50% and 2% rules one seems easy the other hard :(

6 Replies

I was forced into being a landlord a few months back when a work relocation gave us a option. Try to sell our home while being 30K underwater or rent it out at a small loss.

I just write that off as I'm buying a house for a few hundred a month and hope for property appreciation in the future and to escape though.

The 50% rule seems fairly easy here in Louisiana, but he 2% rule seems impossible. That's assuming I'm thinking of it right.

50% take the rent divide by 2 subtract 200/mo for profit what you are left with is your desired note amount. So, for instance:

1250/2 = 625 subtract 200 for profit = 425 for a note? I can find properties like this fairly easy.

The 2% rule is impossible though. There are no 100K properties that will rent for near 2000//mo. Here 3000sq/ft houses barely rent for 2000/mo.

Do you guys find properties that meet both or is meeting enough?

Welcome to BP @John Ja7  !

I've never seen the 50% rule used the way you just described it.  The 50% rule is commonly used amongst BP users as a good ball park estimate for expenses on residential properties.  While it is called a rule, it is a rule of thumb, and as such is a quick estimation tool.  It's not incorrect to use it the way you are, just unusual.  What you describe is trying to achieve $200/door a month as your target net income.

The 2% rule is another quick estimation tool, and as a rule of thumb, it just tells you, you probably want to dig deeper into the details.  It usually works on lower price points rather than 100k plus properties like you used in your example.  I bet you can find 25-30k properties that will rent for 500-600/month.  It's a whole different conversation on whether or not that's what you want to invest in, but those properties are all over Louisiana and other markets.

Don't let these rules of thumb become hang ups for what is a good or bad investment.  A 100k property that makes 1.5% a month can be a very profitable investment.  It will probably make you more on a monthly basis than a 2% a month 25k property.  The devil is in the details of how you finance it, manage it, amongst other factors.

@John Ja7  the 2% rule in Southeast Louisiana is not gonna happen. Some areas in the country allow for the 2% rule to be easily obtained, but it is usually present in lower end properties. ( $50k homes renting for $1,000 ). Did you relocate to or from Slidell? I am originally from Slidell but now live in Covington. I know the area well. 

@John Ja7  I use the 50% rule exactly as you describe.  The rent is the factor you have the least control over.  So figuring that out and working from there is essential.  Backing into the payment, and from there into the price you can afford to pay is what I do.

Getting $200 in true cash flow is a pretty high hurdle, though.

Keep in mind a big chunk of that 50%, about a third, is property management.  If you're local and willing to do the work yourself, you can earn that chunk, too.

The 2% rule, OTOH, is a bad rule.  It only applies to properties with rents around $500.  At higher rents, the ratio can be lower.  If you can find properties that generate $200 in cash flow assuming 50%, go for it.

Also, though, with a big enough down payment you can almost always generate cash flow.  So, divide your expected annual cash flow by the total investment to determine your cash on cash return.  Is that high enough to meet your goals?

@John Ja7  

As stated above, the 2% "rule" is more achievable with cheaper properties in lower class neighborhoods with higher tenant default and turnover. For other areas and markets, people use the 1% "rule".

Where I invest, I have not achieved the 1% rule yet. I average out at 0.8-0.9% but that's good for the area and I'm happy with the cash flow. I always use the 1% rule as my benchmark and try and get better deals every time.

Well, if @Jon Holdman  uses the 50% rule exactly as you described it, then I stand corrected.  I should probably start using it that way.  I hadn't seen it broken down the way you did.  I didn't say it was wrong, just looked unusual to me.  :-)

@Robert Leonard  market rents are a good starting point for analyzing an area.  These don't vary very much.  If a 3/2 in some area rents for $1250 a month, that's a pretty good starting assumption for what you could get.  If your property is crummy relative to competition, you'll get less, maybe quite a bit less.  If you're is extra nice, you might get a tenant quicker, but its not likely you'll get much more rent.  

So, given the rent, knock off 50%, subtract out desired cash flow and you get your maximum payment.  Now use the "present value" function in Excel or a financal calculator to turn that into a loan amount.   Multiple by 1.25 to account for your down payment (assuming 20% down, use a factor of 1.333 for 25% down) and you have your max price.

That's a starting point.  That should produce an acceptable return, which is annual profit / down payment.  The profit (cash flow, really) is from your first calculation.  If that's not good enough, you have to push the price down lower.

Its more complex if there is rehab involved.

Then, look at prices in an area.  How do they compare to the number you computed from rent?  If they're below your max price you've found a good area.  If not, keep looking.

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