Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes
I have been reading about the 2% rule but seriously questioning its accuracy. I got a great deal on a house in a desirable area of Austin for $297k. The rental we are getting is high ($2500) for the area. However, according to the 2% rule, the rent should be $5940. I don't know many places in New York where you would pay that for a comparable property. What % have you found when dealing with rentals?
Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
10y
@Brandon Turner tried to get people to call it the 2% test. That is a much better way to look at it.
The "2% test" is not even necessarily 2%. You have to figure the number that works for you with your goals and in your market. In some areas that may be 1% and others 3% may be realistic.
The point is this is a quick screening tool to see if a deal is close to being a deal. I can use this test in my head in about 5 -10 seconds. That saves me a LOT of time ruling out deals that aren't worth more than 10 seconds to look at.
Nobody says that a rental Has to be at least 2% or that a rental Should be 2%. It is a quick rule of thumb to let you know that if it is 2% you can pretty much count on that deal working from a cash flow perspective.
Investor · Detroit, MI · Member since 2014 · 755 posts · 462 votes
10y
@David Lowe As @Brent Coombs alludes to there are many markets where 2% would be laughed at as being way too low.
I lived in San Diego for several years and loved it but as a RE investment location you are trying to time the market and make sure you have gained enough appreciation to make the property worth holding through the downturns.
Long term investors have done well but are prices going to rise 10% per year for the next 5 years? Or only 2 years? Will it then drop 30% over the next 5 years?
I relocated from Orange County CA because of the opportunities in Detroit and Detroit suburbs.
I like the Detroit market where the cash flow beats all other markets AND the appreciation is second to none.
Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes
10y
@Joe Villeneuve I'm inclined to agree as the US is effectively the size of a continent so difficult for a "one size fits all" approach. How do you calculate the ARV?
Professional · Covina, CA · Member since 2016 · 56 posts · 15 votes
10y
the "rules" that people talk about are general rules, mostly used to determine if a deal merits further investigation. Ultimately, you have to work the numbers! Markets, type of property, and financing really determine a "good deal."
The 2% rule is just a guideline, but more important for you ... check how profitable you are (cash flow) + any expected appreciation (be conservative here) and compare that against the S&P 500 / other investment classes. (Note: cash flow vs. long term investments can make the numbers a bit tricky to compare apples to apples.) However, it will provide a guideline as to whether you've made a good investment.
Note: some properties look great on paper but require a lot of management, especially the lower class properties. It can be very tricky if you have to deal with evictions and poor property managers in these areas. While your returns may look good on paper, you've spent more time on them (which is valuable) than what they are worth.
Investor · San Marcos, TX · Member since 2015 · 272 posts · 360 votes
10y
I don't see how a property cash flows at sub 1%. At 300k you are parking up to 75k in cash in the deal. 75k in cash is a lot to not get a return on that money. If you are not cash flowing then you are strictly investing based on appreciation. I don't really consider that buy and hold. That is more of a long term flip.
I bet your analysis is off if you are showing returns on sub 1%. You are not calculating cap x or other expenses. With 75k you can buy 3 or 4 homes in other areas that are 1-2% or more and will appreciate.
I am break even on a property in Austin that is valued at around 250k. I owe 90k on it and collect $1750 in rent.
Even if you parked a huge down payment into the property that is just throwing money at a deal to make it cash flow but your opportunity costs are still high. You can get a 15% return on your cash investing in other investment types.
Can you post some numbers on this deal?
Real Estate Agent · Austin, TX · Member since 2016 · 111 posts · 64 votes
10y
Just as a general fyi...right now Austin rents are about 12-18 months behind the market... Housing prices have been continually rising during the past 2-3 years, and rents are only increased in yearly increments...when a lease is up. So I would expect rents to keep rising for some time to come. Good news for investors, not so great news for renters!
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
10y
The "2% rule" doesn't guide how much rent you get, it refers to how much you should pay for the property. So if you can get $1,000 per month in rent for a property, in order to meet the "2% rule", you'd need to pay and rehab for no more than $50,000.
This generally does not happen on either the West or East coasts unless you could work a miracle. Real estate sells for just too much there. It can happen in the Midwest, or in the South, or rural areas.
@Joe Villeneuve I'm inclined to agree as the US is effectively the size of a continent so difficult for a "one size fits all" approach. How do you calculate the ARV?
Sales comps over the last 90 days on properties that are:
1 - Within 1 mile of the subject property...and in the same city
2 - Within 10 of the sq ftg of the subject property
I don't see how a property cash flows at sub 1%. At 300k you are parking up to 75k in cash in the deal. 75k in cash is a lot to not get a return on that money. If you are not cash flowing then you are strictly investing based on appreciation. I don't really consider that buy and hold. That is more of a long term flip.
I bet your analysis is off if you are showing returns on sub 1%. You are not calculating cap x or other expenses. With 75k you can buy 3 or 4 homes in other areas that are 1-2% or more and will appreciate.
I am break even on a property in Austin that is valued at around 250k. I owe 90k on it and collect $1750 in rent.
Even if you parked a huge down payment into the property that is just throwing money at a deal to make it cash flow but your opportunity costs are still high. You can get a 15% return on your cash investing in other investment types.
Can you post some numbers on this deal?
Imagine a 4 unit multifamily in a very desirable area that is purchased for $1M and brings in $7500/m in rents. That's quite a bit less than "the 1% rule." Imagine you had to park $250k in it long term. Assume you self-manage. With a 30 year mortgage at 4.25%, after actual expenses (incl house utilities, landscaping, repairs&maint, insurance, taxes), a vacancy allowance of 6%, and CapEx allocations are subtracted, you could be taking home $17k in free cash flow yearly - 6.8% on that $250k.
So, the question is: Is that $250k best allocated to this investment? Is it better allocated to buying 10 SFR in some other market? Is it better invested in a mutual fund holding the SP500 dividend kings? How much value do you place in the $1000/m you're watching your mortgage principal decline? What's the likelihood property values will increase along with inflation? How do you value the Prop13 benefit to the property taxes? What will your tax implications be with this investment? How do you place a value on the potential for actual long-term appreciation in that market on top of inflation? How do you measure the risk associated with this market compared to others? And, risk adjusting all these numbers, at the end of the day, what's the NPV of the income stream? Depends entirely on how you quantify these unknowns - to each his/her own.
I'm NOT saying this is inferior or superior to any other potential investment out there ... just that (A) there can be free cash flow below 1% and (B) this isn't "strictly investing based on appreciation."
On the more abstract level, I think there's a couple things going on here:
You're self-managing. Certainly better to self-manage 4 high-demand units in one location than 10 less desirable properties in multiple neighborhoods, but it's still not strictly passive.
On properties like this, gross rents are higher, but the the expenses aren't. That throws many ratio metrics out of whack.
You better pick the right horse if you're going to play in this race - since all the numbers are super-sized, any errors are magnified compared to the $100k house market. You don't get the luxury of screwing up once.
Happy Memorial Day, everyone! I feel particularly grateful today, and I hope everyone else does too.
Property Manager · Griffith, IN · Member since 2015 · 1k+ posts · 913 votes
10y
In my neck of the woods, investors are getting 2-3% in your C-D areas. In a B area, it's about 1.5%. In the A areas, it's 0.8-1%. However as the % decreases, the appreciation increases and the drama decreases. I know a bunch of guys with dozens of houses in the C- and D areas that are cash cows getting 3-4%. However, it's a war zone with no appreciation. But the house is paid for in 18 months or less.
I have one in an A area at 1.1%. I cash flow $180/m. I also have one in a high C/Low B area that gets 3% and cash flows $425/m. It also only cost me $32K all-in. The A house I could sell in under a month easily and enjoy high appreciation. The other house could sit 60-90 days and I'll break even. I invest for cash flow because appreciation doesn't pay the bills.
Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes
10y
@Leland Barrow This was not a long term flip/appreciation play. It was a cash flow play. Going on the 2% rule however, it would have meant that we would have had to get the property for around $215k which in Hyde Park Austin is impossible. The property has appreciated well which will obviously make up for the sub 2% rental yield.
Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes
10y
@Dawn Anastasi And that is where I am a little mystified. Are there any places in the US where you can command a $1k/month rent but only spend $50k on purchasing the property?
Investor · Overland Park, KS · Member since 2015 · 50 posts · 13 votes
10y
in my opinion D class is an area where property values are declining rapidly.
C class is declining slightly or staying the same. B class is where the numbers still work, the area is stable and property values are increasing 2/3% per year.
One I'm finishing a rehab on in a B area will have a house payment of $600 after refi and the rent is $1200 a month. I'll have 10k left in the deal after refi. I am choosing this strategy rather than investing in a C area and getting all my cash back after refi.
@Dawn Anastasi And that is where I am a little mystified. Are there any places in the US where you can command a $1k/month rent but only spend $50k on purchasing the property?
Baltimore, I own several in baltimore where I paid less that $50K all in after repairs and get over $1000 a month rent.
Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
10y
@Brandon Turner tried to get people to call it the 2% test. That is a much better way to look at it.
The "2% test" is not even necessarily 2%. You have to figure the number that works for you with your goals and in your market. In some areas that may be 1% and others 3% may be realistic.
The point is this is a quick screening tool to see if a deal is close to being a deal. I can use this test in my head in about 5 -10 seconds. That saves me a LOT of time ruling out deals that aren't worth more than 10 seconds to look at.
Nobody says that a rental Has to be at least 2% or that a rental Should be 2%. It is a quick rule of thumb to let you know that if it is 2% you can pretty much count on that deal working from a cash flow perspective.
Real Estate Agent · Sisters, OR · Member since 2014 · 1k+ posts · 1k+ votes
10y
In the places I invest, live, and pay attention to the 2% rule does not exist. An .8% rule would be pretty good assuming it was a clean and in a good neighborhood. I would love to live in an area where there was a 2% rule. I would deal with all of those losers screwing up my place, it would be a pleasure compared to buy and hold and waiting for 10 years to monetize your returns. You could get financially free pretty darn quick if the 2% rule was practical where you live. The appreciation game here in Central Oregon especially lately is a grind and it is long term. But buying and holding with 20% down is not going to take a while my friend. Assuming you are in a market similar to mine, you found a good deal nice work. Me and you will just have to listen to how great the life is for all of those guys in the those areas that get big returns on the podcasts.
Investor · Redondo Beach, CA · Member since 2013 · 147 posts · 50 votes
10y
I wouldn't fixate on the 2% Rule, 1% Rule or any rule for that matter.
From a numbers perspective, focus instead on the Cash Flow and Cash-on-Cash Return. Stick to these metrics and prioritize them over general rules. Use the Rent-to-Price ratio only as a guideline. I certainly wouldn't base a decision to buy a property on the fact that it meets the 2% Rule.