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%2 rental rule does not work

37 posts by 18 users

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Rob K

Real Estate Investor from Michigan

Feb 18 '13, 05:18 AM


Originally posted by Alex R.:
I used to live in Toledo, Ohio and worked in Ann arbor, MI.

This seems to be a good deal if Madison Heights is not a war zone or drug dealing gangs territory.

I heard in Detroit there are plenty of houses that are vacant and abandoned. State will appreciate you much if you take over some, so those properties will not be their problems anymore.

Madison Heights is not a war zone or gangland. It's safe to walk down the street at night by yourself. Detroit is a nightmare. Lots of crime, no police response, etc.

Check out Warren, MI. You can buy a three bedroom house for $10-20K that will rent for $700-800. It's not a war zone. Lots of property crime, but little violent crime. Every third house is abandoned. The problem is the government. They are a gestapo and require ridiculous inspections and permits. It's not even worth buying there anymore. Great deals if you can put up with government abuse.



Tim W. Donor

Inspector from Tampa, FL

Feb 18 '13, 05:31 AM
1 vote


Originally posted by J Scott:
That's like walking into a Chinese restaurant, looking at the menu, and saying, "Hamburgers don't exist!" :-)

Doggone it, that's the best explanation of it I've ever heard. Red state, deep south living is getting to you. You're making good food analogies.



Mark Reynolds

Chicago, Illinois

Feb 18 '13, 05:34 AM
1 vote


The problem here is that the 2% rule is simplistic. It makes assumptions about what operating expenses will be that are, more often than not, inaccurate.

You need to learn Capitalization rates if you are going to get a little more sophisticated. 2% ROI per month would work out to be a 24% cap rate if there were no expenses-- but some operating expenses are inevitable. The problem is, of course that those operating expenses can run up to 50% of the gross income which brings your cap rate down to 12% which is good, but not great. If the properties are truly without operating expenses (again, unlikely) a 24% cap rate is fantastic.

Cap rate= Annual NOI/purchase price. 10% is good, higher is better. If you are not finding properties in this range you are either not looking hard enough (don't do bad deals just because you cannot find good ones) or you are in an over-heated market where fix-and-flips might work but buy and rent probably will not. That said, in the most over-heated market there are good rental deals out there but you may need to reconfigure the property in some way.

That said I just bought a 2/1 condo with a 42% cap rate. Even after I split with my investor partner he will get 21% ROI (no debt) and I will make $4,200 per year. All in all not too bad. Beautiful apt. in good neighborhood. REO not long on market.

Lots of those deals out there in my area.

Oh, by the way, one last thing. Whenever the newbie says "there is absolutely no way to get a deal that . . . . " it is not true. While I am encouraging you to get a little more sophisticated in your analysis I would bet that there are 2%/month ROI deals out there in your market. They are not going to be easy to find. And when you do find one you may need to move quickly. But just because you looked at 50 and didn't find one doesn't mean they are not there. The good news is as you do this more they somehow become easier to find, mostly because you learn how to reject the duds more quickly.



Tim W. Donor

Inspector from Tampa, FL

Feb 18 '13, 05:35 AM


Originally posted by Jon Klaus:
I've gotten most of mine through the HUD auctions, but a few REOs, too. At HUD I've bid 12 times for every one I've won. Anywhere from 67%-115% of asking. Average about 85%.

Exactly. You don't need a better win rate than 1 out of 12 when it comes to rentals. Your money is made by owning the best deal for a very long time. You don't have to flip them.



Tim W. Donor

Inspector from Tampa, FL

Feb 18 '13, 05:37 AM
1 vote


Originally posted by Mark Reynolds:
The problem here is that the 2% rule is simplistic.

It's supposed to be. It's meant to be a 30 second analysis that snaps your head to attention if you find a property that meets or beats the rule.



Michael Galloway

Real Estate Investor from Brentwood, California

Feb 18 '13, 05:49 AM


Forgot to add this disclaimer:

You will need to check with city for permits. You might not be permitted to add the additional unit.

If you chose to build without the permits where it is not permitted, they have the right to stop your progression with a red tag, and fines. In addition you will have to set up a time with them to check that it is converted back to a garage.



Suzie B.

Greentown, Indiana

Feb 18 '13, 07:25 AM


I think 2% deals are possible, just difficult to find.

Michael.. I agree that garages converted to apartments, even efficiency's are a great way to get to 2% however we have learned the hard way that sometimes you have to jump through hoops to get the proper permits. We bought a house with a large 2 story garage on an extra lot. We had to re-zone the parcel to pout the two units in it we wanted. It has its own electric and we paid to have water& sewage put in. A neighbor fought us all the way because she didn't like rentals because she had one of her own right next door to her house and had a bad experience. Took a couple of months to drag through it but we got what we wanted. Still a work in progress, but hope to turn it into a good $maker son



Scott W.

Illinois

Feb 18 '13, 07:25 AM


ah, the 2% again takes on a life of its own. KISS concept - Keep it simple stupid.

I can't emphasize enough. Ignore the 2% rule. Do the 50% rule. Your taxes/insurance may be higher in some areas & you gotta look at your market rent. You also got to consider the rehab budget into your purchase price. Add in 10% for vacancy, etc & 10% for maintenance/repairs/upgrades.

The 50% rule is the way to go to figure out your return on invesment, if you're doing a rental.



Michael Lauther

Residential Landlord from Hampton Bays, New York

Feb 18 '13, 08:14 AM


I can definitely attest to the fact that the 2% and 50% guides do work but you need to those markets that are suited to these parameters. They are not rules as has been stated but do reflect some basic realities. I invest in Dayton Ohio because these guides do not fit my local market and what I a seek is current income from cash investments. I can buy properties that rent for $600 a month for under $30,000 in non war zone neighborhoods in the city. Most properties that need rehab will be in the 2 to 3 bedroom 1000sq foot range with taxes and insurance under 1400 per year. Most cash prices are in the area of 15,000 with 6,000 in rehab. The problem is that there is no resale market at this time. Most sales are cash investors with little retail activity. Dayton is not unique in that there are markets similar to this across the rust belt and i am sure in many other parts of the country.



Jon Klaus Moderator Donor

Real Estate Investor from Garland, Texas

Feb 18 '13, 08:28 AM


Originally posted by Michael Lauther:
I can definitely attest to the fact that the 2% and 50% guides do work but you need to those markets that are suited to these parameters. They are not rules as has been stated but do reflect some basic realities. I invest in Dayton Ohio because these guides do not fit my local market and what I a seek is current income from cash investments. I can buy properties that rent for $600 a month for under $30,000 in non war zone neighborhoods in the city. Most properties that need rehab will be in the 2 to 3 bedroom 1000sq foot range with taxes and insurance under 1400 per year. Most cash prices are in the area of 15,000 with 6,000 in rehab. The problem is that there is no resale market at this time. Most sales are cash investors with little retail activity. Dayton is not unique in that there are markets similar to this across the rust belt and i am sure in many other parts of the country.

Seller financing could be an exit for these low value homes that can't get bank mortgages. Within the boundaries of regulations, of course.



Jon Klaus, SellPropertyFast
E-Mail: [email protected]
Telephone: 214-929-6545
Website: http://www.sellpropertyfast.com


Michael Lauther

Residential Landlord from Hampton Bays, New York

Feb 18 '13, 08:38 AM


@Jon Klaus, I have though about seller financing I am concerned that I may be trading a risk of eviction with the risk of foreclosure. your post however has me thinking.



Andrew O.

Real Estate Investor from San Clemente, California

Feb 18 '13, 08:43 AM
3 votes


People are WAY over complicating the 2% idea.

I see a property I can get for $50,000, I see it will rent for $1000, wow that's 2%, which I know is great...DONE. I know that equates to a gross of 24%.

I see a property for $50,000 that will rent for $750, that's 1.5%, I know I can achieve 2% in 'this' market, I might try and get the price down or look for something higher yielding.

That is all the 2% guideline is for...nothing else. Don't get all caught up on 'rules', these are simple metrics to do a preliminary run of the numbers in your head to see if its worth pursuing.

The 50% guideline would then come next to show that on a 2% monthly, you would net 12% annually, now as some people rightly point out, your costs may be lower. But err on the side of caution, if your costs are lower, great, have a party. If they are higher than you factored in, there may be some heartache on the way.

Andrew



Steve Babiak

Real Estate Investor from Audubon, Pennsylvania

Feb 18 '13, 09:29 AM
1 vote


Originally posted by @Mark Reynolds:
The problem here is that the 2% rule is simplistic. ...

You need to learn Capitalization rates if you are going to get a little more sophisticated. 2% ROI per month would work out to be a 24% cap rate if there were no expenses-- but some operating expenses are inevitable. ...

Mark Reynolds - although I agree with your statement that the "2% rule is simplistic", I have to disagree with your understanding of the 2% rule otherwise. You see, the 2% rule is GROSS rents, not NET rents, so it has nothing to do with ROI - it just says that gross rents should be 2% of acquisition costs (and it pays no attention to actual expenses either, as you pointed out),



Steve Babiak, Redeeming Properties, LLC
Telephone: 6109082183
...


Mike M

Accountant from Garden Grove, California

Feb 18 '13, 10:07 AM
1 vote


Jon Holdman and J Scott give some of the best advice on Bigger Pockets, along with a few others. Jon broke it down and you are getting around 12% cash on cash, nothing wrong with that number!

While there are dozens of financial terms used in Real Estate, terms like Capitalization Rate, Gross Multiplier, Return ON Investment, Return OF Investment, and on and on, the final number is HOW MUCH ACTUAL DOLLARS will you make that you can spend. For example, you can make 100% "Cash on Cash" on a Black Jack hand, but if your bet was $5, you only made $5.00. Or you can make only 1% but if you invested $1,000,000, you have $10,000.00 to spend. (most of the BP members can do better than 1% though)

The point being that as an investor, you need to have a TARGET RETURN that you are trying to make. For me, if I can make 500% of the 10 Year T Bill rate, which is currently 2.00%, I am happy. So anything that makes me 10% or more, with everything else being equal, I am happy. (being equal I mean a newer home, in a nice middle class neighborhood with a strong chance of long term appreciation).

What I have discovered about the 2% "rule" is that generally, it is an OLDER home, in a lower class neighborhood with a small chance of appreciation. I have a friend who bought several residential rentals in Riverside, California for $50,000 that rent for $1,200 a month. BUT, he has to carry a sidearm to collect rent, make repairs or post eviction notices. Sure, bigger returns with greater RISK, but that is too great of a RISK for me!

So just establish a rate of return you want, and go from there, don't pay attention to how much of the price you get in rent.



Tim W. Donor

Inspector from Tampa, FL

Feb 18 '13, 11:02 AM


Originally posted by Suzie B.:
I think 2% deals are possible, just difficult to find.

Suzie, I'm about 90 miles north of you. There's 2% property all around you.



Alex R.

Bakersfield, California

Feb 18 '13, 11:49 AM


When talking about 12% or 24% return cash ON CASH, I guess you are making the assumption that property is purchased and paid off full in cash.

What about a scenario where you put the 20% down payment and finance the rest with a low interest rate that is available in the market nowadays?

In that case ROI will be higher as your down payment was only a fraction of purchase price.



Chris Clothier Donor

Real Estate Investor from memphis, Tennessee

Feb 18 '13, 07:32 PM


Originally posted by J Scott:
Alex -

That's like walking into a Chinese restaurant, looking at the menu, and saying, "Hamburgers don't exist!" :-)

Just like in that example, the problem is, you're not looking in the right place. There are some places where you can generally find properties that will meet the 2% rule and there are other places where you won't find any properties that meet that rule.

And just like when you walk into that Chinese restaurant looking for a hamburger, your options are to find someplace else to eat or to just suck it up and find the best thing you can on the menu. In this case, you can either find a new investing location that does allow you to meet the 2% rule or you can choose to stick in your location and find the best deals available.

Crazy analogy, but I'm hungry right now, and I can't decide what to eat... :-)

You seriously have to stop this! I am checking to see if I can set up an alert for all J. Scott postings just to get a laugh, but I'm afraid I wouldn't get anything else done. That is hilarious - and yet - somehow spot on too!

Chris



Medium_new_mi_logoChris Clothier, Memphis Invest, GP
Telephone: 901-212-9647
Website: http://www.memphisinvest.com
www.MemphisInvest.com 1(877)-773-9998 Chris D Clothier


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