Rental Property Investor · Fresno, CA · Member since 2017 · 109 posts · 48 votes
I bought my two investment properties about 8 years ago and at that time hadn’t heard of Th e 2% rule. When I recently learned of it, I went and did the math. Each of my properties falls between 1.3 and 1.6%. I’m wondering what seasoned rental property investors aim for when it comes to the 2% rule. Do you look for 2% or better? 1.5% or greater? Between 1 and 1.5%?
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
6y
Some of these posts are comical. For CA, anything in the 1.5% range is a heck of a cash flow deal and not easy to find, more often, created. People need to realize that the 2% rule, 1% rule, etc are not Rules at all, merely guidelines meant as a quick back of the napkin analysis. Your purchase decision needs to be made on a full due diligence of the numbers, the property, the market condition,s your goals, strategy, etc, etc. . . .
Any property in this country meeting a 2% rule at purchase is going to be a lower end property likely in a c- or worse area and likely not offer much in the way of appreciation. Ultimately you need to decide for yourself what kind of landlord and investor you want to be. Buying properties for $10k in some states in low end, high crime areas will require some heavy managerial responsibilities and difficulties, legal issues on evictions, etc. These properties may cash flow much larger on a % basis but only you can decide if the risk, time and headaches involved in that asset are worth it for you and your goals.
1% in many areas of different states will equate to break even or even cash negative whereas in some places, may provide small cash flows. In Los Angeles, a single family 3+2 1500 SF standard home built in the 50's is going to run you at least $300k+ (and many areas it will be $500k+) in most areas and is likely not going to bring you $3k+ in rent. The desert cities like Bakersfield and Fresno, parts of the Antelope Valley, etc can find deals in the 1.5% range but they are typically homes that are purchased for sub $200k and not in appreciating areas or in good neighborhoods.
I have a hard time understanding why properties on the west coast are so expensive. ie, a 1500 sq foot home going for $300,000 or more. Around here, you could build two 1500 sq ft homes from the ground up for $300,000. Are the costs of construction really high in Cali? Or what? What drives those high prices?
Same thing that drives the price for everything. Demand. People actually want to be here. Land value is accordingly quite high, and there are many locales where $300,000 won't buy you a vacant lot.
Specialist · New York City, NY · Member since 2019 · 399 posts · 168 votes
6y
1% is the new 2%. Honestly, as mentioned by other people, this has become more of a back of the envelop calculation than a guideline for most big cities in the US.
Rental Property Investor · St Augustine, FL · Member since 2019 · 264 posts · 279 votes
6y
@Nathan Shankles. I try to use the 8% to 10% rule but the rule is not based on the purchase price but on my money invested. If I put $50,000 down on a $200,000 property then I want cash flow minimum of $4000 per year. If I can’t get that why bother. I can get that in the stock market but don’t get the tax deductions. So basically I do RE for tax deductions. The market is much more passive and liquid and at the moment outperforming RE. RE income is classified as passive but owning rental properties is not a rocking chair activity. Plus it is not liquid money. The day the government takes away the tax breaks given to landlords with be time to cash out. So be aware of who you vote for. Not a political statement but a business model statement.
Real Estate Investor · Massapequa, NY · Member since 2015 · 8 posts · 1 vote
6y
@John Teachout The 2% rule is completely impossible to attain in large cities such as New York. What
Percent would work when single family fixer-upers are selling for $1MM? Just wondering if there are any guidelines for high value properties where rent cannot approach that equation.
@John Teachout The 2% rule is completely impossible to attain in large cities such as New York. What
Percent would work when single family fixer-upers are selling for $1MM? Just wondering if there are any guidelines for high value properties where rent cannot approach that equation.
That's why you often see people on the west and east coast investing out of state. For rentals, some parts of the country are just hard to make investment in a rental cash flow any significant amount if at all. In a lot of areas, one could purchase an entire portfolio of properties for less than one would cost in some regions.
Lender · Philadelphia, PA · Member since 2011 · 17 posts · 5 votes
6y
We’re focused on Section 8 properties in C area outside Philly. Our formula is rent / (purchase price + renovations). This evens out the turn key properties vs the higher rehab ones.
We can get $1,150 for 2 bed room which means our budget is $57k at 2%. We try to acquire for $45k and leaves $12k for renovations. Most of the time we’re out for around $8k giving us over 2%.
Rental Property Investor · Temecula, CA · Member since 2018 · 34 posts · 21 votes
6y
@Nathan Shankles great question and thread. I have a very small portfolio of SFHs in Southeast Michigan. My philosophy is similar to @Steve K. I have a busy professional career so I try to get into great areas, buy solid properties, and keep them in great shape, to minimize headaches.
I hover right around 1% (anywhere from .8% to 1.1%) but all my properties are cash flow positive. This investment style suits me because I do not have the skill set to efficiently rehab (I'd have to pay for labor), and I tend to get great tenants with very little issues. I see it as a trade off!
Lender · Philadelphia, PA · Member since 2011 · 17 posts · 5 votes
6y
@Nathan Shankles too early for me to say. The plan is to have 12 houses by end of 2020. We’ll have a mix of Sec8 and regular to test it. Long term goal is scale to 50-100 houses within a few years if our projections are consistent with reality.
I can tell you that we’ve been through a ton of houses both regular and Sec8 in the target area. Some of the most disgusting places are non Sec8.
It’s amazing how much stuff people can buy on a limited budget and never throw anything out.
@Nathan Shankles If your properties are in a good area those are great ratios. My properties ranged from .5%-1.5% on purchase. Maybe not awesome in some people’s minds but they have performed very well and in fact the one that has performed the best overall has been the one that was barely breaking even when I bought it. Why? It’s in a great neighborhood that is in high demand= great tenants and zero vacancy, rent increases of 16%/year with no complaints or turnovers, the rent is high enough that even though the ratio is low the actual dollar amount of profit is plenty to cover unexpected cap ex and maintenance issues, principle pay-down is significant, and best of all while positive cash flow is currently “only” $350/unit/month (achieved through rent increases), appreciation has been equal to $350 PER DAY which has allowed me to refinance and cash out my initial investment plus well over six figures. My C class properties had more initial cash flow on paper but in reality they have more tenant and maintenance issues that eats into profits and have appreciated a lot less and so they have performed much worse overall with everything factored in. Plus they are much less pleasant to own which has become a bigger factor for me as I’ve scaled up both my business and my family. Looking back at the numbers of how my high cap rate vs. low cap rate properties have performed over time as well as the headache factor has converted me to a low cap rate, highest overall quality property in the best location I can afford investor.
This is a perfect example of what I explained above regarding quality of location and property with rent to purchase ratios at 2%. Here is an investor who has experienced first hand the negatives of investing with a main focus of nailing a high rent to purchase ratio. Great real life example.
@Steve K. Thank you Steve! Do you need more capital up front to do your low cap rate/high quality deals?
In a price per unit sense yes. However as far as being a wise use of capital I like them better overall due to initial capital being tied up in those properties for a shorter time period. I've found I'm able to force more appreciation quicker, which means being able to refinance out my initial investment then reinvest it quicker. But yeah of course higher end properties are more expensive generally speaking which does create a barrier to entry and can be a limiting factor. Cap rate is essentially a function of supply and demand so properties in higher demand will usually have a higher purchase price per unit, whereas in the flip side is higher cap rate properties are less desirable to own and considered higher risk so they are less expensive. Buying right is possibly the biggest factor in any asset class. The stakes are higher as price increases, but potential reward is higher too. Higher overall quality properties, if purchased right, offer a lot that lower quality assets don't in my opinion. That doesn't mean it's the best strategy for everyone. For me, I've found that I'm better able to leverage my particular skillset when sourcing off market deals in high end areas and adding value. For example even if I fixed up our section 8 rentals a bunch, they'd still be located where they are and I'm always going to be limited in terms of increasing rents and forcing appreciation to make them more valuable, so no matter what I do it's slower going in terms of building up the necessary equity to refinance out my initial investment or sell for a profit so I have more money tied up in those buildings longer. A lot of this comes back to purchase price and sourcing good deals. It's certainly possible to force a ton of appreciation quickly with lower cost assets, I just haven't had as much success in that niche personally. If somebody else is really good at finding distressed apartment buildings in rough areas and turning them around, they'll be more successful doing that. It's probably a more specialized niche that fewer people can do though. The same is true for managing C-class rentals, if somebody is good at that and C-class property is mostly what the inventory consists of in their area then doing that will be the best strategy for them. I guess it comes down to finding the way you will personally be able to avoid just paying retail prices and getting average returns. For me buying C-class apartments that I'm mostly hands off with has lead to average returns and the few home runs I've hit have been higher end properties that I've been more successful at sourcing for the right price as well as being in great locations that have allowed me to add value, increase rent, and benefit from strong appreciation. So I plan to do more of that. I still have minimum cash flow goals I like to hit, but I'm also looking at the overall returns on a property more now which for me includes the ability to force a large amount of appreciation in a short time frame in order to recoup my initial investment and reinvest it. I'm also looking at tax benefits, principle pay down, risk mitigation/the headache factor/pride of ownership/enjoying what I do on a daily basis because I like working on high end properties and dealing with that tenant base more (even with management in place, or perhaps especially so because management fees can get crazy on low-end properties and it's a lot harder to find high quality management services for low quality properties), and yes I'm looking for that dirty word appreciation. I don't view appreciation as purely speculation as a lot of folks like to say. For me it's a calculated decision in the same way that projecting positive cash flow is. I know my market, which areas are most likely to continue to be in high demand/experience increased demand, where new transportation routes and developments are being built and other factors that make appreciation fairly easy to predict in my opinion. Other markets with less predictable growth or zero growth may make pure cash flow plays a more reliable strategy but that doesn't mean that's the best strategy everywhere. Yes values can always go down, and that's the main argument that buying for appreciation is speculating, but then again rents can also go down. So using that same logic who's to say that buying purely on cash flow can't also be considered speculation? Isn't it also speculation that one will receive a certain amount of rent as well as what ones expenses will be compared to rent? The risk there is that expenses are higher than projected and rents are lower which could be due to factors beyond control leading to higher vacancy rates/needing to lower rent to keep units occupied. Appreciation and cash flow are both affected during a downturn, rents might not fall off the cliff as much as values do but they do go up and down. I'll be the first to admit that exactly none of my cash flow projections have been 100% accurate, so it seems to me like buying for cash flow is actually just an educated guess process much like buying for appreciation is, in my mind anyway although I realize this may go against current popular thought. I like to look for all the ways money is made in real estate and invest in properties that will cash flow as well as possible while also building wealth through appreciation at the same time. To me this means looking at the overall QUALITY of a property not just some arbitrary 1 or 2% "rule". In my local market, with the skills I personally bring to the table, I've had the most success with adding value to the highest quality properties in the best areas I can afford. I'll hold my section 8's for now as well, I like them too and I'm hoping they're in the path of progress long term and will also be a nice blend of cash flow and appreciation eventually, just no longer buying more of them strictly for how they pencil out on paper. The cash flow is good, they just haven't worked out quite as well as my nicer properties have thus far in terms of overall return and in terms of being in line with my personal goals. I'd encourage every investor to look at the skills they personally possess, learn their market intimately, set some honest personal goals, assess available down payment and reserve funds conservatively and honestly in order to avoid being undercapitalized, avoid paying retail whenever possible, and find the best way all those things fit together to find the best strategy for themselves personally. It sounds corny but I'm learning it's a little more of an art than a science and determining whether or not a property is a good value comes mostly from experience and looking at it in it's entirety: location, condition/ construction quality, tenant base and overall rental market trends, cash on cash return, IRR etc. are all equally important or perhaps more important than initial rent to price ratio.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
6y
This is a fantastic nugget from Steve:
"and yes I'm looking for that dirty word appreciation. I don't view appreciation as purely speculation as a lot of folks like to say. For me it's a calculated decision in the same way that projecting positive cash flow is. I know my market, which areas are most likely to continue to be in high demand/experience increased demand, where new transportation routes and developments are being built and other factors that make appreciation fairly easy to predict in my opinion."
Over the years, I have been part of several discussions involving appreciation here on BP and even myself called it "gambling" way back when. This great nugget shows just how wrong I was in my early and inexperienced thinking. While appreciation is certainly not guaranteed and you can't pay your bills with it today, it is something that will pay your bills well down the road if you invest wisely and with a plan as explained above. Loved the entire post, but this portion really hits it home.