How Accurate Is The 2% Rule?
Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes
How Accurate Is The 2% Rule?
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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.
64 Replies
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Ned Carey That is unbelievable. Why do you think the property prices are that low in Baltimore? What kind of areas are your properties in?
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Eric Bilderback Thanks for your input. Have you ever moved market and diversified if Central Oregon is such a grind?
- Real Estate Agent · Sisters, OR · Member since 2014 · 1k+ posts · 1k+ votes10y
No way man! Great fishing, best place in the world for kids to grow up, solid community, beautiful scenery, family. But if I was a bachelor I would consider moving to Detroit.
I'd be breakin necks and cashin checks BABY!
Do it go to Detroit, and when you get going hit me up I'll invest with you!
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes10y
Originally posted by @David Lowe:
@Ned Carey That is unbelievable. Why do you think the property prices are that low in Baltimore? What kind of areas are your properties in?
There are a number of reasons. City government and city tenants are both tough to deal with so many people won't invest here. Also financing is tough meaning fewer buyers because they have to have cash. Lastly the city has lost tremendous population over the last 50 years.
It is simply a matter of supply and demand. Fewer buyers, and lots of inventory of houses.
- Specialist · Honolulu, HI · Member since 2014 · 1k+ posts · 1k+ votes10y
Originally posted by @Leland Barrow:
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?
I am not sure what you mean by your first sentence. Higher rents/purchase price ("2%" properties) invariably means a lower class property with higher maintenance tenants. This is by definition. Also, CapEx costs are usually fixed and end up costing very similar in a $30k and $900k property. Consider that.
A lower rent/purchase price means the market finds the property more desirable. (ie. San Francisco, Honolulu, NYC etc.) which means more profit (ROI, IRR)
My 0.9%-1.1% properties cash flow >$500+ after all expenses and reserve. So I tend to think that is the sweet spot.
- Investor · Singapore · Member since 2013 · 1k+ posts · 3k+ votes10y
I have a less than 0.5% property that happily cash flows $500/month and has appreciated $250K in the last 3 years. I wish I could have more such terrible investments!
- Investor · San Marcos, TX · Member since 2015 · 272 posts · 360 votes10y
You have a good example but are we talking a multi-family unit? My comment was directed towards what I assume is an SFR. Those numbers are a bit arbitrary. I am not aware of any SFR that brings in $7500 a month in rent with a million dollar market value. There may be outliers but if your business plan is based on outliers then go for it.
- Property Manager · Griffith, IN · Member since 2015 · 1k+ posts · 913 votes10y
Originally posted by @David Lowe:
@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?
Yes in my area I'm not spending more than $50k all-in for $1000/m. This is a solid -B to C+ area that has some appreciations (below national average though). But I don't see someone out of state without boots on ground doing everything for someone getting it that low. One could get it in the 70-75k range which is still a solid investment.
- Developer · San Diego, CA · Member since 2015 · 1k+ posts · 1k+ votes10y
Originally posted by @Leland Barrow:
You have a good example but are we talking a multi-family unit? My comment was directed towards what I assume is an SFR. Those numbers are a bit arbitrary. I am not aware of any SFR that brings in $7500 a month in rent with a million dollar market value. There may be outliers but if your business plan is based on outliers then go for it.
Fair enough - if it's limited to just an SFR, I would agree with you. Maybe the numbers could work on the vacation rental side of things or "rent by the room" student rentals, but those are practically different businesses. I don't see SFR working for me unless appreciation was included in my projections.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes10y
@David Lowe I think a better way to look at this is in specific areas the "2% rule" is going to be different. In the area and type of property I invest, the rule is .8% for me. I would call them A neighborhoods. You can find properties in my city that are closer to 2% if you move to less desirable neighborhoods. I have owned properties in those neighborhoods and there is added expense and problems, so it is no longer an area I invest. I look at the 2% rule as a method for analyzing quickly, but you ultimately need to determine what percent is right for where you invest.
- Rock Star Extraordinaire · Northeast, TN · Member since 2015 · 10k+ posts · 16k+ votes10y
Originally posted by @David Lowe:
@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?
Yes, but it's not easy and getting harder. I have several properties that rent for close to 2% of what I am at, all-in. I use 1% of my all-in as a quick-and-dirty on whether it's even worth exploring, but I also mostly consider if and when I pull my cash out, how much of "my" cash will I be leaving behind? If it's little to none, meaning the rehab appreciation will easily pay for itself, the property will almost certainly be worth renting anyway because it means you are either getting it below market, or there's a huge upside to renovations in that area.
The idea scenario is that you own the house for free, meaning that you put $X into buying & renovating, rent at a nice profit level, pull (or are able to pull, even if you don't) your cash back out through rehab & refi, leaving a small note that is <50% of the monthly rent. At that point, you have a cash-producing asset that someone gave you for free - what could be better than that?
Skyline Properties - Investor · San Marcos, TX · Member since 2015 · 272 posts · 360 votes10y
I would like to see some numbers. I am always OK with being proven wrong, but I would need to see actual numbers.
Purchased today:
- SFR
- 25% Down
- Texas, use a current market rent
- All expenses accounted for including property management
Like I said above if your business model is based on one-offs or outliers then go for it. I do not know anything about San Francisco or Hawaii but I would like to see numbers for those areas also. Cash flowing $200-$300 per month on a property that you have $10k-40k in is not the same as cash flowing $500 a month on a property that you have $200k in. The reason that I ended up break even is because of an increased tax burden. I know in California your property tax rate is much lower.
I personally would not park money into a deal that was sub 1%. Your margin of error is very slim and you are depending on at least one variable that is out of your control. Do you stress test properties that are sub 1%? What does it look like when rents drop 20%? I am not trying to bash your investment strategies. It is not my money but I think that the opportunity cost of investing large amounts of cash into SFR deals for even a %6 return is high.
I think that if you invest in a SFR property priced above $250K and at less than 1% your risks in this market are significantly higher than other investments and you will have less return.
- Rental Property Investor · Sioux Falls, SD · Member since 2015 · 9k+ posts · 18k+ votes10y
@Account Closed cash flow and the "2% rule" are very different. Any property should cash flow if you have a good down payment. Cash flow doesn't mean you are getting a good return on your money. For example if you paid all cash for a property, your return on capital may be low, but cash flow could be high. Another thing to consider is that $500 cash flow may be very low for higher value properties. For example if you have a 30 unit apartment complex, $500 cash flow is not great. Appreciation is good, but you don't see any benefit until you sell and it is relative to value. Ultimately the best investment gives you good annual return and a large upside when you sell.
I am not saying your investment is bad (probably was excellent in fact). I am just pointing out cash flow and appreciation are relative.
It does seem very often that properties meeting the 2% rule have lower appreciation because they are in rougher neighborhoods. There are many exceptions of course. Ultimately the rules are guidelines and offer different ways to analyze.
- 10yDawn AnastasiPro MemberRental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votes
Originally posted by @David Lowe:
@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?
Absolutely.
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Eric Bilderback Unfortunately I'm not single so Detroit might have to wait! :) However, I'll be doing big things in San Diego from July onwards so feel free to join our investor community (see my profile for website) or private message me to discuss.
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Ned Carey Fascinating. If the population is dropping and there are fewer buyers, why would flipping or buy to let properties be successful there?
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Account Closed Nicely done. Mine is a 0.7% property cash flowing at $1667 and appreciated $100k in the last 2 years so maybe I'll be joining you in the "terrible investment" club!
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Ian Walsh Do you not think that a national average is a dangerous metric? I am from the UK and if you are investing in London (which is higher than anywhere else in the UK by a long way), you are going to be way off with your national average rule.
- Realtor · Denver, CO · Member since 2016 · 162 posts · 37 votes10y
@Joe Splitrock Thanks for your rationale. I like it.
- 10yDan H.Pro MemberInvestor · Poway, CA · Member since 2015 · 7k+ posts · 8k+ votes
Originally posted by @Leland Barrow:
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.
All you have to do to take out the appreciation is to refinance or ELOC. ELOC on investment properties are slightly hard to find but when I last looked (maybe 1.5 years ago) I found a few.
I have purchased multiple properties at below 1% that cash flow at 20 or 25% down (i.e. without artificially making it cash flow by placing a lot of capital into it) using what many people would consider high cap expense numbers (I usually use $250/month for attach multi units standard rental size and $300/month for detached or SFR standard rental size: San Diego is expensive with expensive cap expense). There are many things that calculate into the cash flow including terms on the loan, vacancy rate, condition when purchased (no deferred maintenance), etc. I have also purchase two units that did not cash flow unless I included the equity on the mortgage payment but with rent appreciation those units will cash flow in June (and I have made in 3 years over $200K in appreciation on those units and have all of my initial investment out of those units (I refinanced a few months ago)). So those units that looked to be my worse units are very soon to cash flow in June) and I have removed all of my initial investment without selling them (without flipping them).
If I can find some multiplexes in my area of expertise to purchase (mostly Escondido) below 80% ARV I would purchase them regardless of if the numbers were below the "1% rule".
- Investor · Redondo Beach, CA · Member since 2013 · 147 posts · 50 votes10y
For interest sake, I ran a cash flow analysis on a range of property prices and Rent-to-Price ratios. I wanted to see why some investors indiscriminately shoot for 2% or 1% and how that translates to cash flow for a given property price. I thought I'd share these results with the BP community and hopefully shed some light as to when 1% or 2% Rules make sense.
I made the following assumptions:
1) Properties purchased with a 30 year loan, 5% fixed annual interest, and 20% down payment.
2) Expenses estimated using the 50% Rule.Sorry if it's hard to read, but it gets larger if you open the image in a new tab.
I color coded the Cash Flow based on the following criteria.
Red: Cash Flow < 0. Yellow: 0 < Cash Flow < $100. Light Green: $100 < Cash Flow < $200. Dark Green: Cash Flow > $200
Each cell shows the calculated monthly Cash Flow for a given purchase price and Rent-to-Price ratio. For example, at 1% Rent-to-Price, the Cash Flow for a home purchased for $100,000 comes out to $71 per month. Here's the quick math: $100,000 x 1% x 50% - $429 monthly debt payment equals $71 of Cash Flow.
Major Takeaways from this table:
1) There's a minimum Rent-to-Price ratio that must be achieved in order to cash flow positive. That Rent-to-Price ratio is between 0.85% and 0.90%. The exact percent will vary on the loan assumptions, but for this case (30 year loan, 5% interest, 80% LTV) we begin to cash flow positive at a 0.86% Rent-to-Price ratio.
2) If you're goal is $100 Cash Flow per month, the 1% Rule will only work if you are buying homes that cost about $150,000 or more. So if your price point is below $150,000, then your target Rent-to-Price ratio needs to increase in order to achieve that $100 Cash Flow goal.
3) If you're goal is $200 Cash Flow per month, then the 1% Rule will only get you there at price points that are much higher. It's actually off the chart, but at around $280,000 the 1% Rule will generate about $200 in Cash Flow per month.
Here's what it takes to hit $200 Cash Flow for varying purchase prices.
- $100,000 home will need to rent for more than $1250 (1.25% Rent-to-Price) a month.
- $60,000 home will need to rent for about $900 (1.5% Rent-to-Price) a month.
- $30,000 home will need to rent for about $645 (2.15% Rent-to-Price) a month.
From looking at the table, obviously a 2% property is generating > $200 cash flow nearly across the board. On paper, these numbers look great. Though in reality, these properties generally tend to be high risk investments. They are often located in higher crime areas and marketed to a less qualified tenants.
Ultimately, I think it's more important to focus on hitting your Cash Flow and cash-on-cash returns criteria rather than fixate on hitting the 2% or 1% Rule. Whatever % you end up getting is more of a byproduct of your investment. It shouldn't define it and it definitely shouldn't be the basis for your purchase.
Prioritize that cash flow and your returns because isn't that what it all comes down to anyways?
- Sherman Oaks, CA · Member since 2013 · 3k+ posts · 2k+ votes10y
Rules don't always mean much when it comes to REI. Location ultimately means more. Just check with Anish, he owns all types .5% thru 2%. The origin of the 2% rules comes from mobile home investing btw and is not found in any textbook nor taught at any accredited institution. Good luck with your search!
- 10yJoe VilleneuvePro MemberPlymouth, MI · Member since 2013 · 13k+ posts · 19k+ votes
"How accurate is the 2% Rule"?
Maybe around ....2%
- Investor · DMV Maryland · Member since 2013 · 867 posts · 370 votes10y
One thing I can say that seems to be pretty on the money is the "50% rule" - or should I say 50% test.. and that is that generally speaking over the lifetime of owning the property, about 50% of the gross rent is going to go towards expenses. Take your rent, divide it in half. If you paid all cash - you now have your true net cash flow. If not, minus your mortgage P and I and THAT is now your true net cash flow (over time).
Like when you have a rehabbed rental but the market demand is very slow for your bed/bath configuration - though just 6 months ago it wasn't, that same configuration leased up pretty quickly - and you're up on a cash-out refi but have no tenant in place yet, so you'll be paying out of pocket for that mortgage shortly until it's leased.. oh and there's leaking pipe you now have fix in that same place...
ask me how I know how this test is apparently a very valid one :-)
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