What it will not tell you is whether debt service eats the return.

Run the cash on the example. Twenty percent down is $80,000, closing costs add $8,000, so $88,000 leaves your account and a $320,000 loan hangs off the property. Pull the payment from an actual lender quote at today's rate rather than an assumed one, because the rate you hear on a podcast is not the rate you get.

The cash-flow step is quick once you have both numbers. NOI is $16,488 a year, about $1,374 a month. Subtract the quoted monthly payment from that and what remains is your cash flow, whether it lands positive or negative.

A deal can clear a six percent floor on the property and still bleed after debt service. The floor tests the property. The payment tests the plan. Both have to survive or the purchase does not happen.

When a low cap rate can still work

A cap rate below your floor can work, but only when the gap is paid for by a case you can hand to a skeptical partner and defend line by line.

Three things earn that exception. Rents you can show are under market with signed leases or comps, a renovation with a written scope and contractor numbers, or appreciation backed by more than a feeling about the neighborhood. A fourth thing does not count, and it is the one people reach for: the belief that the area is about to take off.

Here is the size of the ask on the $400,000 condo. At a 4.1% cap rate it produces $16,488 of NOI. A 6% floor wants $24,000. That missing $7,512 a year, about $626 a month, has to come from somewhere you can name and total up, whether that is rent to market, an expense you can actually cut, or forced value.

Now stress it. One extra vacant month is another $2,400 gone. One bad repair year is $2,400 more. The thin margin on a below-floor deal gets eaten by an ordinary Tuesday, not a catastrophe.

This is not for the buyer who needs the rent to help carry the payment, or who has no reserve behind the down payment. For that buyer, below floor is a pass, whatever the story sounds like on a tour.

Write down how much of the gap the evidence closes. A number you can reach beats a paragraph you can talk yourself into.

The walk-away number is your floor

The walk-away number is your floor, meaning the minimum cap rate and the minimum monthly cash flow you write down before you look at a single listing.

Two figures on one page. The cap rate is the return the property has to earn on the purchase price for the risk to be worth it to you. The cash flow is what has to be left each month after the actual lender payment. Date the page, because the version you write after falling for a kitchen is a different, softer number.

Run the example against it. $16,488 of NOI on $400,000 gives a 4.1% cap against a 6% floor, and that is a pass unless someone shows you, in writing, where the missing 1.9 points come from.

Four documents settle almost everything before you make an offer: the current county tax bill, the HOA statement, an insurance quote, and a lender quote. Those four drive NOI and the debt service, and none of them is a guess you get to make from the listing.

Check in this order. Cap rate first, cash flow second, and if either misses, you are done. A fat cash-flow number on a weak property deal is usually a sign of an optimistic loan assumption, not a bargain.

The order is the whole method.

Frequently Asked Questions

Is the 1% rule completely useless?

No — it is a fast screen for whether a property is cheap relative to its rent, and it takes ten seconds. What it cannot do is tell you whether the property makes money, because it never subtracts vacancy, HOA dues, insurance, maintenance, management or tax. Use it as a first filter if you like, then run the cap rate before you spend an afternoon touring.

What cap rate should I set as my floor?

Yours, not mine. The floor should reflect the risk of the specific property and what returns are actually available in that market — a 6% floor in one city may be too low in another and unreachable in a third. Set it before you shop, in writing, and change it only between deals, never mid-negotiation on a property you have already fallen for.

Should I use gross rent or collected rent in the calculation?

Collected rent. Subtract a realistic vacancy allowance first — one month a year is a reasonable planning number for a single unit — then subtract operating costs. Using gross scheduled rent overstates NOI and flatters the cap rate, which is exactly how buyers end up surprised in month three.

Does the cap rate include my mortgage payment?

No, and it is not supposed to. Cap rate is a property-level measure that treats the building as if bought with cash so two properties can be compared fairly. Your mortgage enters at the cash-flow step: subtract the quoted monthly payment from monthly NOI and see what is left. A deal can pass the cap-rate test and still be negative after debt service.

How do I handle property tax if I do not know it yet?

Pull the current county tax bill for the parcel before you run the numbers — it is public record and it takes minutes. Do not estimate it from a percentage of the price and do not leave it out. On a $400,000 condo, tax is a real annual operating expense, and adding it lowers NOI and the cap rate.

When should I talk to a professional instead of doing this myself?

When the decision turns on your own tax situation, the ownership entity, or a 1031 exchange, talk to a CPA who works with rental owners. And if the cap rate and the cash flow disagree — one clears, one does not — run it against your own budget and reserve before you sign anything.

Pass on the 4.1% condo — unless you can document the gap

Run the example once more and the verdict is pass. NOI of $16,488 on $400,000 is about a 4.1% cap rate, and the illustrative floor is 6%. Only a documented rent-growth or value-add case closes that gap – paper, not a hunch about the neighborhood.

The $2,400 rent that missed the 1% rule by $1,600 a month also misses the cap-rate test. Here both tests agree; only the second one shows you why.

Your first afternoon costs nothing: pull the current county tax bill, the HOA statement, an insurance quote and a lender quote at today's rate. Run cap rate first and cash flow second, all of it before you tour a single unit. That number written down beforehand is what turns a listing from a maybe into a decision.