Should You Invest in Real Estate?

Investing in real estate can be financially rewarding, providing an additional income stream, tax advantages, and long-term financial security. However, it also comes with significant responsibilities. Here are three key points to consider before investing in a rental property:

Financial Stability

Ensure your finances are in order. Investment properties require substantial financial stability. Most lenders require a minimum 15% down payment for investment properties, unlike the lower down payment often needed for a primary residence.

Beyond the down payment, budget for inspection costs, recurring maintenance bills, and potential repairs. As a landlord, you must handle essential repairs promptly, which can be costly, especially for HVAC or plumbing issues. Note that some states allow tenants to withhold rent until repairs are completed, so maintaining an emergency fund for such situations is prudent.

Budget for advertising and tenant screening as well. Screening is the cheapest expense on this list and the one that determines every other expense on it.

CAP Rate and CoC returns

Evaluate whether the investment is financially viable. Find comparable rental properties to determine the average monthly rent. Multiply this by 12 to get your annual rental income. Depending on the market, account for vacancies, e.g. assume 80% occupancy. See section “Capitalization Rate (CAP rate)”.

Responsibilities and Risks

Understand the responsibilities and risks involved. As a landlord, you are responsible for property maintenance, tenant management, and legal compliance. Repairs can be costly, and dealing with problem tenants can be stressful and expensive. Ensure you have a clear plan for managing these responsibilities.

For rental properties, plan on a 25% down payment, resulting in a 75% Loan-to-Value (LTV) ratio.

According to the “1% rule”, if a property can generate 1% or more of its purchase price in monthly rent, it likely has positive cash flow. The “2% rule” is more stringent than the 1% rule, effectively doubling the required monthly rent. However, it can be effective in certain markets, offering a financial safety net for investors facing vacancies or major, costly repairs.

The rule is not folklore — it is a cap rate in disguise, and deriving it tells you exactly when to stop trusting it. Monthly rent of 1% of price is a 12% gross annual yield. Apply the 50% expense rule of thumb and the cap rate falls out:

which is the same 6% baseline this chapter opened with. The 1% rule is therefore a shorthand for “price this deal to a 6% cap.” That makes its failure modes obvious. It breaks wherever the 50% assumption breaks — a new-construction single-family home with no HOA runs closer to 35% and clears the same cap rate at 0.85% monthly rent, while a 1960s multifamily with high turnover and a $700 monthly HOA can burn 65% and needs 1.4%. And it says nothing at all about whether leverage helps: compare the resulting cap rate to your mortgage constant (section “Cash-on-Cash Return”) before you assume a 1%-rule property cash-flows with a loan on it. In a regime where mortgage constants sit above 7%, a great many 1%-rule properties are negatively levered.