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