Disclaimer... New Investor, purchased my first duplex this past Sept. Now to my question:
I understand the 50% rule and the 1% / 2% rule, what amount to you apply the rule? For example if you purchase a property for $125K an you put down 25%. What amount to you use when crunching the numbers? The full purchase price + rehab? Only the Loan amount? or The loan amount + rehab?
You use all of those. I completely the 1%-2% rules other than a gross "is it worth actually doing some math" screening criteria.
I do use the 50% rule (less if self managing) to estimate vacancy, capital and expenses from the rent. That gets you to the estimate NOI for the property.
Now financing comes into play. Use your down payment and loan terms to compute how much cash you need to invest and your payment. Now you can calculate cash flow (NOI - debt service.) Now use the annual cash flow divided by the cash invested to calculate your cash on cash return. Like that number? But it. Too low, keep looking.
Rehab is usually going to be out of pocket, so it adds to the cash required to get into the deal.
The question on which amount you use depends on what you're financing. You always want to use your total amount financed for all your basic calculations. The real question becomes what is driving your investing decisions. If your end game is cash flow, then the amount of cash - assuming you paid for the rehabs out of pocket - may be a non-starter for you.
The easiest thing to do is use the BP Rental Calculator, which will let you put in all the relevant information and give you just about every metric you'll ever need. That way you can determine which one(s) is important for your strategy. Here's the link...
You would apply the rules to the all in cost of your investment. Keep in mind, the 2% rule is sort of a daily weather report and not a report of the overall climate/health of your investment. The 2% rule is not found in any textbook or taught in any of the 4800 US universities. I use the rule like a barometer reading and knowing full well a storm brewing could change those readings quickly.
Free eBook from BiggerPockets!
Join BiggerPockets and get The Ultimate Beginner's Guide to Real Estate Investing for FREE - read by more than 100,000 people - AND get exclusive real estate investing tips, tricks and techniques delivered straight to your inbox twice weekly!
- Actionable advice for getting started,
- Discover the 10 Most Lucrative Real Estate Niches,
- Learn how to get started with or without money,
- Explore Real-Life Strategies for Building Wealth,
- And a LOT more.
Sign up below to download the eBook for FREE today!
We hate spam just as much as you
Join the Largest Real Estate Investing Community
Basic membership is free, forever.