Question on 2% test

4 Replies

Can anyone tell me what the metric is called to explain cash flow per month as a percentage of purchase price? I think it would be a useful tool for investors to go by, rather than saying "this property passes the 2% test," there should be a name for this like the (fill in the blank) rate. I know cap rate is on an annualized basis but i have never heard of a term that tells investors cash flow as a percentage of purchase price. Does such a term exist?

I use cash on cash, the percent earned based on how much I put in the home. It lets me look at my returns based on my down payments since I am a leverage lover ;)

I did some research and found the term is called rent to purchase ratio.

@Aaron Schwartz Did you just answer your own question? Yes, "2%" means receiving a gross rent of 2% of the purchase price, per month. Depending on where you are looking to invest, that may be a completely unrealistic expectation, or elsewhere, a useful way of quickly gauging whether an asking price is in the right ball park.

So the "metric" of whether it should be 1%, 2%, or higher, or lower, for any particular area is largely to do with the other factors that indicate whether a property would be a wise investment:- Is the neighborhood A, B, C, or D? Is the property undervalued compared to what it should/will be worth? Are expenses (cap ex, taxes, vacancy expectation, property management etc) low enough? Lots to calculate! Cheers...

@Elizabeth Colegrove Cash on cash is an important metric to know but looking at factors such as the asset yield and NOI as a function of the asset value is still very important. Your higher your risk tolerance when it comes to leverage is rewarded by cash on cash, but the leverage works both ways. Looking at the investment without consideration of your financing method can't be replaced.

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