# %2 rental rule does not work

I am looking up some houses to fix and hold (rent) and I am doing some analysis, but there is absolutely no way to get a deal which fits the %2 rule.

Here is an example:

http://www.zillow.com/homedetails/2911-Nelson-St-Bakersfield-CA-93305/18892546_zpid/

This is a foreclosed property selling for \$109,500. Let’s say you put an offer of 95 K and you are lucky enough to have it accepted.

2% of 95k = \$1900

That is a far stretch from Average \$900 - \$1100 rent for similar houses in that neighborhood.

Or we can do the match another way: Let’s say we already have someone who has the money and wants to rent this place for \$ 1100

In order to make the 2% rule work, our offer should be \$55,000 (compared to the seller asking price of 109k) this offer doesn’t stand a chance.

It's not a rule, it's a metric to measure whether there is a deal that fits your strategy or not. 2% is generally attained on properties closer to the \$50,000 mark, renting for \$1000 a month.

To be stuck to a 'rule' is silly, see the idea for what it's worth, an idea. There are plenty of areas within the US that 2% is definitely attainable, heck even in CA.

2% is something to shoot for, if it doesn't happen in your market...it doesn't happen. Oh and if its being sold at \$109,500 good luck getting it for that, the market is HOT right now.

Understand what are 'rules' and what aren't.

Andrew

The number isn't the variable. Geography is the variable.

Sigh! The 2% rule, like the old 1% rule, seems to have taken on a life of its own. It works if the rents are about \$500. And interest rates are about 6%. With higher rents and today's low rates, the ratio doesn't need to be so high:

Price: \$95,000
Rent: \$1,100
Down %: 20%
Rate: 4%
Term: 30
Down Pmt: \$19,000
Loan: \$76,000
Payment: \$362.84
Expense %: 50%
Expense Amt: \$550
NOI: \$550.00
Cash flow, monthly: \$187.16
Cash flow, annual: \$2,245.97
Cash on cash: 11.8%

Jon Holdman, Flying Phoenix LLC

It does if you are in the right market. Check this out. http://www.zillow.com/homedetails/1217-E-Barrett-Ave-Madison-Heights-MI-48071/24654762_zpid/ This is a nice home in a working class Detroit suburb. Nice neighborhood, low crime and low taxes. The home gets 3%.

You need to define your deals by discount to current market and yield compared with what investors are expecting in your city.
Your 2 numbers will vary from mine.
For example in Memphis we buy minimum of 20% below what houses are selling for in the street.
And our net yield returns after all expenses must be 11% net.
If I used the 2% rule I would buy a lot of houses in ghettos or nothing at all.

Dean Letfus, Memphisinvestment.com | 901 264 8674 | http://memphisinvestment.com/

My DFW SFRs average over 2%. My average rent is \$925. No class D or war zones.

[email protected] | 214‑929‑6545 | Podcast Guest on Show #46

Originally posted by Jon Klaus:
My DFW SFRs average over 2%. My average rent is \$925. No class D or war zones.

Jon

I will assume when you purchase the property, your offer is 50 % of what property is really worth.

if this is true, how do you get these offers accepted

Originally posted by Bryan Hennen:
It does if you are in the right market. Check this out. http://www.zillow.com/homedetails/1217-E-Barrett-Ave-Madison-Heights-MI-48071/24654762_zpid/ This is a nice home in a working class Detroit suburb. Nice neighborhood, low crime and low taxes. The home gets 3%.

You're right. This house is \$29,900 and would rent for \$750-\$850. What's funny is that it's not even a good deal at \$29,900.

I think the 50% rule is a lot more practical than the 2% rule. I own houses that get less than 2% and others that get close to 10. A lot of it depends on the type of neighborhood you're dealing in. More problems = more money. For a house that sells for \$95K, it would be impossible in my market to get \$1,900 per month.

Originally posted by Alex R.:
Originally posted by @Jon Klaus :
My DFW SFRs average over 2%. My average rent is \$925. No class D or war zones.

Jon

I will assume when you purchase the property, your offer is 50 % of what property is really worth.

if this is true, how do you get these offers accepted

Why would you assume that? I would assume Jon Klaus is buying below market value, but not 50% below. The price-to-rent ratio varies a lot by area. Even here around Denver this varies A LOT. About the best you can do is about 1.5%. Some areas are 0.5% or worse. Many areas across the US are not profitable for rentals. A few work just fine. You may have to go to an outlying area. OTOH, I know Bakersfield is heavily driven by oil. I used to live there and worked for Aera. Its entirely possible that you can't find a better deal in that area than what you described.

Jon Holdman, Flying Phoenix LLC

Alex -

That's like walking into a Chinese restaurant, looking at the menu, and saying, "Hamburgers don't exist!" :-)

Just like in that example, the problem is, you're not looking in the right place. There are some places where you can generally find properties that will meet the 2% rule and there are other places where you won't find any properties that meet that rule.

And just like when you walk into that Chinese restaurant looking for a hamburger, your options are to find someplace else to eat or to just suck it up and find the best thing you can on the menu. In this case, you can either find a new investing location that does allow you to meet the 2% rule or you can choose to stick in your location and find the best deals available.

Crazy analogy, but I'm hungry right now, and I can't decide what to eat... :-)

J Scott, Lish Properties, LLC | [email protected] | http://www.123flip.com | Podcast Guest on Show #10

I've gotten most of mine through the HUD auctions, but a few REOs, too. At HUD I've bid 12 times for every one I've won. Anywhere from 67%-115% of asking. Average about 85%.

[email protected] | 214‑929‑6545 | Podcast Guest on Show #46

BTW, I'm going with pizza tonight. Paying full asking price.

[email protected] | 214‑929‑6545 | Podcast Guest on Show #46

I always felt like my properties were cash flowing really well. Then I heard about this 2% rule and plugged in the numbers. My properties get close to it, but not quit there. Although, I am still very happy with my returns. It's definitely a number to aim for though! Good luck.

in northern cali, it's very possible rentals are not profitable. so why not flip?

ignore the 2% rule. i have no idea how this took off on BP. It's the 50% rule you wanna follow.

search on here how to do the 50% rule. you can also invest in other states if cali won't cut it for a rental.

Originally posted by Scott W.:
in northern cali, it's very possible rentals are not profitable. so why not flip?

search on here how to do the 50% rule. you can also invest in other states if cali won't cut it for a rental.

Technically speaking, bakersfield is in California central valley not NorCal.
Even Sacramento which is even more north than san francisco, is still a part of central valley.

And as a beginner real estate investor, I want to purchase properties within 15 minutes drive max, let alone in a different state.

15 minutes is a very tight constraint. You may have to give up a lot of profit to make that work.

Jon Holdman, Flying Phoenix LLC

Originally posted by Bryan Hennen:
It does if you are in the right market. Check this out. http://www.zillow.com/homedetails/1217-E-Barrett-Ave-Madison-Heights-MI-48071/24654762_zpid/ This is a nice home in a working class Detroit suburb. Nice neighborhood, low crime and low taxes. The home gets 3%.

I used to live in Toledo, Ohio and worked in Ann arbor, MI.

This seems to be a good deal if Madison Heights is not a war zone or drug dealing gangs territory.

I heard in Detroit there are plenty of houses that are vacant and abandoned. State will appreciate you much if you take over some, so those properties will not be their problems anymore.

@Alex R. i was surprised that you were saying that the 2% rule doesn't work in Bakersfield. What that tells me is that it's time to get creative.

I'm in the bay area, i operate in Contra Costa county, Alameda county and i can still, even with all these property values going up find 2% deals.

You have to look a little closer and see what others don't see.

Here is an example:

I pulled up on realtor.com 1517 Pacific St, Bakersfield its listed for \$45,900 its a 3/2 1300 sqft with a detached garage.

At first glance it looks decent and the 2% rule doesn't seem to work because the median rent is \$800 (based on rentometer.com comparing 50, 3/2s in the area this would only get you 1.75% (which isn't bad) but that's not the 2% rule. However what if you could make this into two units? Now your looking at probably 5k-10k in rehab. But take a look around in your Google maps. there are many houses in this neighborhood that converted those back garages. What you will end up with is 1 studio renting for \$435 and a house renting for \$800 = \$1235 / \$55,900 = 2.2 Rule

Now as long as you keep all costs under \$61,750 there's your 2% rule.

I don`t get the 2% rule either. It sounds great, don't get me wrong. I just don't see it as a practical figure for most areas.

I will say I live in an area that has a low cost of living, but can`t see the equation as working out much differently elsewhere. As the prices of properties may be higher in other areas, their rent likely goes up in a similar ratio.

Unless we find a really great buy that no one else jumped on too and drove up the price, it most likely would have to be a major rehab, multi-family, or low income housing area to have a chance at the 2% rule.

Not long ago before the housing bubble burst, I believe small real estate investors were simply hoping their rentals would pay for themselves over the course of time and have a nest egg to cash out at retirement. Now seeing people looking for that kind of cash flow every month.. Very different approach. I like to think those that have a decent cash flow and whose properties are covering better than their own expenses will do very well long term so long as the market doesn't stretch much further downward.

Originally posted by Alex R.:
I used to live in Toledo, Ohio and worked in Ann arbor, MI.

This seems to be a good deal if Madison Heights is not a war zone or drug dealing gangs territory.

I heard in Detroit there are plenty of houses that are vacant and abandoned. State will appreciate you much if you take over some, so those properties will not be their problems anymore.

Madison Heights is not a war zone or gangland. It's safe to walk down the street at night by yourself. Detroit is a nightmare. Lots of crime, no police response, etc.

Check out Warren, MI. You can buy a three bedroom house for \$10-20K that will rent for \$700-800. It's not a war zone. Lots of property crime, but little violent crime. Every third house is abandoned. The problem is the government. They are a gestapo and require ridiculous inspections and permits. It's not even worth buying there anymore. Great deals if you can put up with government abuse.

Originally posted by J Scott:
That's like walking into a Chinese restaurant, looking at the menu, and saying, "Hamburgers don't exist!" :-)

Doggone it, that's the best explanation of it I've ever heard. Red state, deep south living is getting to you. You're making good food analogies.

The problem here is that the 2% rule is simplistic. It makes assumptions about what operating expenses will be that are, more often than not, inaccurate.

You need to learn Capitalization rates if you are going to get a little more sophisticated. 2% ROI per month would work out to be a 24% cap rate if there were no expenses-- but some operating expenses are inevitable. The problem is, of course that those operating expenses can run up to 50% of the gross income which brings your cap rate down to 12% which is good, but not great. If the properties are truly without operating expenses (again, unlikely) a 24% cap rate is fantastic.

Cap rate= Annual NOI/purchase price. 10% is good, higher is better. If you are not finding properties in this range you are either not looking hard enough (don't do bad deals just because you cannot find good ones) or you are in an over-heated market where fix-and-flips might work but buy and rent probably will not. That said, in the most over-heated market there are good rental deals out there but you may need to reconfigure the property in some way.

That said I just bought a 2/1 condo with a 42% cap rate. Even after I split with my investor partner he will get 21% ROI (no debt) and I will make \$4,200 per year. All in all not too bad. Beautiful apt. in good neighborhood. REO not long on market.

Lots of those deals out there in my area.

Oh, by the way, one last thing. Whenever the newbie says "there is absolutely no way to get a deal that . . . . " it is not true. While I am encouraging you to get a little more sophisticated in your analysis I would bet that there are 2%/month ROI deals out there in your market. They are not going to be easy to find. And when you do find one you may need to move quickly. But just because you looked at 50 and didn't find one doesn't mean they are not there. The good news is as you do this more they somehow become easier to find, mostly because you learn how to reject the duds more quickly.

Originally posted by Jon Klaus:
I've gotten most of mine through the HUD auctions, but a few REOs, too. At HUD I've bid 12 times for every one I've won. Anywhere from 67%-115% of asking. Average about 85%.

Exactly. You don't need a better win rate than 1 out of 12 when it comes to rentals. Your money is made by owning the best deal for a very long time. You don't have to flip them.

Originally posted by Mark Reynolds:
The problem here is that the 2% rule is simplistic.

It's supposed to be. It's meant to be a 30 second analysis that snaps your head to attention if you find a property that meets or beats the rule.