What is the 50% rule and the 2% rule explained!
I've only been around a short while here at BP. I've noticed a lot of folks ask the question, What is the 50% rule & What is the 2% rule? I'll give you them with the disclaimer I'm currently not a landlord and am simply regurgitating what I've read here at BP and in books I buy. It's a fact that everyone's market is different and it's best to do your niche research before relying on one rule. However, it appears these rules would make a fantastic starting calculation when analyzing an investment.
50% rule Overview:
50% rule: At least 50% of your rental income will be spent on expenses. So if you get $800 a month in rent, $400 will be spent on expenses external to your mortgage/cost of capital. This is stated to be a conservative rule. Someone else can weigh in on that.
50% rule example: A single family home (SFH) as an investment is currently renting for $1200 per month. What's the maximum I should expect to pay for the mortgage and the expenses?
Answer: You should plan to pay .5 * $1200 = $600 on expenses. This means that you have $600 left over to pay the mortgage and get your profit. If you're looking for a $100 profit per investment, the maximum your mortgage could be is $500.
2% rule overview:
2% rule: Each month you should earn 2% on your investment. So if your house cost $50k, rent should be .02 * 50k = $1k
2% rule example: If a single family home (SFH) as an investment is currently renting for $1200 and the current owner is selling, what is the maximum I should offer for the home?
Answer: Using the 2% rule we can calculate the potential purchase price using the following equation: $1200 / .02 = $60,000. This rule can work the other way as well.
Another 2% rule example: A SFH investment home is currently on the market for $83k. What should I expect rent to be in the area in order to justify the purchase?
Answer: We can calculate this using the 2% rule as well. $83k * .02 = $1660 in rent each month.
2% rule & 50% Rule Conclusion
As with anything, these rules are just general rules. To gain a clear picture of an investment opportunity there are many calculations and situations to consider. I've also outlined many of those calculations such as Net operating Income, Capitalization Rate, and Cash on Cash return in another blog post.