2% Rule

10 Replies

I am fairly new to Biggerpockets but I have been reading books, listening to webinars, podcasts, and following the forums. I just cant really grasp the idea of the 2% rule and why its even called a rule. I understand that it can be used as a guideline and not a set in stone rule. 

I am a commodity broker so I am used to looking at and breaking down numbers. everyday.

I also live in fairfield county where the avg. home price is $1 million. 

That being said here is an example from a BP book below.

The 2% rule states that your monthly rent should be approximately 2% of the purchase price. In other words, a $100,000 home should rent for $2,000 per month; a $50,000 home should rent for $1,000 per month. This is a very conservative estimate that is very simplistic, but can help in deciding if a property warrants a deeper look. In most parts of the country, the 2% is very difficult to achieve, but the closer you can get to that, the better cash flow you'll receive.

okay. it claims that the 2% rule in most parts of the country is difficult to achieve. If that's the case then why is it even called a rule?

heres my example:

$100,000 home = $2,000/month, this you can profit from

$1,000,000 home = $20,000/month, these numbers make no sense

the math just doesnt make sense. there has to be another part of the rule. different parameters and tolerance levels based on region. 

In what areas does this rule hold true? If it doesnt work country wide then why is it called a rule. You simply cant follow this rule in and around major cities. Once you start getting above a home purchase price of 150k-200k the rule starts to lose any value and guideline.

There has to be something else. 

Thanks

Derek

Derek

I am no expert, but I believe if you do a search of the forums, this topic is addressed (and argued) at length.


2% seems to work for most folks who are working in Class C or lower properties.  

I have one duplex and am about 1.1% and it's working for me.


Again, there are guys much more experienced than me on here, hopefully you will get an answer that you can run with.

Good luck

GB

Originally posted by @Greg Baur:

Derek

I am no expert, but I believe if you do a search of the forums, this topic is addressed (and argued) at length.


2% seems to work for most folks who are working in Class C or lower properties.  

I have one duplex and am about 1.1% and it's working for me.


Again, there are guys much more experienced than me on here, hopefully you will get an answer that you can run with.

Good luck

GB

 Oh and my duplex is in a Class B, border Class A location if that helps.

If you do a search there is a great debate about this topic, that I believe started a little tongue-in-cheek but eventually grew to a mud slinging contest.

That rule, in my opinion, is a very early qualifying factor. It's purely to find income property and if that rule works in an area that can still be considered good, with good tenants and minimal problems, then use it.

However, in a market like Phoenix AZ, you won't get anything close to that anymore unless you want to rent to gang members. Here in AZ, I use the 1% rule as my initial qualifier.

There has been plenty of discussion about this recently on the site.  First of all, no one buys a property, or business, or stock on its revenues alone.  Cash flow is what is important.

I have never bought a property that met that so called rule.  The highest I have purchased was 1.67 and I try to buy at 1.33 and that isn't always possible.  If you buy a property with monthly rent of 1.33% of the price and you have a 50% expense ratio your net operating income is 8% of the price.

If I find a property that is close to the above I will dig deeper to determine projected expenses.  It is one shortcut to help me come to a decision.

Use it for what it is worth.

Good Luck.

Bill

I think the consensus on the forums that the "2% rule" should be renamed the "2% test".

@Jon Holdman  is a numbers guy, and he has shown that this is a simplification of the 50% rule where the monthly rent is roughly $500 per unit. 

It's designed to allow 100% financing while still having a certain amount of cash flow. Interest rates and other factors will influence this, of course.

@Derek Grijns   Welcome to BP!  Always great to see another CT native on here.

@Derek Grijns

I just cant really grasp the idea of the 2% rule and why its even called a rule.

Well as Dawn mentioned above we are trying to get people to use the term 2% Test

2% rule is now the 2% test

However it is a "Rule". It is a Rule of thumb. Like any rule of thumb you should recognize when it applies and when it doesn't

$1,000,000 home = $20,000/month, these numbers make no sense

the math just doesn't make sense. there has to be another part of the rule. different parameters and tolerance levels based on region.

Actually this is a great example of how the 2% rule does work. $1 million homes rarely make sense as rentals.

This is a very conservative estimate that is very simplistic, but can help in deciding if a property warrants a deeper look. In most parts of the country, the 2% is very difficult to achieve, but the closer you can get to that, the better cash flow you'll receive.

You seemed to have missed this part. You are hung up on the "Rule" term. Read this part again "the closer you can get to that, the better cash flow you'll receive".  Well OK maybe 1.5% or even 1% will work  better in your area.  Derek the more you can be creative and think outside of the box, the more successful you will be. If you didn't figure this out on your own it is a sign you are not thinking outside of the box. 

Ned, 

Thats the issue. Im thinking outside the box and rarely listen to "rules". Thats why I questioned the "rules" that keep getting mentioned on BP. that was my only issue. Even the test doesnt work for me. i've never been in the box. im always outside. I have a different formula. 

Thanks for all the input I appreciate all the comments. 

Derek

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