Making sense of 2% rule (was there a mistake in the book?)

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I'm trying to make sense of the 2% and 50% rules as stated in the books. I realize they are just rough guidelines, but even as such I'm having a hard time getting them to add up.

First of all, in the example he uses for the 2% rule it seems like he gets it backwards? First he says 2% rule is rental price/home value and uses as example a 2K rent and 300K value and says that's 1.5% - but 200/30000 is 2/3 = 0.67%, which is not even close to making the cut. Am I misunderstanding something here or did he make a mistake?

In general, the 2% rule means you have to charge 2K per 100K of home value. This just seems off to me. For a 300K home you would need to charge 6K in rent. It seems to me that anyone willing to pay 6K in monthly rent wouldn't want to go near a 300K home. Where I live 300K gets you a nice home in a nice area, but 6K rent gets you a posh mansion in an upscale neighborhood, or a penthouse etc. But I don't see any market where there's overlap between 300K homes and 6K rent.

Now for the 50% rule, it makes a bit more sense. It states expenses can be approximated to be 50% of rent, so cashflow will be 0.5*rent - mortgage payment. In other words, as a rule of thumb, rent has to be more than twice the monthly mortgage payment for positive cashflow. With 5.5% interest rate, this means you need to charge roughly $900 or more per 100K to be cashflow positive. That sounds more reasonable, but also doesn't even meet the 1% test.

Just want to check my understanding here, because my takeaway from all of this is that anything with more than 1% rent vs cost means you can support more than 50% expenses and still be cashflow positive - so 1.5% test or more only needs to be met if there are higher than normal expenses (i.e. older house etc).

For example

House price 100K

Rent is $1500 (1.5%)

Mortgage is ~$450

Meaning I could have 1K in expenses (which is 67% of rental price) and still be (barely) cashflow positive

House price 100K

Rent is $2000 (2%)

Mortgage is ~$450

Meaning I could have 1.5K in expenses (which is 75% of rental price) and still be (barely) cashflow positive

House price 200K

Rent is $3000 (1.5%)

Mortgage is ~$900

Meaning I could have 2100K in expenses (which is 70% of rental price) and still be (barely) cashflow positive

House price 200K

Rent is $4000 (2%)

Mortgage is ~$900

Meaning I could have 3100K in expenses (which is 77.5% of rental price) and still be (barely) cashflow positive

In the book, expenses are said to range anywhere from 30%-70% of rental price. So the 1.5-2% test meets requirements for houses on the high end of the spectrum for repairs. Looking at the ones at the lower end of the spectrum

House price is 100K

Mortgage is ~$450

Meaning if I'm on the low end of the spectrum (30% of rental price)with 193 in expenses, rent can be as low as $645 (0.65% of purchase price) and still be (barely) cashflow positive

I.e. I can go down to 0.64% of house price if the house has exceptionally low amount of expenses (brand new, tenant pays for all utilities)

So 0.65% if brand new, tenant pays for all utilities

to

2% if house is old/falling apart and tenant doesn't pay for utilities

Thoughts?

@Malcolm Jackson I agree that the 2% rule is a tough rule to use in every market. I would argue, however, that a $300,000 house is almost never going to make a great rental, so may be the 2% rule proves that as well. I can tell you that I have represented clients in Berwyn, IL where i invest, and they have purchased 2% deals this year off the MLS. They exist, and they cash flow in real life!

I also have found that the 2% rule is easier to achieve in multifamily than in single family. Again, this is probably area specific, and it may be different where you live. Deals can still make sense at less than 2% as well. I recently bought a 9 unit apartment building at 1.5% and it is making money!

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