Is 2% rule a good measure for STR

19 Replies

Hi, BP family

I was recently thinking about a good measure on whether it is worthwhile to convert LTR to STR. I asked around and got different answers. Some say that your STR gross income needs to be at least twice as the LTR gross income, and some say 4X. Such measures seem to be a little problematic to me because they depend on how expensive the STR property is. For example, if I spend $1M on a mansion and the market long-term rent is $3000/m. Even if I make $6000/m by converting it to a STR, i.e., 2X of the long-term gross monthly income, I still could go broke.

This makes me think of the 1% rule for LTR, i.e., your monthly gross income needs to be at least 1% of the purchase price to ensure that the property has positive cash flows. In the same nutshell, I wonder whether. I could use the similar rule on the STR: that is, the gross monthly income of the short-term rentals need to be at least 2% of the market value of the property. This measure incorporates the market value of the property in the test and may be applicable in properties with wider ranges of values. Interestingly, from my super small sample size (2) of STR and short operating time, I found that the gross income of the two properties fit 2% rule quite well. To use a $200K property as an example, the following table listed major differences in income and expenses (please correct me if they are way off) for STR and LTR scenarios and ignored those items that are similar (property taxes, mortgages, etc). In this case, suppose the LTR has $0 positive cash flow after incorporating all other expenses, the STR scenario still has $700/m to $1600/m positive cash flow, which seems to be fair compensations for extra hassle and time related to STR.

Any inputs from you experienced STR operators are welcomed!

Thanks
Lee

STR

LTR

Gross Rent

4000 (2%)

1600(0.8%)

Cleaning, supplies, utilities

1200 (30%)

0 (0%)

Management fee (optional)

800 (20%)

160 (10%)

Vacancy

0 (0%)

128 (0.8%)

Remaining (including management fee)

2000

1312

Remaining (WO management fee)

2800

1152

Don't forget about STR taxes (I'm triple taxed at local, state, and federal) and vacancies

STR regulations change all the time - I wouldn't buy a place unless I was confident in the LTR numbers just in case

I know this that lives in a refinery town. He can buy a 3 bedroom bank foreclosure for a 4 digit number and rent it out for $600/week to 3 refinery contractors as an STR. $200/week is the same as a motel room, and that is what their per diem is based on. But they get a kitchen, washer/dryer, wifi, smart tv and a host of other amenities.

@Leon Lee Here is my two cents...  Forget the rules.  I have LTRs and I have STRs.  My LTRs have done well for me but in comparison my STRs are out of the park.  Now let me back up.  I am totally fine with my LTRs netting me about $250 - $400 month.  I let a management company handle it for 8% and it takes up almost ZERO of my time.  LTRs in my book the way I do it is strictly a 98% passive investment.  The STRs on the other hand are a business and need to be run like a business.  We manage those ourselves.  STRs are not passive they require some work.  My rule of thumb is I need to make enough money on my STRs each month to compensate for that extra work.  - And that my friend is different for each person.

Now this is just my opinion but the good measure on whether or not it makes sense to turn an LTR into an STR is not based on a rule but on your goals. Work the numbers up like you have and determine your reasons for doing it. Does the extra money you will produce with an STR adequately make up for your time involvement to justify going that route in your situation? That is only something that you can decide.

Honestly if anything 2% seems a little high.  That's $120k yr/gross on a $500k purchase.  I have no doubt there are people pulling that off in spades, especially those that purchased their property before the covid real estate boom, but are now renting in the post-covid rental boom.  But I think the numbers still work pretty well even at less than 2%.

Pre-covid there were definitely a lot of folks buying $500k properties with the intention of doing $70k-$80k gross annually and still quite happy with their ROI.

Originally posted by @Fiza Petro :

Don't forget about STR taxes (I'm triple taxed at local, state, and federal) and vacancies

STR regulations change all the time - I wouldn't buy a place unless I was confident in the LTR numbers just in case

Fiza

Thank you for reminding on the vacancy and possibility to convert to a LRT. For 2% rule, I assume that this is the gross income after the vacancy is considered (as short-term vacancy is unpredictable and seasonal). As for converting back to LTR, I agree, that I will only consider those that can cash flow as a LTR (although many believe that we are leaving money on the table by doing that). Otherwise, the risk is too high as the policy on STR restrictions changes fast. Interestingly, 2% rule seems to incorporate that possibility, because it seems that it's more and more challenging to reach 2% as a STR when the property is super expensive.

Thanks again!

Lee

Originally posted by @Ken Boone :

@Leon Lee Here is my two cents...  Forget the rules.  I have LTRs and I have STRs.  My LTRs have done well for me but in comparison my STRs are out of the park.  Now let me back up.  I am totally fine with my LTRs netting me about $250 - $400 month.  I let a management company handle it for 8% and it takes up almost ZERO of my time.  LTRs in my book the way I do it is strictly a 98% passive investment.  The STRs on the other hand are a business and need to be run like a business.  We manage those ourselves.  STRs are not passive they require some work.  My rule of thumb is I need to make enough money on my STRs each month to compensate for that extra work.  - And that my friend is different for each person.

Now this is just my opinion but the good measure on whether or not it makes sense to turn an LTR into an STR is not based on a rule but on your goals. Work the numbers up like you have and determine your reasons for doing it. Does the extra money you will produce with an STR adequately make up for your time involvement to justify going that route in your situation? That is only something that you can decide.

 Ken, 

That is actually the exact reason for me to figure out this rule, because after I calculate the numbers using this 2%, I found that I will have at least $700/m more cash flows for operating it as STR vs. LTR, which seems to be worthwhile for me to spend 15-20 minutes per day per unit. For what I have at the moment and how much my time currently worths, it seems still a deal.

Thanks

Lee

Originally posted by @Ryan Moyer :

Honestly if anything 2% seems a little high.  That's $120k yr/gross on a $500k purchase.  I have no doubt there are people pulling that off in spades, especially those that purchased their property before the covid real estate boom, but are now renting in the post-covid rental boom.  But I think the numbers still work pretty well even at less than 2%.

Pre-covid there were definitely a lot of folks buying $500k properties with the intention of doing $70k-$80k gross annually and still quite happy with their ROI.

Ryan

Your input is helpful! This is exactly the same for the 1% rule for LTR: if your property to be purchased is too expensive, it will be harder to achieve that 1% rule. 

Currently, this rule works for two of my STRs, and they are cheap properties (i.e., making $5500/month gross on two properties with market values of 260K). I assume that the 2% rule may need to adjust for more expensive properties because when absolute positive cash flow is high enough, even if it is less than 2%, the remaining positive cash flow is enough to support the operator. Besides, many people purchase expensive properties in mountains partially because they could use them for vacations, which might be another factor explaining why they are happy to purchase them. 

Thanks

Lee

 

Originally posted by @Fiza Petro :

@Leon Lee Sounds like you're on the right track. Have you selected a market yet?

Fiza

My properties are mainly around the great Atlanta area and my current goal is to convert my long-term rentals to short-term rentals. When they were purchased as long-term rentals, they were roughly meeting 1% rule, i.e., 1% of gross monthly income vs. the purchase price. Personally this feature could be advantageous for short-term rentals, as they could be easily converted back to long-term rentals suppose the STR policy changes in Atlanta (which gives me nightmare often). They are also aimed to compete with economical inns, as the need for such rentals should be in the middle of the bell-shaped curve. I heard a lot about cabins in mountains and STR in resort destinations here but it seems there are not lots of posts about such unsexy STRs. Any pros and cons are more than welcome!

Thanks

Lee

Originally posted by @Ken Boone :

@Leon Lee Here is my two cents...  Forget the rules.  I have LTRs and I have STRs.  My LTRs have done well for me but in comparison my STRs are out of the park.  Now let me back up.  I am totally fine with my LTRs netting me about $250 - $400 month.  I let a management company handle it for 8% and it takes up almost ZERO of my time.  LTRs in my book the way I do it is strictly a 98% passive investment.  The STRs on the other hand are a business and need to be run like a business.  We manage those ourselves.  STRs are not passive they require some work.  My rule of thumb is I need to make enough money on my STRs each month to compensate for that extra work.  - And that my friend is different for each person.

Now this is just my opinion but the good measure on whether or not it makes sense to turn an LTR into an STR is not based on a rule but on your goals. Work the numbers up like you have and determine your reasons for doing it. Does the extra money you will produce with an STR adequately make up for your time involvement to justify going that route in your situation? That is only something that you can decide.

 Great advice!


when you say hitting it out of the park what would say a $200k purchase price STR net a month after all expenses except income tax please?

Originally posted by @Michael Plante :
Originally posted by @Ken Boone:

@Leon Lee Here is my two cents...  Forget the rules.  I have LTRs and I have STRs.  My LTRs have done well for me but in comparison my STRs are out of the park...

 Great advice!


when you say hitting it out of the park what would say a $200k purchase price STR net a month after all expenses except income tax please?


Michael Plante - I only know my market but I would say hitting it out of the park would be doing at least a 30% cash on cash return or better which is getting harder and harder to find.  My guess is you will only be able to find that kind of return in a destination vacation rental market not a city/suburb market but I could be wrong.  But again, this number is different for every person based on their goals and objectives as well as how much their time is worth.

@Leon Lee one metric that has really helped me is comparing the estimated gross revenue to purchase price ratio among properties (ie EGR/PP). This is one way of gauging the efficiency of a purchase and a good way to compare like properties. Good luck!

I would not use rules of thumb for STR. You need to build out a model that includes the additional expenses (furnishings, additional renovations, utilities, services, cleaning, time for each booking). This information is not too difficult to obtain or estimate. Remember revenue is variable in STRs, you will have seasonality. You also are provided lots of flexibility--for instance, you can go after medium term renters for 2-3 months, short term rentals, etc...

@Leon Lee

Hi there, this is my first forum post and I'm by no means an experienced STR investor but I do own 1 and hoping to buy a 2nd soon.

The BP podcast episode 364 with Avery Carl was incredibly detailed about STR and in the discussion she says a 20% CoC is ideal and she also likes to see a profit of 40% yearly expenses. I have used those numbers as a baseline for my deal analysis and have found my first STR property fits well into those metrics even though they are different markets.

I guess to your point, this analysis is a little more in depth than a quick rule of thumb. But once you have a template made for your own analysis it's easy to see if a deal fits or not.

Originally posted by @Alan Martin :

@Leon Lee

Hi there, this is my first forum post and I'm by no means an experienced STR investor but I do own 1 and hoping to buy a 2nd soon.

The BP podcast episode 364 with Avery Carl was incredibly detailed about STR and in the discussion she says a 20% CoC is ideal and she also likes to see a profit of 40% yearly expenses. I have used those numbers as a baseline for my deal analysis and have found my first STR property fits well into those metrics even though they are different markets.

I guess to your point, this analysis is a little more in depth than a quick rule of thumb. But once you have a template made for your own analysis it's easy to see if a deal fits or not.

 Alan

I agree with you, that CoC return is probably the most solid and detailed way to calculate STR. That said, factors such as renovations, furniture expenses and seasonality on income make the calculation on CoC less straightforward. Do you have good templates that you would like to share for STR CoC?


Thanks

Lee

@Leon Lee unfortunately percentages have their limitations, because they are skewed on base amount. You may have a property that doesn't meet the 2% rule, but nets you $1000 per month.  You commented $700 was good additional income for 15-20 minutes per day. Does that mean $1000 isn't good because it doesn't meet the 2% rule? Another property may meet the 2% rule, but not net $700 a month. Is that ok if it still takes 15-20 minutes a day? That is for you to answer.

The biggest reason to choose LTR instead of STR is the extra effort (time and mental strain) involved in managing a STR. It really comes down to how much extra you are netting and if it is worth that extra effort.

Theoretically, if your time was equal, the better use of the property would be whichever produces even a dollar more of income. 

I'd say 2% per month, or 24% per year, of the total cost of the property in gross rents, is a good starting point.  For simple properties without a lot of upkeep/maintenance you will probably do pretty well.  For our larger Estate/pool homes, we target more like 3%.