I'm new to real estate investing and came across the 2% rule for investment properties. I'm looking to invest in NYC (5 boroughs) and can't see how this rule of thumb applies. Purchase prices seem so much higher as to make this target seem impossible.
Any advice would be much appreciated!
It doesn't. A market like New York is a completely different beast than a place like Oklahoma City. In the latter, there is far more room for growth in terms of physical space which helps keep property values down. There is also far less bureaucracy and red tape around building new housing units. Because of that, a market like New York will have much higher entry costs. As a benefit, however, you're far more likely to see substantial appreciation on your property's value over the course of it's life and you're far more insulated from real estate market crashes.
The 2% rule, in my opinion, is most important to follow on properties that are priced well under the $100,000 amount because the cost to maintain and make repairs, vacancy, cap ex, etc., are of higher percentage compared to your purchase price hence the reason why you need to be at that number. Generally speaking the 1% rule makes more sense in the top 25 markets in the US. 2% rule for more rural areas.
Great -- thanks very much. This is very helpful. Even a 1% rule though seems like a lot for NYC. Would it be imprudent to invest in anything less than this? Thanks!
The 2% rule of thumb is derived from other assumptions. The 50% rule, in particular. It ONLY WORKS when rents are about $500. As rents go up, this ratio can be lower and still produce a profitable rental.
The 50% rule of thumb, on the other hand, appears to work for a broad range of markets. So, use that, use the market rent in your target area, and calculate what you can afford to pay. If there's nothing at those prices, pick a different area.
@Beau Blinder is hinting there's a good reason, sometimes, to buy a cash flow negative property - appreciation. Now, its VERY hard to predict appreciation. Just because appreciation has been high or low in the past doesn't mean it will be in the future. And its good to know where you stand as far as cash flow. Many times a newbie investor gets suckered into buying a property with the "cash flow = rent - PITI" myth, only to be in trouble when reality rears its ugly head. If you go in with your eyes open and buy a cash flow negative property assuming appreciation, fine. Its like a savings plan.
Most properties make unprofitable rentals. Especially in expensive markets.
Thanks, Jon. Very helpful indeed. Another quick follow-up question: if I am thinking of hiring a property management company, is there a rule of thumb for how much I need to increase the 50% rule? e.g. up it to 55%? Thanks again.
My family owns a three family in Brooklyn. We have owned it for 35 years. We just refinanced it(there was no mortgage on it). I just did the quick math and we are barely beating the 2% rule and we only took out about 35% LTV. So, I can't see this rule applying here unless someone got extremely lucky. Having said that, I have seen some people get great deals recently. NYC has a lot of cash buyers so competition is fierce.
I live in NYC too & agree the 2% rule can't be done here right now. Most of the advice I've seen on forums & podcast recommend that investors who live in NYC or California (or anywhere where the rent to price is out of touch) rent their homes there & buy investment real estate in other markets where you can get 1-2%.
It's not going to apply in most markets anymore, but certainly not NYC. If you are looking in NYC, just getting anything with positive cash flow would be impressive! If you find 0.5%, jump on it. NYC is not notorious for providing cash flow. If you go to other markets, you can easily hit 1-1.5%.
In one of the podcast, the guest invests only in market that provide returns less than 1. This is simple rule he is following to buy properties in good and in demand areas. I think 2% rule is misleading considering it does not take property tax into account. With 1/3 rent going directly into PE, NJ is one of the worse market for cash flow.
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