The 2% Rule: Fact, Fiction, or Feasible?
I get why newbie real estate investors might be enticed by the two percent rule. In short, the rule states that if you can rent the property for two percent of the purchase price, it will cash flow. Is that true?
Want more articles like this?
Create an account today to get BiggerPocket's best blog articles delivered to your inboxSign up for free
Occasionally. But smart investors should never rely on one rule to dictate their strategies. Some people buy on emotion and justify with logic—and use the two percent rule as said justification. And some people see the two percent rule as a dictate, and panic when they can’t find properties that fit the mold.
Frankly, some truths need to be revealed about this infamous rule—and I’m here to share them. I can only dream of the day that I get on the BiggerPockets Forums and don’t see a single person ask any of the following questions:
- How come I can’t find any properties in my market that meet the two percent rule?
- What if I found a property I like, but it doesn’t meet the two percent rule?
- Where can I find properties that meet the two percent rule?
Sound familiar? Been asking yourself these questions? Kick the two percent rule to the background of your decision-making process. Here’s why.
Note: In no way am I suggesting that it’s your fault for thinking the two percent rule is important. You’re not dumb. If I were just starting out, I’d put some stock in the two percent rule, too. It’s not your fault. It’s misleading marketing.
Successful investing requires accurate, easy-to-understand information about your properties and the markets you invest in. BPInsights gives you the information you need to find your next great deal and maximize your current investments—from expert analysis to proprietary data sets. Start leveling up your investments today.
What Is the Two Percent Rule?
The two percent rule says that the rental amount a property brings in should be at least two percent of the total purchase price.
For example, let’s say you’re looking at a property that costs $100,000. In order to meet the two percent rule, you would need to collect $2,000 per month in rental income. What if you find a property for $80,000, but it only rents for $1,000? Investors dead-set on the two percent rule would eliminate that property—$1,000 is only 1.25 percent of $80,000.
What about the one percent rule?
Something to note on that $80,000 example: While the property doesn’t meet the two percent rule, it does meet the rule’s little sister—the one percent rule. It works just like the two percent rule, but it only requires that the rental amount be one percent of the purchase price.
Some investors argue that as long as you hit the one percent rule, you are still making a good rental property investment. None of these are hard, fast, or concrete rules, so you can do or use whatever you want with them. But first, let me caution you about how much you use them at all.
Two Percent Rule Reality Checks
Yes, the two percent rule used to be really handy. I don’t want anyone to think that this rule never served a purpose—it certainly did. But here’s the truth now.
In no way is the two percent rule truly a “rule.” It is strictly a “guideline.” (Maybe someone called it a rule because “two percent guideline” sounds pretty dorky.) A rule is something you should strictly follow. But investors don’t have to follow the two percent rule by any stretch—and quite honestly, following it could get you in trouble.
The two percent rule simply helped you sift through properties faster. If you’re scrolling through 100 properties in a shopping spree, you could quickly eliminate the bottom-rung options. Even in the two percent heyday, you still needed to run more stats.
Estimations vs. actual numbers
Oh man, does this one get my blood boiling. Hear me when I say—and this goes for every single investor out there—never, ever, ever use estimated numbers when you can use actual numbers! If you’re buying a rental property, the only numbers that you need to estimate are vacancy and repairs. Otherwise, you can find just about every number you need.
That’s why the two percent rule is, for the most part, bunk. It’s only an estimation. It doesn’t tell you for sure what the numbers will be—or even that they will be good.
Let’s say you find a condo unit that meets the two percent rule upon first glance. As you gather actual numbers, you realize the area has high property taxes, the condo fee is astronomical, and, for some reason, insurance isn’t cheap. Once you use those high numbers to calculate hard equations, you’ll realize the property offers minimal, zero, or negative cash flow.
But it met the two percent rule! That’s why I say don’t estimate.
Good properties don’t abide by rules of thumb
Many perfectly fine properties don’t meet the one or two percent rules. Every investment requires trade-offs between returns, cash flow, and risk. You could find a property that meets the two percent rule but is such a high-risk investment due to location, property quality, tenant quality, or a declining market that the projected cash flow will never pan out.
Maybe there’s a quality property in an excellent location—but it would only make, say, a 0.8 percent rule (if one existed). Despite the lesser projected cash flow, it might be a better investment!
There are a million other factors to consider. Does it cash flow? How’s the location? What’s the condition? Is the market growing or declining? Is the tenant pool high quality? Those are the questions that matter—not any “rule.”
Just because something was once a solid rule doesn’t mean it is so now. That’s currently the case with the two percent rule. A few years ago, the two percent rule was viable. Nowadays, that’s not the case. I don’t know of a single (good) market where you could expect to find properties meeting the two percent rule.
I know, I’ve crushed all of your souls. Maybe it will come back one day. Even if it does, though, don’t expect it to apply in cities like Los Angeles or New York City.
Should Investors Rely on the Two Percent Rule?
With all that said, should you ever pay heed to the two percent rule? Not really. The two percent rule doesn’t account for, coincidentally, two things:
- The condition of the property or location
- Your net cash flow
Let’s say you find a $35,000 deal in Florida with a monthly rent of $700. Meets the two percent rule, right? Right.
Two problems. First, I can say with fairly high certainty that any property you find in Florida for $35,000 will be a total junker. Secondly, insurance and property taxes are so high in Florida that combined with the rest of your rental expenses—including repairs on your junker property—you’ll land right at zero (or less!) for cash flow.
So much for that “good” investment.
There’s a lot more to a property than “rules” and guidelines. The closest I, personally, ever got to meeting the two percent rule was a nice rehabbed property in Atlanta I bought for $55,000. It rents for $975 per month. But this was back in the Atlanta heyday—you won’t find a similar deal there now (and if you do find it, be leery).
As the Atlanta market progressed, investors were forced to forget about the two percent rule and start thinking about the one percent rule. By the end of last year, you were lucky to hit the one percent rule! But did barely meeting the one percent rule mean the properties were bad investments? No way! You have to consider quality, location, and tenants—none of which have anything to do with these rules.
How to Determine Feasibility
With today’s hot market, investors are realizing they can’t buy as many cheap properties with great returns as they could even just a year ago. Great news for the real estate market, all of our current investments, and the economy as a whole—but it is forcing investors to settle for lower returns.
At this point in the real estate market, sub-$50,000 properties are, in my humble opinion, sketch. I personally won’t buy anything in this price range. For one, the property will need work. Worse, you’re looking at the lowest class of tenants, which can add significant vacancy, eviction, and repair expenses. An eviction followed by an empty house followed by a nasty turnover repair cost blows your two percent delight out the window, does it not?
In terms of feasibility, here is my process.
- If it doesn’t meet the one percent rule, by how much does it not meet it, and what’s the market? Kansas City properties that don’t meet it might be bad buys. But if you’re in Dallas and it doesn’t meet it—well, that should be assumed.
- If it meets the one percent rule, it should be considered. Run all the numbers and know the expected cash flow.
- If it meets the two percent rule, be leery, but check it out. Again market-dependent. If you’re in Kansas City, yay! Two percent rule! Check it out seriously. If you’re in Dallas… someone has officially found you a junker in a questionable neighborhood that not only needs work but will attract a raunchy tenant.
Use the two percent rule only as a guideline to get you looking at a property. Once you are diving into the numbers seriously, ignore the one or two percent rules entirely. In no way should they justify buying a property.
Do you follow the two percent rule?
Tell us below.