I was listening to the podcast where Josh and Brandon were talking about investing rules, the 2% rule seems rather unrealistic. Is anyone actually acheiving that?
what is the 2% rule
the rent needs to be 2% of the purchase price of the property
The 2% rule is good if you understand the assumptions behind it. I don't remember what all of them are but here are the couple I do remember.
Purchase prices need to be in the 25-50K range generally.
The financing (if any) needs to be for about 6%.
As you start to move away from these assumptions it gets less and less accurate, especially the purchase price metric. It works best in blue collar midwest or more rural areas where prices have stayed historically pretty consistent. I personally don't use the 2% rule. Many rentals in the higher price points will not meet the 2% rule but will cash flow. The 50% rule is pretty widely verified across the entire country for all asset classes(commercial, residential, SFR, MFR). That is that your expenses will be about 50% of gross fair market rent for the area.
So using the 50% rule to estimate expenses along with Cash on cash return will IMO work better for the higher priced rentals. This is of course my personal view on the subject but has been what I have seen for myself.
Thoughts from a third generation real estate investor, developer, property manager, and financier with almost 50 years of experience.
There are no magic formulas or short cuts to successful and enduring success in any business, especially real estate.
Every property is unique. Every "investor" is unique. A percentage formula will get you in serious problems if you do not go way beyond the percentage numbers.
Personally, I have never used any of the popular formulas suggested in this blog. Neither did my grandfather, father, or any of my many mentors. In fact, these types of methods are never mentioned because they truly do not work.
I agree with Tom, I wrote an article for BP on why I dont like the 2% rule.
Acquiring property within the parameters of the 2% rule results in a 12 cap rate (12% ROI as if purchased for cash), assuming expenses of 50% of gross. This is only obtainable on very low end property or on lower middle property in low growth or negative growth areas ( for residential). On commercial property would only be obtainable on class D property, i.e. property with numerous "undesirable" features. While the ownership of these properties can be very profitable, they are management intensive and hence require much time and effort on the part of the investor. When a fair "compensation" is subtracted for the net for the investors time, the 12% return usually evaporates quite quickly.
Utilizing property management companies for these properties is also usually unrealistic as most good property managers do not want involvement in these "problem" properties. The investor usually ends up with a bottom tier property manager, adding much additional cost through incompetence or indifference.
This is not to say that these properties can't be very profitable, I know more than a couple of people who have been very successful investing in just these type properties, more or less following the 2% rule. However, the investment in these "2%" properties is more of a business than it is an investment.
For every rule there exists an exception. There are a few posters on this forum who have been successfully able to invest in 2% properties on a part time basis. Perhaps they can provide their experiences.
You can find properties that fall into the rule but at higher price ranges it's probably not going to be realistic. You'll have a hard time finding a $200k house to rent for $4k/month but it's not that hard to find something for $25k that rents for $500 (or even $750). I don't find that the rule is very accurate because on the lower priced properties I'd expect a lot more than 2% and on higher end properties you won't get to 2%.
Two to three years ago I was trying to hit about 1.7, and doing it (upper blue collar),,today, I'd love to find a 1.4 deal in a nice neighborhood,,they are hard to find,,,,so you have to make the decision, do you sit on the sideline or take a 1.3 deal,,,,,
The deals from a few years ago spoiled me!
If you check out Bigger Pockets Podcast Show 29 I mention that I'm not only getting 2% deals, but in some cases 3% deals. I basically only invest in the zip code where I live because I'm not into warzone properties.
Yes, the properties are priced lower -- I try to stay around $25k per door.
Yes, I don't think this works on higher-end properties. Case in point, I'm renting out a single-family for $1,595/month and the total invested is $86,000. So as you can see that's only 1.85%.
The 2% rule should be used along with all of the other metrics out there to measure performance. ROI, CCR, Expense Ratios, Cash Flow, etc.
I've been investing in the metro Detroit area for about 2 years now. (preparing for the Detroit bashers now). The area obviously has been pretty beat up, but that also opens up opportunities for investors. I bought a property in a decent area. Crime is low, people generally take care of their place and it was ripe for rentals. I bought an REO for $20k cash, fixed it up and renting for $925/mo. My rent ratio is 2.7%. I have a great tenant, pays on time and I have a PM that manages this for me. Now I may be an exception.
Other areas in metro Detroit, I am currently seeing 1.4-1.5%. But I am also looking at +$75K properties that will rent for $1100-$1200.
so take the 2% with a grain of salt and don't live on one metric alone.
I agree with @Dawn A. , it can be done and I tend to do even better than 2%. I also do it in a little higher price ranges. $40-50K rent for $1200-1300.
The 2% rule is a great rule of thumb. It seems the detractors don't understand what "Rule of Thumb" means. No one should ever buy based on such a crude formula and no one is actually suggesting that. It is only a quick screening tool to see if you are in the ballpark.
Depending on your goals, resources and financial position you can adjust that 2% number. If you are a high income earner, want the depreciation, don't care about cash flow and are buying for appreciation then perhaps you may choose to use 1%.
Because of these variables the 2% rule is less valuable than the 50% rule.
Good luck - Ned
I am almost glad to hear that not everyone is getting 2%. My rentals a closer to 1.0 - 1.2%
maybe it is my location, but I never see anything with that kind of return. And i live in one of the most investor frindly areas of california.
@Charles Cline I would say it's most certainly location-driven. California seems to be more expensive than other areas of the country (not Manhatten however).
I was having no problem getting 3% in B- to C+ areas before prices started going up this past year. It can be done, but it's on the lower priced properties. The deals I like are houses in the $20-30K range that rent for $750-950. Those are some good returns.
In our area you could buy properties for under 40k two years ago. Now you can't find anything under 80k, unless it is destroyed or a HUD that investors can't get too. I have not seen anything in our market come close to 1.2% in the last three months. I am looking all the time!
Agree that rentals are achieving less than1% currently in the Northern Colorado market. Although I'm still finding opportunities because of the strong demand and still very limited supply of available properties to buy. It's my buy and hold properties for more than 5 yrs. that approach 1.2%. I'm still out there looking and finding opportunities because of the strong demand for rental properties.
It all depends on your buying criteria and what you want. I won't buy cheap houses, so I will likely not get the 2% rule. If you are down for cheap houses, then you may be able to get it (at least on paper).
I wrote an article on it-
I have another one in there called Battle of the Cap Rates which is fairly related but not 2% rule-specific.
Im glad someone started this discussion. Was looking at possible buy and holds in my area and no way could I get that formula to work. I paid $155k for my house and I think the most I could rent it for would be $1,500, if that.
Kind of a relief!!
I will say it over and over again that the 2% rule only works on lower-priced properties that rent well. You will absolutely not get those kind of returns on higher-priced properties. My problem is I'm becoming too complacent with 2% and need to try aiming for 3%.
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I know I'm replying to a dated post but figured I'd share my Boston suburbs (metro west) experience. I have a duplex and a triplex. Both in the $300,000 + range. I'm getting 1% on both of them.
They are both C+ properties in quiet blue collar neighbs. They were purchased with very little deferred maint. Probably could do slightly better if buying something that could use a little sweat equity but my 1099 job (and family/social life) is too demanding for that.
PS. Currently looking to buy & hold outside of the North East to get better returns. Just wanted to stay close to home to start with.
@Steeve Breton What would it take to Upgrade your properties to A/B Tenant status? And how long is the payback?
We had this discussion at our Movers and Shakers last Friday 1/3/14.
@Dawn A. "I will say it over and over again...." You sound like my mother;-)
In my world there's cashflow properties and appreciating properties, I go mostly for appreciating, so the 2% isn't even in my Universe.
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