Understanding Cap Rates in Real Estate: With and Without Mortgage Payments in 2025
Are you chasing the 1% rule in real estate investing, hoping it’s the golden ticket to profitable rentals? At heyyproperty.com, we’re here to debunk the 1% rule myth, explain when it works, and show you how to evaluate rental properties smarter—especially in high-tax markets. Whether you’re eyeing multifamily properties in Jackson, MS, or retail spaces in Baltimore, this guide will help you maximize returns and avoid common pitfalls. Let’s dive into the truth behind the 1% rule and how to make informed investment decisions in 2025!
What Is the 1% Rule in Real Estate?
The 1% rule is a quick heuristic for rental property investors. It suggests that a property’s monthly rental income should be at least 1% of its purchase price to ensure profitability. For example:
A $200,000 property should generate $2,000/month in rent.
A $300,000 property needs $3,000/month.
The rule aims to screen properties for positive cash flow, assuming that high rent relative to price signals a strong return. But is the 1% rule a reliable metric, or just a real estate myth? Let’s break it down.
Want to calculate your property’s potential cash flow? Check out our Rental Property Calculator to get started!
The 1% Rule Myth: Why It’s Not Always True
While the 1% rule is a handy starting point, it’s not a one-size-fits-all formula. Here’s why the 1% rule myth can mislead investors in 2025:
1. Ignores Operating Expenses
The 1% rule only compares rent to purchase price, ignoring operating costs like:
Property taxes: In high-tax states like New Jersey (2.47% average rate), taxes can eat into cash flow.
Insurance: Varies by location (e.g., $2,000/year in Florida vs. $800 in Ohio).
Maintenance: Older properties in Cleveland may cost 1–2% of property value annually.
Vacancy rates: Markets like Baltimore (7% multifamily cap rate) may have higher turnover.
For example, a $200,000 property renting for $2,000/month (1% rule) may seem promising, but if taxes are $6,000/year, insurance $1,200, and maintenance $2,000, your net operating income (NOI) drops significantly, slashing profitability.
2. High Property Taxes Break the Rule
In high-tax markets, the 1% rule often fails. Consider a $300,000 property in Austin, TX, with a 1.8% tax rate ($5,400/year). Even with $3,000/month rent, expenses like taxes, insurance ($1,500), and maintenance ($3,000) total ~$9,900/year, leaving a slim NOI. Compare this to Jackson, MS (0.62% tax rate, $1,860/year for $300,000), where lower taxes preserve cash flow, making the 1% rule more viable.
Curious about property taxes in your target market? Explore our Real Estate Market Insights for city-specific data!
3. Market Dynamics Matter
The 1% rule doesn’t account for local market conditions:
Low-cost markets: In Jackson, MS, or Augusta, GA (8% and 7.6% cap rates, per 2025 data), properties often meet or exceed 1% due to low purchase prices and strong rental demand.
Premium markets: In San Francisco or New York (3.5%–4% cap rates), achieving 1% is nearly impossible due to high prices and compressed yields.
Appreciation vs. cash flow: In Tampa, FL, investors may accept lower rents (0.8%) for long-term appreciation, ignoring the 1% rule.
4. Financing Impacts Returns
The 1% rule assumes cash purchases, but most investors use mortgages. A 20% down payment on a $200,000 property with a 6% mortgage (2025 average) adds ~$9,600/year in payments, reducing cash flow. In high-tax areas, this squeezes margins further, making the 1% rule less reliable.
When Does the 1% Rule Work?
The 1% rule can be a useful initial filter in specific scenarios:
Low-cost markets: Cities like Jackson, MS, or Baton Rouge, LA, where cap rates hit 8%+ and taxes are low.
Low-maintenance properties: Newer multifamily or retail in Augusta, GA, with minimal upkeep costs.
High-occupancy areas: Markets with low vacancy (e.g., Tampa’s 4.5%–6% multifamily cap rates) ensure steady rent.
For example, a $150,000 property in Cleveland (7.7% office cap rate) renting for $1,500/month meets the 1% rule. With taxes at $2,000, insurance $800, and maintenance $1,500, NOI is ~$13,700/year, yielding a solid 9.1% cap rate—proof the rule can work in affordable markets.
Ready to find high-yield properties? Browse our Investment Property Listings for top markets!
How to Evaluate Properties Beyond the 1% Rule
To make smarter investment decisions, ditch the 1% rule myth and use these metrics, especially in high-tax markets:
1. Calculate Cap Rate
Cap rate (NOI ÷ Property Value) reflects true yield. A $200,000 property with $24,000 rent but $12,000 expenses (taxes $5,000, insurance $1,000, maintenance $2,000, vacancy $4,000) has an NOI of $12,000, or a 6% cap rate. In high-tax markets, aim for 6%–8% to offset costs.
Learn more in our guide: Understanding Cap Rates for Real Estate Investors.
2. Cash-on-Cash Return
Measure returns on invested capital. For a $200,000 property with 20% down ($40,000) and a $120,000 mortgage at 6% ($7,200/year), if NOI is $12,000, cash flow is $4,800 ($12,000 - $7,200), yielding a 12% cash-on-cash return. High taxes reduce this, so prioritize low-tax markets like Baton Rouge.
3. Total Return
Combine cash flow, appreciation, and tax benefits. In Pittsburgh (6% multifamily cap rate), a 0.8% rule property may offer 3% appreciation and tax deductions, outpacing a 1% rule property in a stagnant market.
4. Local Market Analysis
Use tools like CapRateIndex or heyyproperty.com’s Market Reports to assess:
Rental demand (e.g., Baltimore’s 7% multifamily yields).
Tax rates (e.g., New Jersey vs. Mississippi).
Vacancy trends (e.g., retail’s low vacancy in Sun Belt cities).
High Taxes? Here’s How to Adjust
In high-tax markets like New Jersey or Austin, the 1% rule rarely holds. Instead:
Target 1.2%–1.5%: A $300,000 property needs $3,600–$4,500/month rent to cover taxes (e.g., $7,200/year at 2.4%).
Negotiate price: Buy below market value to boost NOI.
Tax strategies: Appeal assessments or explore deductions (e.g., depreciation).
Focus on appreciation: Accept a lower initial yield (0.8%) in markets like Tampa for long-term gains.
Need help navigating high-tax markets? Contact our Real Estate Experts for personalized advice!
Conclusion: Smarter Investing in 2025
The 1% rule myth oversimplifies real estate investing, especially in high-tax markets or premium cities. While it’s a quick filter for low-cost, high-yield markets like Jackson, MS, or Cleveland, OH, savvy investors use cap rates, cash-on-cash returns, and local market data to uncover true profitability. At heyyproperty.com, we empower you with tools and insights to find the best rental properties, whether you’re chasing 8% cap rates in Baltimore or steady returns in Tampa.
Ready to invest smarter? Explore our Investment Guides or Get Started with a free consultation today!
Keywords: 1% rule real estate, 1% rule myth, rental property investing, cap rate 2025, high-tax markets, real estate investment tips, heyyproperty.com
Disclaimer: Always consult a financial advisor before investing. Market data based on 2024–2025 estimates.
