The 2% rule kills values

Buying & Selling Real Estate

The 2% rule kills values

Jay HinrichsBusiness Member

Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes

As one who had never heard of the 2% rule or 1% or any of the other terminology that floats around BP,, I just became aware of the 2% rule. I was talking with a fellow from Oregon who was lamenting that there are no 2% rule properties to be had in Oregon when I asked what is this 2% rule he said if a property cost 100k it needs 2k in rent.. Well that's not going to happen anytime soon around here. But I told him it happens in the Hood's of America fairly regularly. Mainly because you need those kinds of margins to make 1% or less when the missed rent increased maintenance etc etc of owning them comes into play.

So then I got to thinking well heck if everyone is running around wanting the 2% rule and if that is the only way folks will buy the lower end rentals then the values will never go up. As values could only rise if rents rose.. And we know rents may rise a little bit and HUD stays fairly stable year in year out.. And so many of these properties rely on hud to get some kind of consistent cash flow. So if one is buying in these areas and uses the 2% rule then justifies their investment because historically real estate rises this just won't happen if all your buyers use this rule... The values will just remain the same the neighborhoods do not turn around for the better they get worse as more renters move in etc etc. Your forever stuck with a value that is 2% no matter the condition of the house history or lack thereof of rental rolls.

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Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes

12y

This is a classic example of mass stupidity IMHO. Someone invented the 2% rule because that was the sweet spot AT THE TIME. It was never a "rule" it was simply a calculation that fitted good deals at that moment.

It is no more valid than saying you should never pay more than 2 grand for a brand new car. That was a sound rule in 1970 but it is laughable now.

Unless value to rent ratios remain static there is no such rule.

Just like the 2% rule.........

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Jay HinrichsBusiness Member
OP
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
@Larry Turowski
do you manage your own properties and do you live in the community you invest in?
are your loans through national lenders or local comminty banks... I have always found it hard to get loans ( can't get anymore because I have more than 10) from local banks if I do not live within 100 miles of the property...
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Robert Piller
Austin, TX · Member since 2013 · 103 posts · 19 votes
12y
Good discussion:
In most businesses (real estate, retail, wholesale mdse, etc.) there are those folks who work out a profit per deal and others that work out a percentage for profit margin.
One is not better than the other--unless you are talking to an accountant (they always seem to prefer % of profit).
People need to do what works for them -- if they've been around the block for a while.
If they are a newbie--try to aim for as close to the 2% rule until you have a few years worth of your own data and track record to steer you one way or the other or just to right the ship a bit.
Your numbers won't lie and then you can fit you own experiences into your own strategy--not anyone else's.
Until then, I suggest playing it more conservatively.
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Larry Turowski
Flipper/Rehabber · Rochester, NY · Member since 2014 · 1k+ posts · 1k+ votes
12y
@Jay Hinrichs Yes, I do manage my own properties, and yes they are local. I just closed on a blanket loan this morning with a credit union. This is a portfolio loan. I hold the properties under an LLC.
Oh, and my properties are nice, and in B areas.
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Mark Masiel
Lima, Lima · Member since 2014 · 59 posts · 11 votes
12y
@jscott posted:
"If I can't make 12% unleveraged return, I have better options for my money. So, I will typically only buy a rental if it will hit the 2% Rule."
In my opinion that above post says it all. If you are planning to buy and hold you need a certain ROI or you should invest in another market. Why would you bother with less ROI than "easier" vehicles such as Mutual Funds? Now if you are justifying your low ROI on future prices-then that's called speculation and that's fine if that's your business model. If your business model is to cash flow then you need to decide what ROI makes your investment sound and worth your time. I don't see why this is so complicated.
(Sorry I only have mobile use right now and can't use full features)
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Jason C.
Philadelphia, PA · Member since 2014 · 13 posts · 3 votes
12y
Seems like everywhere I look I see 2% deals... I aimed for 2% for my first two properties. And i got closer to 2.5%. I'm buying 2 more in the winter and to be honest I actually think ill aim for 3% this time. I see no point in buying expensive houses for very minimal increased rent. If I buy a house in Philly for 150k ill see maybe 1000-1100 in rent. If I buy 6 houses for 25k a pop ill see 750-800 a house. Why the heck would I ever buy the 150k property. It's a little different cause I buy on all cash but I don't see the point If I want to maximize returns.
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Account Closed
Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes
12y
Originally posted by @Jason C.:

Seems like everywhere I look I see 2% deals... I aimed for 2% for my first two properties. And i got closer to 2.5%. I'm buying 2 more in the winter and to be honest I actually think ill aim for 3% this time. I see no point in buying expensive houses for very minimal increased rent. If I buy a house in Philly for 150k ill see maybe 1000-1100 in rent. If I buy 6 houses for 25k a pop ill see 750-800 a house. Why the heck would I ever buy the 150k property. It's a little different cause I buy on all cash but I don't see the point If I want to maximize returns.
Because you will generally be more profitable on the higher property because of appreciation and rent growth. You have to look at the whole holding period.
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Jay HinrichsBusiness Member
OP
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
@Jason C.
do you live in your area and do you self manage? there is no question the older big cities of the northeast offer those deals every day of the week.. and twice on Sunday.. there is a reason for this of course as we all know.
I am fully on board with those that live in the community and want to gut it out in the lower end that it can and will be successful if you treat it as a business and stay right on top of the properties.
becomes personal preference and how busy in other walks of life you are and your risk tollarnces.. IE would you let you wife drive over to those houses in the evening to collect rent?
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Jason C.
Philadelphia, PA · Member since 2014 · 13 posts · 3 votes
12y
Holding period means nothing to me but what do I know,I only own three properties (house and two rentals all cash) 1000 in rent for 150k or 4500 in rent in 6 25k props is a big wow for me. I understand they will mean more Mainteance but look at that return. I'm listening to the counter arguments but who wouldn't want that increased 3500 for a little "more" headache.
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Jay HinrichsBusiness Member
OP
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
@Jason C.
so back to the point of my post 2% or 3% or whatever kills values.. it drives the values down not up... It drives cash flow up.. But when you go to sell aren't other intuned and informed buyers going to want the same deal you got... 2 to 3% and your rents I would guess will stay static for years to come so you really don't have any equity growth.. in those areas. But I have never been to Philly save a train ride through there from DC to NYC.. all I saw was boarded up ( actually concreted in) tenements... It reminded me of Cairo... I was thinking man if someone just got to the states and their only impression of the states was this train ride they would not be very impressed between leaving DC and entering NY LOL I know there are great parts of every city not taking a poke at yours. Just my obseravations.
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Mike McKinzie
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
12y
As a long time investor, I am trying to figure out how to "easily get 12% returns, guaranteed" on any stock, bond, mutual fund or other investment vehicle? I know you can do it in notes, but they have their on inherent risk. You give me a solid 6-8%, cash on cash return, and I am happy with the rental I bought. I buy below market value, buy only Class A properties, most less than 10 years old and get solid tenants who stay several years. Repairs are minimal and management is CHEAP!
Would it be possible for me to take $100,000.00 down to Charles Schwab, Merril Lynch, or any of hundreds of brokerages and be GUARANTEED to get a check for $12,000.00 or more, annually, FOREVER? And without touching the principal! If so, I bet there would be LONG LINE out their door!!
I have paid $40,000 for a house that rents for $795.00 a month. It can be done, but it takes a lot of work and a little skill. I have also paid $75,000 for a house that rents for $795.00 a month. And I have paid $100,000 for a house that rents for $795.00. Shoot, I own a house today that I paid $400,000.00 for and it rents for $1,600.00 a month (a former personal residence). I guess I have NO RULES, except one, TO MAKE MONEY! If I don't make as high a return as you do, OH WELL! Kudo's to you. 3%, 6%, 9%, 25%, I have made all those returns on different investments. But the stock that made me 50% this year may make me -38% next year. But those monthly rents just keep coming every first of the month!
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Jason C.
Philadelphia, PA · Member since 2014 · 13 posts · 3 votes
12y
Originally posted by @Jay Hinrichs:

@Jason C.
do you live in your area and do you self manage? there is no question the older big cities of the northeast offer those deals every day of the week.. and twice on Sunday.. there is a reason for this of course as we all know.
I am fully on board with those that live in the community and want to gut it out in the lower end that it can and will be successful if you treat it as a business and stay right on top of the properties.
becomes personal preference and how busy in other walks of life you are and your risk tollarnces.. IE would you let you wife drive over to those houses in the evening to collect rent?
The one property I would let her walk at night to collect the rent , the other one I would but she would have to call me when she got there. Haha :)
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Jay HinrichsBusiness Member
OP
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
@Jason C.
check back on this thread after 2 to 3 years of those tenants and see what your expenses are it will take a big bite out of that cash flow that cash flow is assuming they all pay rent on time and your have little or no fix it issues... As we all know those tenant bases are pretty rough on things...But if your going to do it go for it.. build up as many as you can so you can hire people to do the dirty work for you,,,, that I am sure is many peoples goal.. If you live there work it like a business it can work but it is a hard bizz no doubt and takes time and effort just like any other business.. You could also invest 100k in a coffee shop and probably make 35 to 40k a year Net. But then you would have to deal with the employees>
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Jay HinrichsBusiness Member
OP
Real Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
12y
@Jason C.
good honest answer on your wife going to your properties.. glad your aware.
In my C stuff over the years I would go there mid week during the day but we always were packing No way at night no way on weekends. LOL and no way wife by herself.
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Dawn AnastasiPro Member
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
12y
I think the "to 2% or not to 2%" depends on every investor and their personality. Everyone CAN invest out of state or in another area if they want, but not everyone WANTS to for various reasons. And that's "100% rule" okay. :)
I personally like the cash flow and the rent checks coming in every month. But it's understandable and you have to realize that if you buy a property with a bunch of problems, you either have to fix them all right away (which contributes to your capital outlay and reduces your "% rule" amount) or you fix them over a number of years and just consider it part of ongoing maintenance.
Real estate is nice and flexible so different people can do things different ways. I know that there are people who do the "D" class property (like in the "hardcore" post above) and that's what they do and they are happy with it. Personally, that's not for me because I want to be able to be around the neighborhoods my properties are in and I don't want ghetto tenants.
And yet, there are people who ONLY do "A" class property and are happy with that. Personally, that's not for me either because I don't want to pay that much for a property. I like getting my properties cheap and being able to pay them off quickly and collect cash flow every month.
To each their own ...
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Jason C.
Philadelphia, PA · Member since 2014 · 13 posts · 3 votes
12y
I also don't have d class properties. Please don't look at the numbers and assume d class. When you assume.....you know
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Karen MargraveBusiness Member
Moderator
Realtor, General Contractor, and Developer · Redding, CA · Member since 2009 · 7k+ posts · 4k+ votes
12y
As with all rules, they're made to be broken! Having been on BP for quite some time, I think the biggest mistake newcomers make is finding something like the 2% rule and thinking it's the holy grail. EVERY region of the country, state, city, neighborhood, niche, etc. is unique and it's important to look at a much bigger picture than numbers on paper. What is the local economy (is it broad based or based on one sector) What is the median household income? Is the area growing or declining? Is the age of the population spread out or concentrated (college kids, seniors, etc.) What is the demand for housing?
Can you imagine what rents would be in southern California if the 2% rule were used? The point is, in some areas of the country, the rule works well, and in other areas, you need to look at different criteria. I hate to see people that are learning get mislead into thinking the 2% rule is some magical rule that investors hold fast to, it's not.
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Mike McKinzie
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
12y
Originally posted by @Jay Hinrichs:

@Jason C.
You could also invest 100k in a coffee shop and probably make 35 to 40k a year Net. But then you would have to deal with the employees>
The nice thing about the way I have set up my REI is that I could die tomorrow and NOTHING CHANGES. I could be in a coma, nothing changes. I can go on a 3 month cruise and NOTHING CHANGES. I do have one small job each month, two of my seven property managers still don't make Direct Deposits, so I do have to sign and deposit two checks a month.
Owning a Coffee Shop? I can't imagine the NIGHTMARE. I can get an 8-5 job, earning a six figure salary, why would I BUY a 5 AM to 1 AM, seven days a week job for $35 to $40K a year?
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Chris Martin
Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes
12y
@Mike McKinzie I don't think he implied you would run the coffee shop. That's what the local manager is for. Now if you were an Owner/Operator... then I agree with your post. Many franchise owners and NOT owner/operators, since that is literally impossible when you own 10 franchise operations in 3 states... you just can't be an O/O.
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Ed L.
Residential Real Estate Agent · Hattiesburg, MS · Member since 2011 · 475 posts · 141 votes
12y
@
@Jay Hinrichs undefined
Yikes we covered a bunch of ground.
The reason many investors went bankrupt was a combination of 1% properties, leverage, a recession, sinking property values, and capital expenditures that came up early in their ownership. Over time they would have been cash flow positive, but at that particular point in time they were cash flow negative, and underwater. That's my best guess on that issue.
When I'm purchasing properties at 2% they have to be significantly below market value even in MS. I go in and rehab for long term, and in the process I'm building instant equity. My last house was purchased for $27,500. After rehab I'm at $40,000, and it rents for $850. Realistically it would bring close to $85,000 after rehab in the retail market. In a way it's kind of a 1% deal when you think about it in those terms. For me though, I'd rather sit on it and cash-flow vs. taking the short term profit and giving uncle sam half in the process.
You really can't find (A) neighborhood properties that yield 1% in or around Hattiesburg. The rental market really can't bare much more than $1,500 rents and there isn't any new construction for $150,000 or less. There isn't a way to buy and add value to the (A) neighborhood properties because they are new and in move in condition. If a tenant has a good job, good credit, and can afford $1,500 rents they will likely be buying a home in the near future. We have a huge volume of inquires for up to $1,500 per month for 6 months.
Regarding price appreciation we are basically right back where we were pre recession with regard to home values. Looking back that was widely considered a unsustainable bubble, yet somehow this time is different? We lost right at 6 years, and wage growth is barely keeping up with inflation. I really don't see another bull run on home values from this point forward. I think best case they will continue to keep pace with inflation, and worst case the fundamentals that brought down the US economy last time will rear their ugly head again.. This time I fear the FED isn't going to be able to put a floor under it by dropping interest rates.
I hope for everyone I'm just being a pessimist.
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J ScottPro Member
Moderator
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
12y
Originally posted by @Jay Hinrichs:
In my C stuff over the years I would go there mid week during the day but we always were packing No way at night no way on weekends. LOL and no way wife by herself.
That's your C stuff? I can't imagine what you consider to be D stuff! :)
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Chris Pasternak
Real Estate Broker · Pueblo, CO · Member since 2013 · 366 posts · 303 votes
12y
It's all in the eye of the RE holder... I personally find comfort in striking a balance. I don't like one extreme or the other (A class, D class). I like to cashflow and I use 2%. The couple properties I have both are 2%, cashflow and came with a few initial repairs. Probably C class neighborhoods but not the "C class" spoken of before that requires a weapon to be carried while mowing the lawn... Nothing pressing about the repairs but it cleans the place up and my tenants are happy their landlord is doing something, as are the neighbors : ) Appreciation smells and spells like speculation to me. I'll take the money while I can get it and collect it without getting killed : )
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Sharad M.Pro Member
Carlsbad, CA · Member since 2010 · 1k+ posts · 1k+ votes
12y
Originally posted by @Larry Turowski:

Originally posted by @J Scott:

I'm one of those people. If a property generates 2% of purchase price in gross monthly rent, and if my expenses/vacancy/capex equal about 50% of gross rents, then I'm generating about 1% of purchase price in net monthly rent. That's 12% of purchase price in net annual rent, or about 12% return on an unleveraged purchased.
If I can't make 12% unleveraged return, I have better options for my money. So, I will typically only buy a rental if it will hit the 2% Rule.
@Sharad M. (the @ link thing isn't working here) posted
Can I pivot the conversation a bit? What ROI (yearly cash on cash return) are you looking for?
Sharad, according to your scenario, netting only $1,141 on $4,000 gross monthly, a 2% deal yields a 34% return ($13,393 / $40,000).
J Scott, you are expecting to net $2,000 on $4,000 gross monthly, so yearly that is at 60% return ($24,000 / $40,000).
Is that right? Sharad, are you happy with 34% and J Scott, do you look for 60%?
Larry, I purchase my rental properties free and clear, so I don't see anywhere close to 34% ROI on my money. My cash on cash return is around 12-18% and I am pretty happy with that.
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Sharad M.Pro Member
Carlsbad, CA · Member since 2010 · 1k+ posts · 1k+ votes
12y
Originally posted by @Jay Hinrichs:

@Jason C.
good honest answer on your wife going to your properties.. glad your aware.
In my C stuff over the years I would go there mid week during the day but we always were packing No way at night no way on weekends. LOL and no way wife by herself.
Jay, I think what you are calling C would be D-- for me. I think that's one thing that is so subjective is definition for each area class. Something that's A for me might be B for you and vice versa.
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Dawn AnastasiPro Member
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
12y
Originally posted by @Sharad M.:

Originally posted by @Jay Hinrichs:
@Jason C.
good honest answer on your wife going to your properties.. glad your aware.
In my C stuff over the years I would go there mid week during the day but we always were packing No way at night no way on weekends. LOL and no way wife by herself.
Jay, I think what you are calling C would be D-- for me. I think that's one thing that is so subjective is definition for each area class. Something that's A for me might be B for you and vice versa.
To me also what Jay calls "C" I would call "D". I call my stuff "C" but more like "C+" because the tenants are lower income but not ghetto. But I've been at one of my properties at 11 pm and another day at midnight on a Saturday, by myself, with no protection whatsoever (and I'm a pretty small female) and I didn't feel danger at all.
I guess everyone's definition is different.
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Will BarnardPro Member
Moderator
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
12y
Originally posted by @J Scott:

Originally posted by @Jay Hinrichs:

In my C stuff over the years I would go there mid week during the day but we always were packing No way at night no way on weekends. LOL and no way wife by herself.
That's your C stuff? I can't imagine what you consider to be D stuff! :)
I was going to say the same thing. I think people are confusing the difference between C class and D class. While I would never want to live in a C class building, I sure do love the cash flow it puts off and I can go there at night without packing and without fear. D would require the firearm and limited to no night visits.
This thread became long very fast so I did not read everything, but going back to the start, while it may be a great phrase name for the thread, I certainly do not believe it to be true. Values are affected not just by rental rate increases. Lowering expenses, markets driving cap rates down, economy, and many other factors can trigger price appreciation.
As to the rule, again this gets confused by many misguided individuals here on BP. As rental rates are higher, expense ratios get lower are the rule needs to be adjusted accordingly. For example, you can obtain the exact same cash on cash from buying at a 1.5% rule in one area as you would buying at the 2% rule in another.
I think the only thing the 2% rule kills is the dead horse around here. :)
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