Does the 2% rule apply to ALL CASH DEALS??

Question

Should the 2% rule be applied when your purchasing a property with ALL Cash????

Account Closed · Answer

These rules or guidelines are a quick way to determine if you want to spend more time.  They are tools to help you make good investment decisions in other words.

You need to know though what you are looking for.  If you don't have an investment plan you will pass on deals that might have worked for you.

Jon Holdman · Answer

The 2% rule works best for $500 monthly rents.  Its does assume financing, and gets you about $100 a month, assuming 100% financing.

The 50% rule, OTOH, always works, seemingly regardless of price.  It doesn't consider financing.

Commercial deals often use "cap rate", which is NOI / purchase price.  If you're paying all cash, this metric applies.  Combining the 50% rule for all expenses and the "2% rule", you get a 12% cap rate. The "1% rule" gives you a 6% cap rate.

Rent: $500
Expenses: $250 (50% rule)
NOI: $250
Desired cash flow: $100
Max payment: $150
Max loan: $25,018.74
Ratio: 2.0%

Now, consider a realistic financing scenario
Price: $25,018.75
Down: $6,254.69 (25%)
Payment: $112.50
Actual cash flow: $137.50/month
Actual cash flow: $1650/year
Cash on cash return: 26.4%

Pay all cash:
Actual cash flow: $250/month
Actual cash flow: $3000/year
Cash on cash return: 12%

Now, with $1000 for rent, some steps omitted:
Rent: $1000
NOI: $500
Max Payment: $400
Max loan: $66716.65
Ratio: 1.5%

Loan:
Down: $16,679.16
Cash flow: $200/month
Cash flow: $2,400/year
Cash on cash return: 14.4%

All ash
Cash flow: $6,000/year
Cash on cash return: 9%

If you are buying all cash, and do apply the 2% rule, you keep you cash on cash return up at 12%, as for the other example.

Paul B. · Answer

In my opinion, whether you pay cash or finance should have little to do with what you're paying for the property -- or anything for that matter. I don't pay more for a car because I can borrow the money instead of paying cash.

And the 2% rule is not a "rule," per se, it's a guideline. There are some markets where you're just never going to get 2% per month in rents without taking your life in your hands. To say that you "overpaid" if you bought a duplex for $70K that rents for $1,000 a month is, again in my opinion, a generalization that should be avoided. Would it have been nicer to pay $50K? Yes, of course, but that doesn't mean it's realistic.

Each market is different. Each investor is different.

Jon Holdman · Answer

The simple answer is yes, you would have overpaid.

The rent is the factor you control the least.  When you're buying rentals, you have to figure out the rent you will get first, and work backwards from there.

That said, it also depends on your criteria.  If you pay all cash, $70K for that property, and it gets $1000 in rent, then you will net $6000 a year after all expenses.  That's 8.6% cash on cash return.  Is that good enough for you?

Note that the 50% rule doesn't mean your cash flow will be $6000 per year.  Some years will be good and your cash flow will be $12,000 less the taxes, insurance, property management and maybe a little maintenance.  Other years will be much worse when you have a major expense.

Ray Dixon · Answer

SO let me make sure im understanding this right.  If i pay 70,000 for a property that i want to rent out using the 2% rule the monthly rent should be $1,400.  So now my question is what if the the going rental rates in that area for rent is 1,000 a month  for that property.  Does that mean i would have over paid for that property?

Jeff S. · Answer

This rule has to do with price and income only. The monthly rent should be 2% of the purchase price. The $100,000 duplex should gross $2,000 per mo.

1% rule $100,000 duplex should gross $1,000 per mo- $500 per unit rent.

Does the 2% rule apply to ALL CASH DEALS??

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