1% rule or 2% rule?

[Nick Seginowich]

I’ve heard both the 1% and 2% rule thrown around on bp, and it seems to me like these are pretty different numbers. Does anyone actually find 2% properties? And I feel like the 2% rule is more of an exception rather than a rule?

[Dan H.]

Originally posted by @Russell Brazil:

Yield is a function of the risk of the underlying asset and market.  You can find properties at 3, 4, 5%, or be at propertied at 1/2%.  That yield merely reflects the risks associated with the property. Higher yield, higher risk.

I mostly agree with Russell (on this post and virtually all his posts) but will add in that the yield reflects risks, headaches/work, desirability, etc. I do not think it is risk alone.

In a particular market area, the higher rent to value ratio is set by the market. The market takes into account numerous factors that include risk, expected return, level of effort, desirability of the unit (who does not want a beach side cottage?). etc.

I find that the higher the rent to value ratio associated with an area, the worse the area is and in general the worse the tenants are (more late/missed payments, more evictions, more wear and tear on the property, etc.).

Basically, the market results in the retail values being what the RE is worth in the current market. Areas with higher rent to value ratios will often produce the lower return due to things like no appreciation, worse tenants (evictions, missed payments, wear and tear), higher insurance, HOA, property tax rates, etc.

I recommend against most newbies purchasing in the highest rent to value areas in their market. There is a reason why an area has the highest rent to value and it is not because everyone is missing that it is a great investment area.