The 2% rule kills values

[Jay Hinrichs]

As one who had never heard of the 2% rule or 1% or any of the other terminology that floats around BP,, I just became aware of the 2% rule. I was talking with a fellow from Oregon who was lamenting that there are no 2% rule properties to be had in Oregon when I asked what is this 2% rule he said if a property cost 100k it needs 2k in rent.. Well that's not going to happen anytime soon around here. But I told him it happens in the Hood's of America fairly regularly. Mainly because you need those kinds of margins to make 1% or less when the missed rent increased maintenance etc etc of owning them comes into play.

So then I got to thinking well heck if everyone is running around wanting the 2% rule and if that is the only way folks will buy the lower end rentals then the values will never go up. As values could only rise if rents rose.. And we know rents may rise a little bit and HUD stays fairly stable year in year out.. And so many of these properties rely on hud to get some kind of consistent cash flow. So if one is buying in these areas and uses the 2% rule then justifies their investment because historically real estate rises this just won't happen if all your buyers use this rule... The values will just remain the same the neighborhoods do not turn around for the better they get worse as more renters move in etc etc. Your forever stuck with a value that is 2% no matter the condition of the house history or lack thereof of rental rolls.

[Ryan Hebert]

Originally posted by @Matt R.:

Originally posted by @Robert Ortiz:

@Ryan Hebert

Can you imagine 2% in Boston? we'd either have tonstart renting 2 beds for $7000 or roofie all the sellers before presenting offers!

 Plenty of investors get well over 2% in Boston. They started at less than 1% typically. And why it is not an actual rule for investing. 

 Would this not assume that rental rate must exceed property appreciation? In Boston, it tends to be the other way around, unless you are calculating JUST off of the initial purchase price.

[Matt R.]

Originally posted by @Ryan Hebert:

Originally posted by @Matt R.:

Originally posted by @Robert Ortiz:

@Ryan Hebert

Can you imagine 2% in Boston? we'd either have tonstart renting 2 beds for $7000 or roofie all the sellers before presenting offers!

 Plenty of investors get well over 2% in Boston. They started at less than 1% typically. And why it is not an actual rule for investing. 

 Would this not assume that rental rate must exceed property appreciation? In Boston, it tends to be the other way around, unless you are calculating JUST off of the initial purchase price.

 Good point. I am only speaking in actual investment $$$ terms. Many areas will never achieve current equity value to rents at 1% or 2%.  Some investors consider that a good thing not bad. There is usually multiple years lag time on that current rental price front. The more important part for some is the direction of profits...up vs down. 

[Matt R.]

To perhaps somewhat clarify the % point. There was an investor who thought since his equity greatly increased and rents did not increase as fast meant he should sell. He was not considering his return on equity and confused his cash on cash vs ROE. He sold those those to get better cash flow and understandable. Turns out just a couple years later he was selling those "better initial cash flow moves" for 10s of thousands less than what he paid a couple dozens months ago. You might want to figure out the direction of any cash flow vs equity beforehand is the lesson. 

[Ian Walsh]

When prices exceed the rent rates where investors can make money, in non owner occupied areas, then there tends to be a bubble.

[Brent Coombs]

Originally posted by @Matt R.:

Originally posted by @Robert Ortiz:

@Ryan Hebert

Can you imagine 2% in Boston? we'd either have tonstart renting 2 beds for $7000 or roofie all the sellers before presenting offers!

 Plenty of investors get well over 2% in Boston. They started at less than 1% typically. And why it is not an actual rule for investing. 

Sure. But the very point of this thread is: "2%" (of market-value) at the time of purchase! 

You are making the converse point. Everyone here knows that "0.75% Rule" properties will likely become 1%, 1.5%, 2% etc. over time, providing you've got deep enough pockets to keep paying the negative cash flow UNTIL it turns positive.

[And, providing they had deep enough pockets to get their negative-cash-flow, DTI-wrecking loan to begin with!]

[Jay Hinrichs]

@Ian Walsh I was at the Oakland summit and the key note was Bruce Norris and one of the main topics was are we in a bubble.. Mr. Norris premise was there is no bubble unless 40% of your MLS inventory is short sales foreclsoures or bank owned.. and we are so far from that.. so even though cash flow metrics from many folks stand point out side of the west coast are flawed in CA... that does not in any way indicate a bubble.. does it indicate lack of cash flow day one yes.. but not a bubble... at least according to Mr. Norris.. @J Scott  J you were there did you catch the keynote and did you agree?  Bruce has been a pretty savvy west coast investor for many years..   However you also hear him saying what is he doing now.

and that is buying value add or undervalue dirt and building new construction ( like we all like to do) in the sun belt. And of course our bread and butter hard money lending.. can't ever get away from that... so Ian your right on doing that part of the business..

[Ryan Hebert]

Originally posted by @Brent Coombs:

Originally posted by @Matt R.:

Originally posted by @Robert Ortiz:

@Ryan Hebert

Can you imagine 2% in Boston? we'd either have tonstart renting 2 beds for $7000 or roofie all the sellers before presenting offers!

 Plenty of investors get well over 2% in Boston. They started at less than 1% typically. And why it is not an actual rule for investing. 

Sure. But the very point of this thread is: "2%" (of market-value) at the time of purchase! 

You are making the converse point. Everyone here knows that "0.75% Rule" properties will likely become 1%, 1.5%, 2% etc. over time, providing you've got deep enough pockets to keep paying the negative cash flow UNTIL it turns positive.

[And, providing they had deep enough pockets to get their negative-cash-flow, DTI-wrecking loan to begin with!]

 @Brent Coombs, at least in the Metro Boston market, I have analyzed deals where positive cash flow can still be attained by the 0.8% rule. And with a HCOL area like Metro Boston with little doubt about its future economic prospects, sure you could argue the 1% rule will be surpassed at some point. Hold it for long enough, sure 2% is inevitable. Ideally, this would also be after adjusting for inflation, so real rent increases.

But the idea that you could get 2% in a HCOL area without higher risk (older property, bad neighborhood, lower demand, worse schools) of bad tenants? Color me skeptical. Especially when you're dealing with such a tenant-friendly state as MA.

[Amit M.]

Originally posted by @Matt R.:

To perhaps somewhat clarify the % point. There was an investor who thought since his equity greatly increased and rents did not increase as fast meant he should sell. He was not considering his return on equity and confused his cash on cash vs ROE. He sold those those to get better cash flow and understandable. Turns out just a couple years later he was selling those "better initial cash flow moves" for 10s of thousands less than what he paid a couple dozens months ago. You might want to figure out the direction of any cash flow vs equity beforehand is the lesson. 

foot

meet

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3words

[Brent Coombs]

Originally posted by @Ryan Hebert:

Originally posted by @Brent Coombs:

Originally posted by @Matt R.:

Originally posted by @Robert Ortiz:

@Ryan Hebert

Can you imagine 2% in Boston? we'd either have tonstart renting 2 beds for $7000 or roofie all the sellers before presenting offers!

 Plenty of investors get well over 2% in Boston. They started at less than 1% typically. And why it is not an actual rule for investing. 

Sure. But the very point of this thread is: "2%" (of market-value) at the time of purchase! 

You are making the converse point. Everyone here knows that "0.75% Rule" properties will likely become 1%, 1.5%, 2% etc. over time, providing you've got deep enough pockets to keep paying the negative cash flow UNTIL it turns positive.

[And, providing they had deep enough pockets to get their negative-cash-flow, DTI-wrecking loan to begin with!]

 @Brent Coombs, at least in the Metro Boston market, I have analyzed deals where positive cash flow can still be attained by the 0.8% rule. And with a HCOL area like Metro Boston with little doubt about its future economic prospects, sure you could argue the 1% rule will be surpassed at some point. Hold it for long enough, sure 2% is inevitable. Ideally, this would also be after adjusting for inflation, so real rent increases.

But the idea that you could get 2% in a HCOL area without higher risk (older property, bad neighborhood, lower demand, worse schools) of bad tenants? Color me skeptical. Especially when you're dealing with such a tenant-friendly state as MA.

Of course you're right to be skeptical. THAT's the point of this thread!

Though, color me skeptical about those positive cash flow positive properties that only generate 0.8%/m. My guess is you'd only be achieving that IF its ongoing expenses ARE significantly lower than the "50% rule", and/or your loan terms are so good that hardly anyone can get them! Remember, Investment loans are typically for a much shorter span than 30 years, and at a higher interest rate than owner-occupiers can get. Very/too close to the edge, is my napkin calculation...