2% rule before buying a rental property?

5 Replies

Hello everyone,
In one of the BP podcast, Brandon Turner said that the 2% rule works for him in general. According to him, for example, if the property is listed for $100k, then the expected rent should be at least 2k per month. Therefore, 2% return on a buying price is a good deal. But, here in Chicago and neighboring areas, the 2% rule doesn't make sense unless if I misunderstood Brandon Turner. Here in my area, the return on rental income is more like 1% only if the property is new or in great condition. Otherwise, majority of the time it is even less than 1%. So I would like to know if I am missing anything here or if there are any rental investors who follow the same rule.

@Dawal Limbachia I'm fairly new to investment properties but I've never heard of a 2% rule. And to get $2,000 a month for a $100,000 property wow. Wheres it at I need to crap together my pennies and buy it

One thing to keep in mind when you listen to podcasts, is when was it filmed?  The 2% rule may have been a fine metric after the GFC in 2009-2012ish, but as time went along and prices began to rebound, the 2% rule has became virtually impossible in all but a select few markets.  Also, factors such as neighborhood quality will effect it.  A C-D-or F class property will likely have a significantly higher ratio than an A class property, but those F class properties will come with many additional problems that can easily eat your theoretical cashflow projections alive.  Lastly, price also matters.  Its entirely possible to still get 2% properties if you look into cheap markets.  A home that sells for 30k might easily rent for 600/month.  However just because this 30k property hits the 2% rule doesn't necessarily mean its a good buy since repairs tend to destroy any anticipated cashflow on these cheaper units.

As a matter of personal preference, I only buy units in B or higher areas, and anticipated rent must be at least 1200/month for me to consider it.  I wouldn't worry too much about the ratios and what other investors are getting in different markets, because you don't know what quality of products they are buying.  Narrow down your focus to a similar style of home within your city, and only compare the ratios of properties that fit your criteria that way you are comparing apples to apples. 

My quick and dirty calculation is 1% of purchase. There is so much more that goes into figuring out whether you ought to buy something that one shouldn't base it on a single metric. I have found that if I don't get at least 1% I might as well not own it right now. I know some people buy for appreciation and worry less about rent but I can't afford a bunch of non-cashflowing properties so I don't do that.That doesn't mean I don't consider something that is lower % but around me right now a typical family 3/2 1500 sf is pretty much starting at $400k and is renting for $2000. I have no way to make this work. So .95% may be workable or maybe you can offer less or whatever but .5% is unlikely to work and even if you have cash, your cash on cash return would be low. I'd rather throw it into index funds, get about 8% and not deal with tenants.

Study up on the different calculations you can use to analyze your business. Play with the BP calculators. Do dry runs using stuff you find listed in your area and find rent for a similar house (Zillow can be helpful with their rent estimate, I don't blindly accept those in real life but they would be fine for practicing). Plug things into a calculator and see what happens. Also try scenarios like, your tenant calls in the middle of the night with a broken water heater etc to see if you will have enough reserves to afford repairs.

Yield in any investment vehicle is a function of the underlying risk in the asset and market.  So a 2% property holds much more risk than say a 1% property.  In major metro areas, where demand is high, you should expect ratios considerably lower than 1%.  In the highest risk areas you will see the highest ratios.