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The 1% rule is a guideline that real estate investors use to evaluate whether a property will generate sufficient cash flow. The rule states that the monthly rent collected should be at least 1% of the total cost of purchasing the property, including purchase price and any necessary repairs. For example, if a property is valued at $200,000, the monthly rent should be $2,000 or more. This rule helps investors determine if the investment has potential profitability by ensuring rent covers a significant portion of their mortgage and expenses.

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Understanding the limitations of this rule is also essential. While the 1% rule provides a useful starting point, it does not consider other important factors like property taxes, insurance, vacancy rates, and maintenance costs. Markets with high property values may not meet this criterion but could still be lucrative because of property appreciation. Conversely, in lower-cost areas where properties meet or exceed the 1% threshold, rental demand and growth potential might be limited.

Another important aspect is comparing market trends. An investor should look at local market conditions to assess if rental prices align with the 1% rule or if they are significantly higher or lower. Factors such as economic growth, job opportunities, and population trends can influence rental prices and property value appreciation, affecting an investment's overall viability.

Real estate investors often use additional metrics alongside the 1% rule to get a full picture of potential returns. These may include cash-on-cash return, cap rate, and more detailed cash flow analyses. Combining these methods allows investors to make well-informed decisions, balancing current rental income with long-term growth and profit potential.