What is the 7% Rule?
The 7% rule is an investment screening tool used by real estate investors to quickly evaluate whether a rental property has the potential to generate positive cash flow. Essentially, it states that the annual gross rental income should equal at least 7% of the property’s purchase price for the investment to be worthwhile.
This rule serves as a preliminary filter, helping investors identify properties that may meet their minimum return requirements before conducting more detailed analysis.
How Does the 7% Rule Work?
The 7% rule works by establishing a baseline threshold for rental yield. When an investor finds a property, they calculate what 7% of the purchase price would be annually, then compare that figure to the expected gross rental income.
If the property’s annual rent meets or exceeds this 7% benchmark, it passes the initial screening and warrants further investigation. However, if the rent falls below 7%, the property may not generate sufficient income to cover expenses and produce positive cash flow.
Investors use this rule during the early stages of property evaluation to save time and avoid analyzing deals that are unlikely to meet their investment criteria.
The 7% Rule Formula
The formula for the 7% rule is straightforward:
Annual Gross Rent ÷ Purchase Price = Rental Yield Percentage
For a property to pass the 7% rule test:
Rental Yield ? 7%
Alternatively, you can calculate the minimum required monthly rent:
Minimum Monthly Rent = (Purchase Price × 0.07) ÷ 12
Real-World Application of the 7% Rule in Real Estate
In practice, real estate investors apply the 7% rule when screening multiple properties in a market. For example, if an investor is considering a property priced at $200,000, they would calculate that the annual rent should be at least $14,000, or roughly $1,167 per month, to meet the 7% threshold.
This quick calculation allows investors to immediately determine whether a property aligns with their cash flow objectives. Markets with lower property prices and steady rental demand often make it easier to find properties that meet the 7% rule.
Conversely, in high-appreciation markets where property values are elevated, finding rentals that achieve a 7% yield becomes more challenging, pushing investors to look for value-add opportunities or alternative markets.
How the 7% Rule is Used
Investors use the 7% rule as a first-pass filter in their property search process. When browsing listings or receiving deals from wholesalers and agents, they quickly run the numbers to see if the property meets this minimum standard.
Additionally, the rule helps investors compare opportunities across different markets. A property that achieves an 8% yield might be more attractive than one at 5%, assuming other factors are comparable.
However, savvy investors recognize that the 7% rule is just a starting point. After a property passes this initial test, they conduct comprehensive due diligence that includes operating expenses, vacancy rates, property condition, neighborhood trends, and financing costs.
The 7% Rule in Other Words
Simply put, the 7% rule means that for every $100,000 you spend on a property, you should collect at least $7,000 in annual rent. It’s a quick mental math tool that helps you separate potentially profitable deals from those that won’t generate enough income to justify the investment.
Think of it as a speedometer reading on a highway—it gives you an immediate sense of whether you’re in the right range, but it doesn’t tell you everything about the journey ahead.
