Real Estate Deal Analysis & Advice

2% Rule? 50% Rule? Here’s the #1 Real Estate “Rule” I Use to Assess Property

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Ah, the everlasting debate about which is the best formula to use to avoid failure and succeed at being a real estate investor. My great-grandfather used the 1% rule: Rent the property for at least 1% of the purchase price, and you should be safe. In many places this rule seems to have gone by the wayside, and now it’s the famous 2% rule. Two percent of purchase price, and you’re almost guaranteed to not lose! And hey, if you can get to the 3% rule, you’ll be rich in no time!

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Or how about the 50% rule? If the property rents for $1,000 per month, then you should plan on spending at least $500 per month on expenses and vacancies, not including your principal and interest payment. This is obviously meant to be used over the long term. As many discussions on BiggerPockets have outlined, this is a very general guideline, and it should be used as just that, a general guideline.

My wife and I have used the 1% or 2% rule more than we have the 50% rule, and overall they have done what they are asked to do. We have had cases, however, where even with these “rules,” we have had very bad years on certain properties.

Related: The 2% Rule: Fact, Fiction, or Feasible?

How I Lost Money on My “1% Rule” Property

Take, for instance, a property we purchased in mid-2012 in Texas. This was a brand new construction, a never lived-in property. It was just over the 1% rule, but it was a brand new home, meaning it had a full warranty for one year, so if there were any problems (not caused by the tenant), we wouldn't have to pay for the repair. And many of the major systems were covered for up to 5 or even 10 years. I'm happy to report that in 2013, we didn't have a single call from our property manager for a repair. I'm unhappy to report that we made less than $500 the entire year on the property.

How can that be? We were over the 1% rule. We didn’t have a single repair. Here’s what happened.

The property was rented for $1,650 per month, and the tenants had been in the property since shortly after we purchased it. Suddenly, early in 2013 we were getting our monthly statements from our property manager, but we weren’t seeing the money deposited into our account. This had happened late in 2012 as well, but she had made a lump-sum payment to get us current right after the first of the year.

Then we received word that the tenant was breaking their lease. The happy couple decided they weren't so happy and had split up. Per the lease agreement, the tenants were responsible for all rent until we could get the property re-rented so we had a small level of comfort. Then things got worse. The next week we received an email from our property manager after numerous inquiries that she had shut down her business the week before, as she was now bankrupt.

Coincidentally, we hadn’t received the first email announcing the news. So now we had a vacant unit, no property management company and a bankrupt property manager who owed us over $5,000. We had two properties with her and were now missing both security deposits on two month’s rent on one. By the time we got a new property management company lined up, got the house rent-ready and got a tenant in, it had been over 2 months. That, my friends, is how we made less than $500 on one property while adhering to the 1% rule and having no maintenance issues.

The 1% rule did hold up to its end of the bargain, as we didn’t lose money and we hadn’t used it as a golden rule, just as a guideline, as it should be used. We were disappointed with all that happened, but we were happy we didn’t lose money. We’re still happy that we have the property, and it’s now back to making us over $400/month and we still have an asset we can sell if we need to. We still look at the 1% guideline when evaluating properties, but we have a different rule that weighs much more heavily on our decision. This is our “Comfort Rule.”

Related: Why the 2% Rule Can Get Beginning Investors Into Trouble

What is Our “Comfort Rule?”

When we are evaluating a property, we try to get hard numbers on as many things as possible. While you may not be able to get an exact amount for taxes and insurance, you can get pretty darn close if you do your research. My wife has been in the mortgage industry for years so we can get very accurate numbers without having to hassle a loan officer if we'll be financing the property.

Other expenses such as utilities, if we’ll be paying any, vacancy, and maintenance — the ones you can’t get hard numbers for — we calculate using our best judgment based on our past experience and input from others, and we try to be conservative in our estimations. As I said, we will quickly run the 1%/2% rule to see if it works. If all of these things check out, then we move on to our most critical decision, are we comfortable with the property and the numbers? This is the ultimate decision. Are you comfortable with the purchase you are about to make? Are you comfortable that you can float all of the expenses on the house during a disaster like we had? If you’re not, regardless of what the numbers tell you, then it’s not a good deal for you.

There are plenty of rules and guidelines out there to use to try to ensure your success in real estate investing, but none is going to be a sure thing. Even our “Comfortable Rule” isn’t a sure thing, but it definitely makes us a whole lot more at ease when purchasing a property than any of these other rules.

What rules do you use when evaluating properties for purchase?

Leave a comment below, and let’s discuss!

Eric is a real estate investor with a full-time job who owns This Couple Buys Houses with his wife. They have been buy and hold investors since 2004 and have begun flipping properties as well, with holdings in multiple states. Eric and his wife live in California with their four dogs. Eric loves sharing is experiences and helping other real estate investors. You can reach Eric on the Bigger Pockets site or via his website. This Couple Buys Houses
    Amy A. from Portland, Maine
    Replied about 6 years ago
    Your article made me curious, so I just checked to see if the 50% rule was true for me last year. My multiunits where I pay all utilities except electricity were 55%, 32%, 52%, 48%. My single family home, which had 2 months of vacancy, was 40%. I think that averaged over a few years, the 50% rule is generally true if the landlord pays utilities. I always use it for a quick calculation when the seller doesn’t have (or is not willing to provide) good records, which is pretty often!
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied about 6 years ago
    Hi Amy and thank you for providing your experience. I agree that the 50% rule should be used to look at a long term buy and hold, that it may be way off if used in the short term.
    Curtis Waters Rental Property Investor from Charlotte, NC
    Replied about 6 years ago
    I purchase based on return. I use a 2 benchmarks. First one says that the property should provide $200/month. If rent is $1600 the most you can pay is $140,000. So this benchmark would modify the 1% rule to add some cash flow. Benchmark 2 calculates CAP rate. Monthly rent less utilities, taxes, insurance, and $100/mo maintenance (per $100K value). Multiply net times 10 (gives you 2 months for oops) for the annual net operating income (NOI). For a CAP rate of 10%, you would multiply the NOI by 10. The maximum price you would pay for the property would be the lesser of these benchmarks. See the article I wrote (http://bit.ly/hobbycap) for more details and an online calculator.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied about 6 years ago
    Thanks for you input Curtis. Those are both great ways to evaluate a property, and we are with you, we generally do not consider a property if it will not cash flow $200-$300 per month. Cheers!
    Corey Reyment Wholesaler from Green Bay, WI
    Replied over 4 years ago
    Do you look at that per door or per address for cash flow?
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied over 4 years ago
    We are currently only invested in single family properties so I guess both. If we purchase a multi-family in the future we would look at the per-door cash flow and in that case our criteria may change.
    Michael Benson from Dittmer, Missouri
    Replied about 6 years ago
    Great article, thanks for taking the time to share your experience! I’ve found that where I live in the Northeast, that if the landlord pays for utilities, the cost for heat can take the 50% rule and make it more like the 60-65% rule. Generally for properties where the tenants pay their own utilities it is closer to 50%.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied about 6 years ago
    Thanks for your feedback Michael. You show a great point that the numbers can easily get skewed, hence why we use this rule but by no means is it our primary factor. Cheers!
    Fred
    Replied about 6 years ago
    I use cash flow rather than the 1 or 2% rule. In a purchase of 199000 property I have to get a $500-$700 cash flow or I wont purchase the property. On our last two purchase we paid 199500 and they are returning $554 and $612 cash flow per month. neither property meets the 1 or 2% rule. Am I wrong in looking at it this way?
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied about 6 years ago
    Hi Fred and thanks for sharing your experience. I think you may be calculating the 1%/2% rule incorrectly. Your cash flow shouldn’t equal 1% or 2% but the amount you rent the property for each month. So if you paid $199,500 for a property then it should rent for $1,950 per month to meet the 1% rule and $3,900 to meet the 2% rule. And I’m with you that cash flow is more important than meeting any rules. Based on the numbers you provided I would be happy with those properties as well…assuming those numbers include vacancy and maintenance. Cheers!
    Cydni Anderson Real Estate Agent from Long Beach, California
    Replied about 6 years ago
    Seems to me that if you’re making that much cash flow, you’re doing something right! Cheers!
    John Thedford Real Estate Broker from Naples, FL
    Replied about 6 years ago
    The 1% “rule” and 2% “rule” are general guidelines. I often look at these but they are never the deciding factor. Until you plug in all the numbers there is no way to determine the quality of a deal. One factor with no steadfast “rule” is how much you “make” when buying below market. I personally put quite a bit of weight on this factor alone. A large discount (after you consider ARV) also brings a fix and flip factor into consideration. Real estate has so many variables….the only constant being you can make a lot of money…..or lose a lot of money:)
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied about 6 years ago
    I agree 100% John which is why I wrote the article. These are by no means “rules” and a decision to purchase a property should not be made based just on these guidelines. As I stated, the most important question in my opinion is, after running all of the numbers are you comfortable with the purchase? Cheers!
    Mike Krieg Investor / Syndicator from Austin, TX
    Replied about 6 years ago
    It’s the CAP rate for me to start with. Anything below 8% makes me uneasy. I need to see a good spread between the cost of capital and the return. Beyond that I look at projected first year ROI. I need to make somewhere north of 15% on my initial investment that first year and thereafter.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    Hi Mike, thanks for your feedback. Your comment proves my point exactly. The “comfort” rule will be different for everyone and yours makes good sense. Cheers!
    Dawn Anastasi Rental Property Investor from Milwaukee, WI
    Replied almost 6 years ago
    If I’m purchasing in cash I want the property to at least get 2.25% of the purchase price in rent. My goal used to be closer to 3% but in the last year or so prices have been going up in general so it’s hard to get 3% deals anymore. I also would like to see a minimum of $400/month net cash flow.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    Thanks Dawn. I’m honored to have someone of your stature comment on one of my posts! We’ve looked into the Milwaukee market and have seen over 2% properties but haven’t found the right one yet. We were in contract on one that was close to 3% but some things came up that didn’t fit our “comfort” rule so we backed out. There will always be another deal but it’s hard to get out of a bad deal. Thanks for reading!
    James Syed Real Estate Broker from Mount Olive, IL
    Replied almost 6 years ago
    Great article. I loved it. Read every single sentence of it. I agree we could use 2%, 50% rules as guidelines, but at the end of the day it’s real / actual figures that matter. I must admit I have got so much better after joining BP and thanks to Brandon Turner for teaching us FREE the rules and other formula / techniques to evaluate properties better. In addition, thanks to Josh for putting such a wonderful site together. Like Brandon says “people who read, succeed”.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    Thanks for the feedback James. I couldn’t agree with you more. While these are commonly referred to as “rules” I don’t think the term fits. And I also agree that I think we all have gotten better thanks to BP, myself included!
    Albert Yamoah Rental Property Investor from Garland, TX
    Replied almost 6 years ago
    Great article! Might I ask though, why would you have a property manager for the new home?
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    Hi Albert. Thanks for reading and great question. We live in California and the new home is in Texas. We self-manage our one property here in California but everything else we leave to those who are local to the area. It comes down to highest and best use of time. Cheers!
    Scott Worland Real Estate Investor from Chattanooga, Tennessee
    Replied almost 6 years ago
    These “rules” are interchangeable. Thanks to @Luke Holcomb for hashing this out with me on the chalkboard. The “2% rule” is simply a 12% cap rate using the 50% rule to calculate expenses. Both are metrics to determine a reasonable purchase price using the monthly rent. Let’s say a property rents for $2000 a month. Let’s represent the unknown purchase price as “P”. In both cases we simply solve for “P”. 2% Rule: 0.02*P = $2,000 P = $2,000/0.02 = $100,000 12% Cap rate using 50% rule for expenses: (0.5 * $2,000 * 12)/P = 0.12 P = (0.5 * $2,000 * 12)/0.12 = $100,000 Using the commutative property of multiplication, we can regain “the 2% rule” from the last line of the above equation: P = ($2,000) * 50 or $2,000/ (1/50) or $2,000/0.02 Let’s say you use 40% for expenses (so you keep 60% as net operating income, not an error below) and you want at least a 10% cap rate, then your quick percentage “rule” is simply: (0.6 * $2,000 * 12)/P = 0.10 P = $144,000 and $2,000/$144,000 = “1.38% rule”
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    Thanks for your feedback Scott. I must say however that these “rules” are meant for a quick, easy evaluation of a property. I majored in Math in college and have to say that evaluating all of your numbers and formulas was anything but. I’m not saying it’s not accurate or doesn’t work but holy cow! But this is also another point of my post, whatever works best for you and makes you feel most comfortable! Cheers!
    Scott Worland Real Estate Investor from Chattanooga, Tennessee
    Replied almost 6 years ago
    @ Eric, I completely agree. I have seen post where folks say things like, “I don’t trust things like a 2% rule, I only care about cap rates.” All I was trying to show was that when you look a little closer at the underlying structure of “these rules”; you discover that they are really saying the same thing in different ways. I didn’t intend for someone to run through the above numbers each time they asses a deal. Thanks for your corrective though, I should have been more clear.
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    You make a good point Scott. Thanks again for your input.
    Andrew Cordle from Alpharetta, Georgia
    Replied almost 6 years ago
    Thanks for this post! I always reading about other investor’s buy fix hold strategies!
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied almost 6 years ago
    You’re welcome Andrew and thanks for reading!
    Casey Stuebs Contractor from Spokane, Washington
    Replied over 5 years ago
    Thanks for writing this article, you are definitely right Eric! Thanks for allowing us to learn from your experience!
    Eric Black Rental Property Investor from Santa Maria, CA
    Replied over 4 years ago
    You’re welcome Casey. We are all students forever so I try to share my experience and limited knowledge when I can. Cheers!
    Matthew Norem
    Replied over 3 years ago
    It is pretty easy to determine the property taxes and insurance costs, Then I use a formula of 10% of rents toward ongoing repairs, plus 15% for long term reserves needs. From those numbers I estimate an NOI, and project any equity gains yr 1. based on the loan I will pursue. From that I look for the following ratios: Sale $ / List $ <95% 1% Rule+ Cap Rate 10%+ Cash on Cash 8%+ Equity Gain 6%+ Debt coverage 1.25x+ If i meet most of these criteria, I will consider a purchase.
    Ricardo Olivos
    Replied over 1 year ago
    Very interesting Matthew, thanks for your advice!