2% rule and CAP rate vs. COC return

7 Replies

Hello,

I am new to REI and BP. I have been looking at property in San Diego (which is listed as the most expensive city in the US) and I am able to find properties that meet more than 15% cash on cash return, but do not meet the 2% rule, and have 5-7% CAP rate.

Is one rule more important than the rest? Or is it all really subjective? Any advise is greatly appreciated. I am at the beginning of my journey in REI.

Breanne

Welcome to BP. it's a great place to put and end to your restless nights :)

My $0.02 is that there is no single supreme rule, it's rather a harmony of rules that we all bend and adjust to make an overall "music to my ears". It largely depends on your objective with the purchase, which if you can disclose, we can give you more info on your strategy.

Hi @Bogdan Cirlig  ,

I am looking to Buy and hold. Of course I want positive cash flow, but I am not looking for an immediate return. Does that make sense? 

send me a PM or post here how you finance the deal and some numbers and we can all look and give you feedback. There's a forum "analyze my deal" best to do it there.

I don't have a particular property with numbers yet. I have been doing to math on what I've been seeing on the MLS and I haven't been able to find any that meet the 2% or CAP rules. Some of the posts I have seen give the impression that I will go bankrupt if I don't meet the 2% rule. From my perspective, if I am making more than 15% COC return, with positive cash flow (albeit not substantial), I am not doing so badly. But I wanted to see if there was something really flawed with my thinking.

Once I have real numbers I will definitely be asking advise, but for now i'm just looking for general opinions on the rules so I don't waist too much time looking at properties that won't work. Thanks, again!

@Breanne A.  

  West coast the 2% rule is meaningless and borders on Ludacris.. yes you can get that in some very small rural west coast towns but not in major metro areas.

The play on the west coast is and has always been.. NO return on investment during the hold period but your tenant paid off your property.. And now you can sell it for 750k since you own it free and clear and since its west coast rental issues are somewhat mitigated compared to other areas of the country

There are a number of ratios or metrics that tell you something about the property.  The first one mentioned was monthly rent to purchase price or cost.  This one tells you little because it only looks at rent and price.  If you assume a 50% expense ratio then a 1% monthly rent corresponds to a 6% cap rate.  obviously, 2% would correspond to a 12% cap rate.  You can see that estimating your expense is important.

If you are paying cash then the cap.rate and appreciation equals your return.  I don't try to estimate future appreciation because I would not be good at it.

Your cash on cash is a function of the property performance and your financing.  It is the same as cap rate if you are using all cash.  Cash on cash can be affected by length of loan, interest rate and whether it is interest only or not.  So you can see that the highest cash on cash is not necessarily investment.

I, personaly, look for 8 cap properties or higher when paying cash.  At a 50% expense ratio that corresponds to a 1.33 monthly rent to price number.  If I am close to that I will go further to estimate expenses.  If I am borrowing money I want 3 percentage points above my cost of money.  For instance, if I can get a 4% loan then I need, at least, a 7 cap property.

I hope that helps.

Good Luck.

Bill

Thank you all for the info.

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