Pretty reliable. I generally use that as the minimum cutoff. I actually tend to look in the 1.3%-2% range for cash flow properties.
If you already have properties, they may be worth keeping based on a number of things despite not hitting the 1% rule (selling costs, intertia, taxes, etc.), but it's worth evaluating, and if you're looking to purchase new properties for cash flow, it's probably best to ignore anything that doesn't hit the 1% rule.
(Of course you may have a different strategy - appreciation - in which case you may even accept negative cash flow, in order to try and achieve that.)
To answer your questions:
1) It is the gross rent you are receiving.
2) Initially you calculate based on what you paid plus rehab costs, and then on an ongoing basis you can calculate it based on the value is as a potential metric to look at whether or not you may want to sell.
Rules like this, however, are merely initial broad tools to demarcate and easily narrow all the properties out there (e.g. cut out any that don't meet it right away).
If you are making a small wooden toy boat from a giant tree, you will need several tools to eventually whittle it down. The 1% rule is the ax that fells the tree - you need much more fine analysis after that to determine more.
So your property may be significantly worse than the 1% rule if you have higher than expected expenses (if, for example, you have high heating bills that you pay, and not the tenants, for some reason).
Back to the question title, I'd say it's quite reliable, and personally wouldn't be buying a property for 100k that only rented for 800/mo.
If your primary goal with these investments is cash flow, you'd better be getting much better than that. (For example, my latest property, purchased last month, was for 27k and is rented for 600 - but market rent is closer to at least 700-750, it just currently has a tenant already in place.. another property I put an offer on last week will be for 37k purchase, 8k rehab, 45k total, rent for about 950/mo. These are straight cash flow plays in decent areas, but I'm not factoring in a ton of appreciation.) If you are an accidental landlord not treating it as a business, you may be getting worse than that. I'd advise anyone getting into rentals purposefully though to be looking for good investments, not just mediocre ones that happen to be near to them.
And, as always, it greatly depends on your local market. It can be hard to get 2%, 1.5%, or even 1% in certain markets. My advice to people in that situation, however, is: go find another market.
As the RealEstateGuys Radio Show and Podcast say: "Live where you want to live. Invest where the numbers make sense."