Residential Real Estate Investor · Kansas City, MO · Member since 2014 · 10k+ posts · 5k+ votes
I am not a fan of the 2% rule, although I will say I think rent/cost is my favorite calculation. We usually determine what type of rent/cost we can accept in any given area and go from there. According to Gary Keller, the national average is 0.7%. Pushing for 2% at all times, I fear, will push investors to war zones with bad contractors doing subpar rehabs.
Cash flow is also variable, for example, a property you're all into for $20,000 that rents for $400 will not cash flow as well as a property you're all into for $40,000 that rents for $800 even though the ratio is the same. The fixed costs of maintenance, turnover and what not outweigh the more variable costs of taxes and debt service. Insurance can even have an inverse relation to price.
We've gotten 2% before quite a few times, but in our lowest end areas. In the nicer areas, we get more like 1.5%, but do just fine. In our nicest, it's around 1.3%, which is tight, but the appreciation potential is better. So in other words, I don't think the 2% rule is very good, what are your thoughts?
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
12y
Before we start discussing whether a rule is good or not, I think we should all be on the same page as to the definition of that rule...
For me (and I think for many others here), the 2% Rule simply states that, "If your gross monthly rent is at least 2% of the purchase price of the property, the investment is likely a good one."
To say that the 2% Rule is a bad rule would be to say that you could be earning 2% of the purchase price in gross monthly rent and the deal is still likely not good. And I'm pretty sure that's not what you're suggesting.
In my opinion, the 2% Rule doesn't say that an investment that doesn't meet this threshold is not a good investment; only that an investment that does meet the threshold *is* a good investment.
the 2% rule does not consider what utilities that the tenants pay versus the owner, it doesn't consider high tax areas versus low tax areas, it doesn't consider high HOA fees versus no HOA fees etc.
It is just one thing to look at, not the only thing to look at.
BTW previously I bought I bought a property in the "very good neighborhood" where the yearly rent was 82% of the purchase price, so it complied with the 82% rule!
You are miscalculating the rule. The 2% rule is based off the ratio of monthly income to purchase price. You really were falling under the ~6.83% rule.
BTW previously I bought I bought a property in the "very good neighborhood" where the yearly rent was 82% of the purchase price, so it complied with the 82% rule!
You are miscalculating the rule. The 2% rule is based off the ratio of monthly income to purchase price. You really were falling under the ~6.83% rule.
Purchase Price: $100,000
Annual Income: $82,000 (82%)
Monthly Income: ~$6,833.33
Monthly Income/ Purchase Price = ~6.83%
I did not see the post where you corrected your self, my apologies!
Real Estate Investor · New York City, NY · Member since 2014 · 21 posts · 28 votes
12y
I actually have never heard of the 2% rule...I don't think its possible in NYC. On a 400k property I'd have to charge 8k a month rent. Rates are closer to .6% - .9% in my neck of the woods of worse.
Thanks @Andrew Syrios. I've been working on those as well I'm just not exactly sure what a good cap rate would be exactly. I'm pretty green at all of this but I'm learning fast. I've been finding that many of these owners don't have much in the way of numbers and records. Either that or they don't want to disclose them.
I aim for above 10 using conservative numbers (not the seller pro forma). But I guess it's fitting to be on a thread about rules of thumb because shooting for a 10 or better is really just that. It really depends on the area, comparable sales, quality of the building, potential financing, etc.
Carlsbad, CA · Member since 2010 · 1k+ posts · 1k+ votes
12y
I think it should be called 2% Rule of Thumb. It generally applies in markets like Midwest. To me all it does is quickly discard some properties that don't meet that 2% threshold in some areas. Some areas that threshold might be 1% and in others, it might be 0.5% and some markets it might be 3%. It depends on what markets you are talking about.
RE is extremely local. I invest in one county and I can't even use the 2% Rule of Thumb across the whole county. Some cities in the county that I invest in, I will be lucky to get even 1%. Some properties will not even meet 0.5%.
Real Estate Broker · Mount Olive, IL · Member since 2013 · 1k+ posts · 310 votes
12y
2% rule is just a rule of thumb. There's no silver bullet when it comes to real estate investing. You can't just say OK since it meets the 2% gross, it's a good investment or it doesn't meet the 2% rule so it's a bad investment.
You must all figures to conclude as to if this investment make sense or not.
And I assert that it would very hard to find a property that meets 2% rule in cities like New York, Los Angles, Chicago, Houston, Miami, etc (excluding war zones). Most likely you will find 2% rule properties in rural areas.
I think it should be called 2% Rule of Thumb. It generally applies in markets like Midwest. To me all it does is quickly discard some properties that don't meet that 2% threshold in some areas. Some areas that threshold might be 1% and in others, it might be 0.5% and some markets it might be 3%. It depends on what markets you are talking about.
RE is extremely local. I invest in one county and I can't even use the 2% Rule of Thumb across the whole county. Some cities in the county that I invest in, I will be lucky to get even 1%. Some properties will not even meet 0.5%.
It is NOT one size fit all rule.
I definitely agree that it should be seen as a rule of thumb, however, my main point is that because it's so vague and does't apply to a ton of markets and submarkets, it doesn't even qualidy as a good rule of thumb. Its just, well, a bad rule.
Rental Property Investor · Manteno, IL · Member since 2009 · 2k+ posts · 2k+ votes
12y
But the problem I see is that a new investor is going to have a really hard time getting started if they somehow think they're supposed to be getting deals at the 2% rule.
Just to give you an example, I'm in about 10 different towns here in my part of Illinois. And a typical bread and butter deal for me is a house with an ARV of 135k that rents out for 1,300 a month. Those are solid rentals.
In order to hit that 2% rule, I'd have to be all in to the house for 65k (i.e. purchase plus rehab). Thats an LTV of better than 50%. And I'm sure there are some investors that say they are finding deals at 50% LTV. But the reality is that if you're getting all in at 70% LTV or better, you're doing a pretty good job.
So I just don't see how the 2% rule has a lick of value at all. I would bet that over 80% of the deals people are doing don't come in at the 2% rule. So doesn't that make the 2% rule a completely useless barometer?
I've got 29 houses. Not a single one came in at 2%! Not a one!
And the absolute best deal I did doesn't even come close. Just did this 2 months ago and I am tickled pink. But it doesn't come close to the 2% rule and that 2% moronic rule might actually have scared someone new to investing away from this deal. Thats why I think its just completely useless and actually a detriment.
984 Anndon Lane, Braidwood. 5bdrm, 3ba, 2,400 sq ft home built in 97 or 98. Bought for 103k. Put in 17k in rehab. All in at 120k. House appraised out at 195k and 200k (had an appraisal done for the purchase and another one at refi). I used hard money so my actual out of pocket was roughly 5k total.
House rents for 1,650. My PITI is roughly 1150. Gross profit is 500 with an equity capture of roughly 80k.
Thats a home run deal for someone like me. But its not even close to 2%. I'd easily say it was probably the best deal I've ever done and I'm not even close.
So why even bother with some rule that has so little value to most investors?
Because, honestly, that rule has NO VALUE given it applies to so few deals in the overall deal pool. And I say that knowing that I'm sure that there are some areas in the country that may actually be able to swear by that rule. But, again, I would bet that over 80% of the deals that people do on here do not fall within that 2% rule. So whats the point of having it?
I still believe that gross profit is the one metric that makes the most sense to evaluate whether a deal is a deal or not. It takes into account everything - rents, taxes, home prices. And if you know your gross rent, you can very easily know whether you're going to make money.
I'm sure you'll know you're going to make money at 2%. But considering it almost never happens and definitely almost never happens on anything beyond the lower end markets, I just don't believe it has enough value to be considered a rule of thumb worth pointing to as a rule of thumb.
How's that for what I really think. :-)
I would love to see the people getting these deals post their actual numbers. Purchase price, rehab costs and rent amounts so that they can prove me wrong. But I just don't see how this rule has any merit outside of the lower end homes/areas.
I would bet that over 80% of the deals people are doing don't come in at the 2% rule. So doesn't that make the 2% rule a completely useless barometer?
Sounds like you have a different definition of the 2% Rule than I do.
Your statement above doesn't make my definition (posted earlier) useless...
The last two rentals I've purchased were in good neighborhoods and met the 2% Rule -- I essentially didn't do any further due diligence on these deals and was 100% comfortable with the purchases.
Milwaukee, WI · Member since 2014 · 8 posts · 2 votes
12y
I have never used the 2 percent rule or have I heard of the two percent rule. I agree it sounds good for units or houses costing under 60k , even if you had a higher value rentale say 200,000 single family and rent is 4k miss one mo. rent and this is not a viable deal or how can you build for those numbers ?
Investor · Los Angeles County, CA · Member since 2012 · 962 posts · 279 votes
12y
It's difficult to even hit 1% in ghetto areas where I'm at. Either it's too conservative a rule, or I'm in a bubble that's about to burst. Probably in a bubble...the stock market is at it's high (the last time it was this close was right before the stock/housing market crashed)
Investor · Aurora, Ontario · Member since 2014 · 48 posts · 2 votes
12y
Hi everyone,
IMO the 2% would make it so that no investor on Canadian soil could be profitable. That or we'd be looking at low-income/mobile homes as our only means to an end.
Investor · Marion, IA · Member since 2010 · 177 posts · 117 votes
12y
I see a lot of 1900's houses in the ghetto that are cash flow cows and would easily hit the 2% rule. But good luck keeping those places full of tenants who pay on time and don't cause any problems.
Investor · NY · Member since 2014 · 74 posts · 49 votes
12y
From what I've been seeing, the 2% rule mostly applies to properties that are not going to appreciate for one reason or another. Either war zones, bad school disctricts, urban blight, etc. Obviously I'm not saying this applies 100% of the time and I'm sure some deals can be found in nicer areas that meet this rule but I think it has become very difficult as the market has rebounded.
I'd rather look at properties that get at least 1% monthly rent of the purchase price with the chance for appreciation.
Financial Advisor · Duluth, MN · Member since 2012 · 156 posts · 194 votes
12y
For what it's worth, I use the 2% rule as a filter to investigate deals that cross my path. Just like the gross rent multiplier (GRM), however, it gets abused. I've had sellers try to cite both ratios as a selling point and when I dig into the numbers, I find the expense ratio is too high.
Thus, the 2% rule and GRM are simply tools to help you filter properties and determine which ones are worth conducting more due diligence. I'm more than happy to look 1.25s or 1.5s if the property fits my model.
For example, I'd rather have a 1.5% with low expenses than a 2% property with high expenses.
Bottom line, it's about net operating income, ease of management, and location. If you can find a nice property in a nice neighborhood you will attract nice tenants.
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
12y
I find it interesting that so many people think the 2% Rule is bad simply because these deals aren't common or because these deals aren't available in their areas. Rattlesnakes aren't common in my area and I don't come across them very often, but I still think going the other direction when I see one is a good rule of thumb... :-)
I consider any property that meets 2% in a decent area to be a good investment (probably some exceptions, but likely not too many). I would never say that a property that hits 1% is a bad investment (under certain circumstances, I'd be happy buying these), but certainly when I start to see properties in the 1% range and below, I consider that there may be other investments that are better. When we get much below 1% and if you exclude appreciation and leverage, there are almost always better investments (in my opinion).
Now, there seems to be a lot of discussion of appreciation here as well. Lots of people throwing around the term and implying that they believe where they buy will see appreciation over and above inflation rates. While that's likely true in some areas over some period of time, it's not likely to be true in most areas over a longer period of time. But, people don't want to accept that reality of history.
For some reason, there is this myth that buying any random piece of property and holding it for 30 years will make a great investment. Statistically, that's not the case. If you want to bank on appreciation as part of the equation, I would recommend having data to support that. Better yet, I would recommend having inside information on local politics that will drive population and/or employment growth in the area, as that's typically the biggest driver of real estate appreciation in non-top-tier markets.
Residential Real Estate Agent · Hattiesburg, MS · Member since 2011 · 475 posts · 141 votes
12y
I've found you really can't go wrong with the 2% rule.
It limits you to smaller and cheaper properties, which in the long run increases cash flow due to reduced maintenance, taxes, insurance, & capital expenditures.
Everything from painting to hvac replacement is cheaper on my little $35,000 1,000sq/ft cottages. They gross $750-850 per month..
To get to $1000 per month rents would require buying larger homes(1,500 sq/ft) and investing $75,000+ per property minimum.
I also like being able to offer a SFR home for about the same rent as apartment units. There's a lot of people who want a sfr home but can't afford $1000 rents
Last part is I can save up and pay cash for lower priced home.. I'm pretty averse to long term debt on rentals... I've seen far too many investors leverage to buy rentals and then mysteriously go bankrupt.
Investor · Tulsa, OK · Member since 2008 · 154 posts · 54 votes
12y
I think the financing is starting to affect the 2% rule for long term landlords as well.
Once I started getting mortgages in the 4% range - it started to make sense to deviate from the rule. I got a house with $1100 in rent and a $340 monthly payment even though it is only at %1.57.
However the 2% rule was a great yardstick to measure how good the deal might be when I was a newbie.
Investor · Thermopolis, WY · Member since 2012 · 4k+ posts · 4k+ votes
12y
The 2% rule is very good for measuring possibilities versus everyday opportunities. If you want pure cash flow it needs to be compared to the 2% rule, if you want more safety and possible appreciation you are unlikely to find it. if you do you had best grab it now. Anything that helps you evaluate what to look at closer is a helpful rule for me.
Investor · Hampton Roads, VA · Member since 2014 · 1k+ posts · 418 votes
12y
2% rule in my area would probably equal a 90% vacancy rate. I'll go with less cash flow and more stability. Life's too short to be slumming it up for a couple extra hundred bucks a month when I could be smoking a cigar and relaxing.
I see a lot of 1900's houses in the ghetto that are cash flow cows and would easily hit the 2% rule. But good luck keeping those places full of tenants who pay on time and don't cause any problems.
This hits the nail on the head for me. In some areas its different, but many investors I know (including myself) started in areas that were worse than we should have because we were going for those great returns. Turns out those returns were only on paper. You and I may know those areas are too rough, but a newbie might not. In that way the 2% rule can actually be a dangerous goal.