Question on 2% rule of thumb mentioned in podcasts.
Sycamore, IL 路 Member since 2016 路 48 posts 路 14 votes
Being in Southern California, there is almost no chance you will come close to the 2% rule, especially for a SFH. This rule is far more likely to be achieved on a $30k house (requires only $600/month rent). There are a lot of places in the US that have houses like this, but many are in C or D neighborhoods. A lot of out-of-state turnkey companies get close to this 2% rule, but the risks are higher (vacancies, unexpected repairs/damages, evictions).
I've seen it often stated as the 1% rule in many areas, especially in better neighborhoods. However, in SoCal, you still only achieve that 1% rule in multi-families, not in a SFR.
Good and helpful points by all.
One way that I describe it to my friends who are interested in REI is that there are 5 ways to make money in real estate, and usually you are going to make a trade-off. If you want to maximize cash flow, you will probably lose out on equity appreciation. If you want to maximize equity appreciation, you will probably not cash flow well or at all (SoCal!).
5 Ways to make money in REI (from a blog post on BP, I think)
1. Equity capture at time of purchase (buy a $100k house for $70k)
2. Cash Flow (pay $1200 in monthly expenses= PITI + all expenses including CapEx, vacancy, and maintenance, BUT make $1400 in rent = net $200 monthly cash flow)
3. Equity appreciation (buy a $100k house and 2 years later, it is worth $135k)
4. Tax benefits (depreciation, Real Estate Professional loophole, interest deductions)
5. Principal pay down by renters (your renters are paying off your $75k loan to $0 over time)
#1 - #3 usually involve trade-offs.
If you buy an out-of-state, cash-flowing, turnkey rental, you can realize great cash flow but you are likely overpaying a little (no equity capture) and will likely not see great appreciation. If cash flow is important to you, then this is a great investment.
Most people consider SoCal and NorCal an equity appreciation play. Cash flow may not be realized, but many count on their property going up, possibly doubling or more in value. This has been realized in the past, even in recent years, but most see right now (mid-2016) as not a good time for that kind of play as prices don't have much more room to go up. Critics of this argue that you can't predict the future, but there is no denying that people have made a ton of money over the years in CA and similar markets through appreciation (esp post housing crash).
Flipping is obviously not about cash flow or anything else, but equity capture at time of purchase.
BRRR combines equity capture, cash flow, and possible appreciation, so it has gotten a lot of interest, esp in the BP world. It's like flipping a house and selling it to yourself (financed through a bank who pays you for the house), then renting out the house w/ positive cash flow. Sounds great, but not as easy to execute (although not impossible as many are doing it).
If you find a house that you can (1) buy for 70 cents on the dollar, (2) cash flows $1000 per month with great tenants, and (3) is in a great appreciation area in an A or B neighborhood, then you've found the holy grail of real estate! Let me get a piece of that deal!
I agree with most of this and it is a great explanation of the trade offs ... bottom line is there is no free lunch, if you are getting one it is usually in exchange for the others, and that could be ok if it is a conscious decision/strategy from the investor, but can lead to trouble if the investor is making trade offs without being aware.
The one point where I would like to sharpen a bit though is on the cash flow. It is true that markets with high appreciation tend to not cash flow well in the SHORT TERM, but it is not necessarily true that they do not cash flow well in the LONG TERM. High appreciation rates go hand and hand with high rates of rent increases. To illustrate, which one cash flows better?:
1)2% rule property, with average rent increases of 2%
2)0.7% rent to purchase price property, with average rent increases of 6%
The answer depends on many things, and time frame is one of them. Depending on if you are talking in the short term or long term makes a big difference on the answer to this question, as do a lot of other factors.
I read all your comments over and over again guys! Thank you everyone for your inputs.
@Account Closed, thank you for keeping in mind that I am new and addressing critical things that someone like me are likely to miss. Although I knew, I might come across focusing on PTR based on my question, I did not realize that I actually am trying (so hard) to get cash flow and appreciation in one deal. It made sense when you stated they were derived from two things. I also like that you gave me examples. It made your points clearer.
@Dawn Anastasi and @Katrina P. thank you for providing locations and specific numbers of what you've done. It makes me see how you've done it and it translates well to me, learning wise.
@John Lee you always provide very specific details. I really like that. It makes me think. I also like how you breakdown things and explain them one by one. It helps a lot in understanding concepts; being new is a phase-thank you for keeping that in mind when responding to my questions. with this kind of support, i'm definitely on way to getting my foot in the door! Thank you so very much too for brushing me up with the acronyms. 馃槉馃槉馃槉
@David Faulkner-great pointers! Another example of someone who translates well with newbies! I like how you made me aware of timelines. It makes me think and consider what to do even with the place I have now! As a newbie, uber excitement can just overcome one and if not careful, one may make quick moves because their focus is only on specific things. I thought I already knew, but being new can be dangerous. It also made me realize to look at a bigger picture. A longer goal. And with that, I also realized how important to truly understand the property--Location, condition, price; etc.! So now I am thinking... how do I find out these information when eyeing a purchase? aah..realtor. but how do you find a good one?!
I cant thank you all enough; I love learning and you are all wonderful mentors!