All around the world, even though housing prices vary markedly, there is one guiding principle that property investors use as a rule of thumb. It’s the 1% rule. Just type the words “1% rule” and “property” into your internet browser and you will literally find millions of investment articles and books on this subject.
Simply put, the rule says that you should charge a monthly rent equivalent to 1% of the purchase price of a property plus any immediate repairs that are needed. For example, if you pay R1 million for a house, the minimum rent should be R10 000 a month. If you pay R1 million but need to invest R200 000 in repairs before you can rent it out, then you should charge your tenant R12 000 a month.
This rule exists because wise investors know that, over the medium term, you will need to fork out about 50% of the rent you have received in maintenance and repairs to keep the property in an acceptable condition. Roofs need to be repaired or replaced, buildings painted and woodwork replaced or varnished. Bathrooms need updating or plumbing fails. Subtract rates and taxes and you are left with a return on investment (ROI) of 3-4%, much less than the average return on the stock market but also much less risky.
Now 99% of us are never going to be property tycoons buying up houses and flats left, right and centre. Nevertheless, it is still a good rule to keep in the back of your mind when you are looking to rent or buy a property.
Let’s show how using this rule can be useful. Recently, a 26 square metre apartment was advertised for sale for R535 000. The apartment is well-situated along a main road in walking distance of the town centre.
In the property description, the real estate company said that the current rent was R3 910 but a new lease could be signed for R4 200. The handy bond calculator on the website said that monthly payments at 10.25% interest would be R5 252. The monthly levies were R880 and rates and taxes were R790.
Now any good property investor worth their salt would walk away from this flat. Why? Well, simply put, it is actually going to cost them money, R1 842 to be exact, just to pay the rates and taxes and cover the bond repayment difference. Bond repayments are R5 252 but the rent is only R4 200. And this is before one even thinks of recovering all the costs that are incurred in buying and registering a property which typically equate to 8-10% of the purchase price. Add in the amount of money that will be spent on maintenance and repairs and one can quickly understand why this isn’t a great investment opportunity.
If you were looking to rent and not buy this apartment, it should also ring alarm bells. If your landlord, the investor who bought the property, is already losing money every month, how likely are they to promptly repair faults and do maintenance on the flat. One of the perennial complaints renters have are that landlords don’t invest the money to keep the property top-notch while getting repairs done can take time. Often, in frustration, the tenant just pays to have them done.
Finally, if you are a first time buyer and looking to get onto the property ladder or someone looking to downsize, the asking price of the flat should also raise questions.
The first most obvious one is what is the real value of the apartment? If the rent is only R4 200 then maybe the flat is only worth R420 000? After all, if an investor won’t bite, then why should you? For most of us, buying a home will be the biggest investment we ever make. We all hope that if we ever need to sell, we will make some money. So there is nothing worse than paying too much for a home and then having to wait years while the market catches up.
The second question to ask is whether you would be better off renting the flat and putting the R1 842 you will save into an investment account instead. All around the world, many people have asked the same question, done the sums, and worked out that they would be better off renting and investing their spare cash.
Now, someone knowing all this information might still come to the conclusion that this flat is worth paying the asking price. Perhaps, in being able to walk everywhere, petrol costs will reduce and they will get fit and healthy as a bonus as well. Or maybe they believe that flat prices are going to increase significantly so they will be able to make a profit if they sell or at least break even. Maybe the buyer has no intention of selling and this is the last property that they will own, so other considerations are more important than price. Some properties have amazing views that you can’t put a price on. Others are close to schools and people are prepared to pay a premium for this. In the end the maxim of “willing buyer, willing seller” applies in the real estate market.
No matter if you are a buyer, seller or a renter though, the 1% rule is a good guide to have in the back of your mind. If you choose not to follow this rule, then you know it is a conscious and rational decision you have made and not an emotional one.
Read up more and make up your own mind about the 1% rule. Sage advice, a guide but not a rule, or advice that is better ignored.