2% Rule is the Stupidest Thing EVER!

110 Replies

It's misleading as all hell.  It doesn't focus on the truly important elements of the underwriting.  And @Brandon Turner  is not helping anything by continuing to talk about it on his webinars.

[Note from Brandon: see my response at the bottom of page 2 of this thread... ;) ]

Who cares what the income is? The NOI is what's important. 2% Rule is garbage and cannot even be used as a rule of thumb, y'all!

Learn how to analyze property, and run far and fast whenever you hear anything about any rule of thumb.  There are no rules of thumb in this business.  Be professional about this...

@Ben Leybovich  Ok I'll bite and play your game.  2% rule is simply a way to quickly figure out if a deal is even worth spending the time to truly analyze it.   

Haha - it doesn't do that.  I could look at a 1% deal and it could be a great investment.  Ans I could look at 3% deal and it could be terrible.  Tells you nothing, @Cal C.  

I think a rule of thumb, in general, should always be taken with a grain of salt. No market is the same, what might work for him might not work for you. I'm sure if you ask Brandon, he will say the same thing then continue to explain that you need to have experience in the game to know how to analyze property properly. 

@Kyle Gregg  - I tell Brandon every day.  In fact, I yell at him through skype every day about this.  He agrees with me, but still thinks people should know it.  I think it just confuses things...

@Ben Leybovich    I think you like to cause trouble when you get bored. But in this case I agree with your assessment.

I have purchased properties now in four different states. The rent/price ratio that makes sense in each of these areas is very different, and not close to 2% in any of them. The factors that affect a deal vary drastically from place to place, and using a fixed rule of thumb can be very misleading to say the least. 

In my primary buying area, I have developed (through lots of detailed analyses) a ratio that I can use as a rough estimator to screen deals. But I always do a more thorough analysis of each property before making an offer. And  I throw that ratio out the window when I'm looking at a property in a different area.

Originally posted by @Cal C. :

@Ben Leybovich  Ok I'll bite and play your game.  2% rule is simply a way to quickly figure out if a deal is even worth spending the time to truly analyze it.   

 Gotta agree with Ben here.  It's too misleading.  I've tried for years to come up with a shortcut to save time by coming up with a quicky analysis tool that would let me know "if a property is worth analyzing".  Couldn't do it...and one of the ones I passed on was a variation (more involved) of the 2% rule.

It was all over the place because every market is different.  I don't spend %...I spend cash.  What I found was if I just learned about the different markets I was interested in, and continued to analyze those markets for changes in them, I did a better job of "quick analysis" by eliminating markets instead of properties first.  If the market was worth my time, then all the properties in that market was worth my time.

Then, I use 2 really simple formulas to analyze the property fast.

1 - Rent - expenses >= $300/month (including debt from refi & PM)

2 - ARV x 80% (or whatever my current %ARV/refi is) + CF from 1st year >= My cash in (inc. rehab)

If the market passes the test, and the property I'm looking at in the market does too, then I do a full analysis.

I usually buy a property if realistically I can get all my money back within 4 yrs.

Consider the 2% rule as a first layer of filtering? If you were given information on 1000 properties, what would you do to get a quick assessment to which to dive deeper into? 

Originally posted by @Kyle Gregg :

I think a rule of thumb, in general, should always be taken with a grain of salt. No market is the same, what might work for him might not work for you. I'm sure if you ask Brandon, he will say the same thing then continue to explain that you need to have experience in the game to know how to analyze property properly. 

The only rule of thumb I follow in REI applies to rehab.

"Don't hit my thumb with the hammer...hit the other nail".

You are damn right this is how I have fun, @Ron Averill  .  What the hell else do I have to look forward to - doing deals?  I am so bored I duno what to do with myself!  BP is the only fun in my bring life!

But, this doesn't change the fact that 2% Rule is crap, and newbies would be better of not knowing anything about it.

I mean, at least let's talk about the GRM to evaluate rent per sq.ft. That barely means anything more, but it's at least something...

@Kyle Gregg - use the GRM as the high-level of filtering. It at least tells you something about the marketplace...

I'm fairly certain Brandon has never suggested adhering to the 2% "rule of thumb" in isolation of all the other factors needing to be taken into account regarding a possible good deal (area, comps, rehab$, kerb appeal, tenant history/potential, funding costs, economic forecast)...

Before I even heard of such a rule, my first one brought in $100/w gross for $50k purchase price, and I might still happily use that "rule of thumb"any day of the week.  Cheers...

Eh, it's about as helpful as the 50% rule...

Generally speaking, I'm looking at the rent ratio to purchase price to help drive what the CoC will be when comparing properties in a concentrated area. In the same market, things like property taxes, vacancy rates, insurance rates, etc are all likely to remain proportional. If both properties are priced at $100,000... the one that rents for $1,800 a month is likely to be a better investment than the one which rents for $1,600 a month.

Now comparing a $100k property that rents for $1,800 a month in Michigan versus a $100k house that rents for $1,600 a month in Montana is a completely different story.

Everybody should have their own rule of thumb for quick filtering, and that will vary drastically by every market, and each persons comfort zone. It may be a percent or it may be cash flow or purchase price vs actual value (or ARV -repairs.)

The important thing is that people have access to the science behind every rule of thumb, whichever one it is, so they can decide what's best for them. 

That's my politically correct answer, my other answer is, the 2% rule is the dumbest thing ever and I would still be slaving away at my god forsaken hellhole of a 9-5 if I'd known about the 2% rule when I started, I couldn't agree with Ben more!

Originally posted by @Ben Leybovich :

Hey, @Joe Villeneuve - what's a hammer?

 That's that thing that carpenters use, that my wife wants me to use, that I know how to use...(shhhh...don't tell anyone), that a lot of REI think they can use to save money on rehab.

I guess this depends on the location. 2% I look at as a warning sign. It might indicate there is a fundamental flaw in the properties value as in declining values ahead, tenant quality issues, higher management challenges, higher turnovers, theft, vandalism, high crime, bad schools and just about everything in regards to location is in question. So as a general rule of thumb it is great that way.  There are always exceptions obviously. 

When researching this rule the best origin I could find was it was born from mobile home investing, which would make sense. To apply to real property in the same fashion might lead up to the above issues in short order. 

They do not teach the 2% rule in any known accredited institution.  The 2% rule is not found in any textbook. I have not talked to one formally educated real estate pro who has heard of it or would use it as a bases to invest. 

I think in Brandons case, we have one individual in one part of the country who achieves this and quickly translated 2% as if this was a certain rule for others to adhere to. The reality is that could be questionable advice.  No offense to Brandon as it works for him and we are all products of our environment. 

Thanks Ben! 

I gotta agree. I think the 2% rule paints with waaaaayyyyyyy too broad a brush. A $200,000 house at 2% will cash flow much, much better than a $25,000 at 2%. I think it also tempts newbies to invest in really bad areas where properties look great on paper (but only on paper). In my humble opinion, the rule should die.

I am too much of a stats nerd to find the 2 % rule to be useful. It's worth the time plugging the numbers in a spreadsheet or the bigger pocket calculator to see whether a deal should be considered.

I consider myself abrasive, but even Ben makes me say to myself " Here he goes again kicking up dirt". I do see where your coming from though.  

Location and neighborhood. If the property is in a location that people want to live in. That is a good starting point. It's hard to convince a tenant to live in a property that you wouldn't live in yourself. Regardless of the rule, I look for property I would be proud to own and confident to show. Tenants stay long term and you build a quality portfolio.

We don't follow any "rules". We simply created a "rough" business plan that included a "criteria" of the houses that best fit our model. From there we have out together our strategy and adapted turning "road blocks" into tool! 

While generalizations are a great way to get started learning about real estate. It is important to realize that every market is very different and one must adapt for their area!

Originally posted by @Matt R. :

When researching this rule the best origin I could find was it was born from mobile home investing, which would make sense. To apply to real property in the same fashion might lead up to the above issues in short order. 

They do not teach the 2% rule in any known accredited institution.  The 2% rule is not found in any textbook. I have not talked to one formally educated real estate pro who has heard of it or would use it as a bases to invest. 

I think in Brandons case, we have one individual in one part of the country who achieves this and quickly translated 2% as if this was a certain rule for others to adhere to. The reality is that could be questionable advice.  No offense to Brandon as it works for him and we are all products of our environment. 

Thanks Ben! 

 It does seem like the "2% rule" would most commonly work in areas where financing is restricted or non-existent, there is little potential for appreciation and the focus is on returning principal as quickly as possible.  

That scenario does seem to describe most mobile homes.  Not to say you can't make money in them as an investment, just that the emphasis has to be on maximizing cash flow.

I had heard about the 1% rule before being interested in real estate investment.  Interestingly it looks like the historic norm is more of a 0.0625%(ratio of price = 15*annual rent).


http://www.nytimes.com/2008/10/16/business/economy/16housing.html?em=&pagewanted=all

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