Chicago 2% and 50% rule

11 Replies | Chicago, Illinois

Does anyone have any thoughts on applying the 2% rule and 50% rule in the Chicago area? I know that cost of living and rents are higher in Chicago, does this explain why I am having a hard time finding properties that the 2% and 50% rule apply?

I am looking at multi-unit properties on the Northside.

3 unit building: 2101 N Lawler Ave, Chicago, IL 60639

2 units are 3 bed/1 bath @ $1200/ per unit

1 unit 2 bed/1 bath @ $850

$3,250  total monthly rent

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List price $298,900

Taxes $3,500/year

B- Neighborhood

I think what you'll typically find is that the 2% rule only works in the lower priced areas - i.e. houses under 80k or so.  Where maybe you can buy an 80k house for 50k and can get 1k a month in rent.

But when you start talking about houses that are selling in the 300k range you are not going to come close to hitting 2%.  Even if you steal that for say 200k, you are not likely going to hit 4k in rent on it......  Not saying its impossible. But if you are waiting to find that deal before you will pull the trigger, you may only end up buying one property in the next 5 years. :-)

If you really want to know whether a house is a deal or not, run the numbers.

Estimate your purchase plus rehab. Figure out how you're going to finance. i.e. 20% down plus rehab out of pocket? Hard money? 

Then look and see what that payment will look like once you rehab the house, get it rented and get your end loan financing on it. And then figure out how much money you'll be out of pocket total on the deal.

20k out of pocket.
Payments (principal, interest, taxes and insurance)  of say 1500/mo.
Estimate your rent. Say 2,400/mo

And now you have a gross profit you can look at to see if the deal makes sense for you. If you have a gross profit of 900/mo, what does that net look like (i.e. repairs, vacancies, capex). Say 500/mo? 400/mo?  That gross to net calculation is very subjective to investors.

But ultimately, now you have what you believe is your net. 400/mo which is 5k a year.
Is 5k a year a good return on 20k to you? Yes? Then take it down.

And don't forget. Not only would you be making 5k or 25% return on your money with the rental cash flow. But you'll have principal paydown on that mortgage of another 300/mo or so maybe? Add that in as well (3,600/yr).  Add in maybe 2 or 3% for appreciation or another 4 to 6k a year maybe?   

Now what is that investment really returning on that 20k investment?

Its not just your 5k in rental income. Its rental income plus principal paydown plus appreciation. Which may be closer 13k total per year.

And, oh by the way - don't forget that your princpal paydown will only go up over time as your loan gets paid off further. And don't forget that rents typically go up over time as well. And, yea, don't forget - appreciation will go up as well. 2% of 300k is 6k.  But in 10 years, if that property is worth 350k, then your appreciation will be 2% of 350k or 7k a year.

And, lastly don't forget that your depreciation will make that rental cash flow completely tax free. So even though you're cash flow will be 5k, that 5k in income will be tax free (at least for the first 10 or so years depending on how much rents go up).   What is 5k worth pretax? 7k?

But again. If you're in areas where the prices of the homes you're buying are over 100k, don't bother with the 2% rule. I focus on the LTV numbers and the gross cash flow. If I'm able to get all in at 70% LTV AND I'm able to have a gross cash flow of $400 to 450/mo or more, I'm going to jump at the deal because I know I'll have positive cash flow and I know I'll make a lot of money in the long run.

2% is nearly impossible to find in Chicago outside of its riskiest neighborhoods. There are investors who know those areas well and can make that kind of return, but you need block-by-block knowledge and management expertise to do so successfully. 

Finding properties with expenses less than 50% of rents isn't that difficult in Chicago. Whether or not your heating systems are separated (and paid for by your tenants) is a big factor there. 

The 2% rule is tough to find in most of Chicago, but keep in mind it's a rule of thumb to help you determine whether you should further investigate the numbers. I prefer to use GRM for this determination.

For the sample property you listed, the Gross Rent Multiplier (GRM) is 7.66, which is fairly good for the area. Your target will depend on your area, but the lower the class of the neighborhood, the lower you want the GRM. Also, the sample property you listed is in more of a C to C+ neighborhood.

I'm a new investor and have been crunching the numbers for weeks on a property we want to close on, but realized this week I had some calculations wrong that are making my numbers significantly different than I thought. The goal was to rent three of the units and live in the 4th--ideally having the rents cover our mortgage and expenses completely. 

The property was completely renovated this year, so there shouldn't be any significant maintenance costs, but insurance and taxes are quite high because this is a 3 unit plus additional coach house with garage on first floor and unit on top floor. From my research, these are top rents we could get in the area as the market currently stands.

Could someone look at our calculations for a property and give us some insight if this is a good deal for Chicago? The property value will likely go up in the next few years because Logan Square is a hot market and so should rents but want to make sure its a good deal now. Please help. Thanks in advance! 

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@Diana Rdzanek

The 2% and 50% rules are rules that if you restrict yourself to, you may never buy an a decent investment property. Thats what they are. :-)

Sorry. Had to take the shot at those rules.  In terms of the answer......
I'm cheating here but @Jon Holdman had one of the most concise descriptions of the rules in a post awhile back so I thought I'd just repost them here.

The one exception I might add to the 50% rule is that I've seen some people suggest the 50% includes PM fees. So if you're doing your own PM, then those people suggest that expenses are really 40% of the rent. But I'm taking liberty with the rule there as some suggest its 50% if you self PM. Not sure which group to believe in terms of the definition

But here are a good rundown of the two rules:

-- from one of Jon's Post----------------------------------------------------------------------------

They're related, but are actually two separate rules of thumb. The 50% rule is that operating expenses and vacancy are about 50% of the rent.

The 2% rule says if you can find a property priced such that the rent is 2% of the purchase price, it will cash flow. Note that you cannot use this to figure out what the rent should be. The market dictates the rent. Rather, you have to use it to determine how much you can pay.

the 50% rule is stated that 20% is for repairs/maintenance/cap ex, eviction, nonpayment of rent, vacancy and another 20% for interest payment, principal, taxes, & insurance.

the remaining 10% is if you PM.

Originally posted by @Scott W. :

the 50% rule is stated that 20% is for repairs/maintenance/cap ex, eviction, nonpayment of rent, vacancy and another 20% for interest payment, principal, taxes, & insurance.

the remaining 10% is if you PM.

The 50% expenses rule does NOT include your borrowing costs! To quote @Jon Holdman from an earlier thread: "The 50% rule simply says that 50% of gross rents will go to vacancy, expenses and capital. This does not include the P&I payment, but does include taxes and insurance".

Of course, whether that rule is applicable for specific properties, "depends". The point is: your borrowing costs are EXTRA, so unless your mortgage payments are less than (the other) 50%, your cash flow is looking suspiciously likely to be NEGATIVE!