How far would you deviate from the 2% rule?

Question

I just happened to be reading some of the threads on here, and it got me to thinking.  I don't generally use the 2% rule, but I don't disagree with it either, as a rule of thumb.    I've done 2.5% percent, and best deal I ever did was for 1/2% (break even on rent, home run on appreciation).

I've been in this for 16 years or so.  I tend to use GRM more - a 50x deal is a screamingly good one to me, assuming it's a neighborhood I know (I only invest in areas I know well, and feel pretty strongly about that...).  The most I'm generally willing to pay is 144x GRM, and I have to see significant development or cheap money to make that work.  Thats like a .7% rule.

Do any experienced people go under a .7%, or over a 144 with any frequency?  If so, how would you defend it - I've found those places are pure development/appreciation plays, and cover their expenses at best.  And I was a lawyer before doing this full time, and am a fully qualified contractor, with people who work for me.  My expenses are wholesale, not retail.

Joe Villeneuve · Answer

I agree with @Judah Hoover and @Andrew Syrios .  Anyone that uses an arbitrary % when analyzing property is missing the whole point of why we invest in RE to begin with... and I would consider someone sloppy.

Andrew Syrios · Answer

The 2% rule is garbage, I would just discard it entirely. It really depends on the area. That being said, I personally would never go under 1% and would want to be closer to 1.5% usually. I only buy properties that cash flow, so I use as realistic of assumptions as I can and make sure that even with debt service, the property still cash flows for us.

Judah Hoover · Answer

I agree with @Andrew Syrios. I think using a percentage, what ever percentage, is way too simplified to work. You could use this type of "rule" to quickly screen properties and see if they are even in the right ball park, but other than that I don't see many successful investors using that model.

There are too many variables, and when fully computed what looks good might be awful. In this area we normally buy at about 1% and there are areas that you could buy at 2%+... but you would never actually get the rent, vacancies and turnover are so high.

Charles Frankenhoff · Answer

Got out, it was the death of a thousand paper cuts.  Don't even do my own closings.  And yeah, that was my take on site demographics, but I thought I'd take a flyer.  I've actually found development opportunities to be my best returns, though pure speculation makes me nervous.   Big hesitation on 5/25 commercial notes for that reason, even though more opportunities there these days thanks to the flood of people in retail

Charles Frankenhoff · Answer

I think I didn't articulate my point very well above.  The question isn't about the 2% rule, per se, or the plus and minuses of rules of thumb, which I think people have done a great job of explaining on here.

What I'm more curious about is how far experienced people push the edge of the envelope on the numbers.  The general "rule" that comes up amongst the sophisticated investors is 144 GRM, as being the outer limit (barring a crazy cheap conduit, or other not normal situations).  This would be for properties with ironclad appreciation built in, usually some sort of clear cut development opportunity. (all normal variables normalized)

I was wondering if anyone thought that was overly conservative, based on substantial experience.  I will say in my experience at that point you aren't making anything on rent, after appropriate reserves, it's appreciation or die.

Bill Gulley · Answer

Welcome to BP, Charles!

Are you still practicing at law or did you master it and get out? (LOL)

Great to have another attorney on BP.

Consider the audience targeted on BP, mostly new folks with some of us old guys hanging around. Rules of thumb are generally for newbies, but it is a "drive by" indicator. I suggest a sharp pencil and a calculator.

I'm doing a 100% financed deal right now, mentoring someone, a combination of private money and seller financing and it will most likely be a rental, not a flip.

The 2% rule hasn't entered my mind, much less a concern, it wouldn't meet that and this distressed sale is at about 80% of what a future flip price would be with limited fix and paint.

I will structure the financing to force cash flow, working things backwards rather than the conventional borrow, PITI, hope for the best from a tenant.

My rule, is any property that doesn't eat any hay is a good deal that isn't a pain to manage and cash flows. Pretty simple.

I've done many with negative cash flow or break even after taxes that made money from forced appreciation and speculation, besides, 2% for rents won't fly at all in my market, you need to be more aware of opportunities and engineer the right transaction around here.

With your experience, I doubt you need to justify your approach! Good luck :)

How far would you deviate from the 2% rule?

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