You should check out biggerpockets.com there are a lot of really smart people over there.
The 1% rule is actually a more lenient 2% rule (which you will find on BP) which states that you should be able to rent out your house for 2% of the purchase price ie a 225K house should be able to rent for $4,500/month. now I know what you are thinking, THAT IS CRAZY, and I agree, but there are people out there that get deals like that. That being said I think the 1% rule is realistic, and that a somewhat savvy investor should land somewhere in the middle, I usually look for 1.3% but lets look at where the numbers come from and why there is a 1% rule.
Lets assume you buy a $100,000 house and put 20% or $20,000 down at 4% your monthly payment of just principal and interest is going to be roughly $382/month.
Now the 50% rule states that 50% of your monthly income will go to Taxes, insurance, maintenance, vacancy and cap ex. Now I personally don't like the 50% rule, because it doesn't account for what you rent it for, you could rent your house for $1 a month, and I don't think $0.50 would cover your costs, but the fact is that this is a long proven rule, because generally all these things are stated in percentages. roughly shown below
Vacancy 10%
repair 10%
PM 14%
Tax Insurance 16%
Lets use the 1% rule to determine our 50%
1% of $100,000 home is $1,000 and 50% of that is $500 we now add that to the 382 we are paying in principal and interest
500+382= $882/month so if we rent the house out at the 1% rule, we will be netting $118/month
which is $1416/year. Now what kind of a return is that? $1416 our return divided by $20,000 our initial investment equals about 7% return, which we all would agree you would get in a vanguard fund. and this is why the 1% rule exists, not because you cant rent out a house for less than 1%, but because it is not any better of an investment (but a lot more of a headache) to own a rent house instead of just throwing that money into a vanguard fund.
Now I know what you are thinking, what about appreciation? what about principal payments?
Appreciation-Appreciation should follow inflation 3% per year on average, anything above that is called speculation, not that money cant be made land spec-ing it is not investing it is gambling and therefore I do not count that in my projections, its the icing on the cake.
Principal pay down- Some people will argue that hey you forgot to include principal pay down, I mean after all someone else is buying you a house. and that is a valid point. I would just say have you looked at a amortization schedule? your principal portion of your payment starts really small and grows really slowly until at the end of the 30 year note you are paying mostly principal, so i would say that if you are in it for the long haul, then sure 1% works and the principal pay-down is the above and beyond return on your choosing to invest in real estate instead of index funds. But since the principal pay off is so slow early on that extra return can be wiped out if you decide to sell it relatively quickly say less than 5 years and that's also assuming that there is not decrease in the value of the property.
Now I will say that there are a lot of people who would say that using the 1% or $1000 for 50% rule is generous and we should use closer to the 2% so as you can see the profits would disappear quickly, but that is my best explanation of the 1% rule, and why it exists, and why if its below 1% or significantly below 1% you should probably just sell and throw the money into a vanguard fund and save yourself a headache