Where did the 2% rule originate?

Question

Hi Folks, I thought there was a sticky somewhere spelling out the 2% rule and how it originated.  Maybe getting confused with the 50% rule.   But anyway want to find out how to back up the 2% price valuation.

Jon Holdman · Answer

This rule is a straightforward calculation.  Unfortunately it contains a bunch of assumptions that are often unstated.  If rents are about $500, you purchase with a 6%, 30 year loan, and are using a property manager (therefore putting your total capital, expense and vacancy in line with the more broadly applicable 50% rule), you will still make money if you pay about $25K.  If rents are higher, interest rates are lower and you're self managing (and contributing your labor for free) that simple rule of thumb doesn't really work.  The 50% rule (that is, 50% of gross rents will go to expenses, capital and vacancy), OTOH, seems to be much more broadly applicable.  Many disbelieve it.  But any time anyone's presented any significant amount of data (i.e., not just a rental or two for a few years) it seems to be borne out.

Will Barnard · Answer

Nobody decided or stated it was that or must be that. Simply put, in most circumstances, if your deal meets or exceeds it, you are pretty much guaranteed to have cash flow. If you are below it, you still may have cash flow or may not depending on the circumstances.

Andrew S. · Answer

applicability of the 2% rule even varies within a particular location.  In my neck of the woods, the places that would generate 2% are in neighborhoods you may not want to walk through at night.  For the better neighborhoods it's really more a 1% rule.....

George Paiva · Answer

Thanks, yes for certain not in New England or better yet in my home state of CT.  Here the 50% rule is more like 75% and the 2% rule is more like 1%.  The only reason I can make it here is by self managing and having a lot of family in the trades.

Dawn Anastasi · Answer

It's one of those "rules of thumb" for cash flow, not necessarily a hard and fast rule. And again, it doesn't apply to all areas of the country.  Keep that in mind.

George Paiva · Answer

Exactly like where did this come from?  I already know how to calculate it and very comfortable in valuating using capitalization rates but I usually get a weird look when I compare my cap rate valuation against a 2%.

Oh I focus on multifamily, not single for investing.

Account Closed · Answer

Thanks Mr. Holdman.

Account Closed · Answer

Who decided it should be a 2% rule.

Joe Gore

Dawn Anastasi · Answer

2% rule = 2% of the purchase+rehab costs is the rental amount

Example: Purchase $70,000 + $30,000 rehab = $2,000 monthly rent

This rule doesn't apply in some areas of the country.

George Paiva · Answer

Oh and yes already tried the search

Where did the 2% rule originate?

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