For beginners in real estate, you've probably come across the 1% rule in guides to investing. This rule is a guideline used by many real estate investors to determine whether a potential investment property is worth pursuing. Here's a closer look at the 1% rule and how it applies in Canada.
What is the 1% rule?
The 1% rule is a simple guideline used to evaluate the potential profitability of an investment property. According to this rule, the monthly rent collected from a property should be at least 1% of the purchase price. For example, if you buy a property for $200,000, the monthly rent collected should be at least $2,000. If any repairs need to be made on the property, these should also be added to the original home price.
Why is the rule used?
The rule provides a quick and easy way to evaluate the potential profitability of an investment property. By using this rule, investors can easily determine whether a property is worth pursuing further or not. If the monthly rent collected is less than 1% of the purchase price, the property may not generate enough cash flow to make it a worthwhile investment. The rule is, however, only a guideline and shouldn't be used as the only factor in determining profitability.
Is the 1% rule applicable in Canada?
While the 1% rule can be applied in Canada, it's important to note that the guideline is likely created for the American real estate market, and Canada's market is significantly different. In some cities, such as Toronto, finding properties that meet the rule may be more challenging due to the high purchase prices and low rental yields. In other cities, such as Windsor and Sudbury, finding properties that meet the 1% rule may be more manageable.
Other Calculations to Consider
There are a lot of factors that contribute to the profitability of a property, including location, demand, and condition of the building. Here are a few other ways to calculate the potential profitability of the property:
Debt-service coverage ratio (DSCR)- This is also very simple but more thorough. Subtract all your annual expenses, such as mortgage payments, utilities, municipal and property taxes, maintenance costs, and insurance, from the total yearly rent. If income equals 125% of expenses, the profit will be acceptable.
Gross income multiplier (GIM)- This formula is simple: divide the building's purchase price by annual gross income. This ratio may not be accurate because it only considers some of your building-related expenses. However, it's an easy way to compare similar buildings in different areas.
Discount rate- This is most applicable to commercial buildings or those with 12 or more rental units. This is another simple calculation; divide the net income generated by the building by its market value. The discount rate is used mainly for comparison purposes. For example, you can compare your desired building's discount rate with market discount rates by building type and location.
These are still all guides and should never be the only consideration used when buying a property.
Speaking with a professional will help you determine if a property will be profitable. Visit www.regalwayhomes.com/book-online to book a consultation with experts today!
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