50% rule and the 2% rule

[N/A N/A]

I thought I had heard another investor say that the two rules were basically the same thing. Maybe I misunderstood, but if not could someone explain how they are the same thing??? And also, the 2% rule seems to work best when searching for properties under 100k. It seems that rents are a larger portion of the purchase price the lower the purchase price. Hope these make sense.

THANKS!!

[Jon Holdman]

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 an emperical rule from observations of many properties. I've seen it other places than posters here. For any particular property, esp. a SFR, it may be less in some years. But, all it takes it one big expense to go way over and bring the average up.

The two rules do work together. If you collect 2% of the rent each month, you're collecting 24%/year. If expenses eat 50%, your NOI is 12%/year. Interest will probably run you about 8%. That leaves you 4% of the purchase price each year as profit. If you only collect 1% each monty, and pay 50% in expenses, that leaves you an NOI of 6%. Interest is going to take all that and 2% more. If you have an amortized loan, you'll have a bit less cash each month, but you'll get that back when you sell.

Sometimes people say, well, I'll put a big down payment on the property to try to make a higher price work. Say 50%, and assume 1% rent. You still have the same 6% NOI. But, now your interest cost is only half, or 4%. So, it looks like the property cash flows 2%. If you look at it that way, you've invested that 50% into an investment that returns nothing. Or, if you look at it as a cash on cash return, you're 4% on your money. Less than bank CD's.

Reflex, you say its impossible to find a property in your area that will cash flow using these numbers. I assume you really mean its very hard to find a property that meets the 2% guideline. True in many places, including right here. But, if you pay more, you won't make any money.

Jon

[Hollis Cook]

I ran the numbers again, taking out all seller cash back, 10% down with a selling price of $299K (out of pocket increases to $48k) the C on C ROI still comes out at $582 the ROI drops to 19.29% but the the 50/50 rule increases to $511, is that because of my increase in cash down? The 2% rule is still way off. I can't figure this out, please help. Thanks!

[Rob U.]

In Colorado, a property for sale for $260,000 (built 2009), monthly rent $1,700 for this property. Unless I'm buying crack houses, there is no chance of paying $85,000 for a property and getting anywhere near $1,700 in RELIABLE monthly rent.  Also, you're telling me that I should assume $850/mo in expenses?  That is very unrealistic, more like 10x too high actually.  I could buy property in Kansas, follow the 2% rule, and have deadbeat tenants who don't pay rent, don't have stable jobs, and property values stay flat for decades.  

Someone please explain how the 2% and 50% rules make you money in real estate, not in theory, but in actual practice!

[Nadia Cervoni]

Hi there. Question about the 50% rule. Is one aiming to have simply a positive cash flow to assume it's a good deal? Or is there a threshold you should aim for? Thanks.