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.
Comments (16)
Hello! I´m comparing the 2% rule and the 50% rule with the Rental Property tool that BP offers. The results are super different, like going from hell to heaven. Should I trust more the BP tool over the 50% rule? I´m a newbie so I appreciate the help. thanks!
Laura Casillas, almost 6 years ago
Wow, I wish that rule worked in San Diego. If that was the case rents would have to be 4-5 times what they are currently to justify the valuations. I would imagine that there are fewer and fewer areas of the country with B grade properties that fall within the 2% calculation?
Matt Rachow, almost 7 years ago
Awesome synopsis!! Thanks for the clarification. I love the reverse use of the 2% rule. New Investor here!! Where do you get a feel for the rent in a market? Zillow.com?
Pierre Toussaint, over 7 years ago
Brian the 2% rule is just a wag. In hot markets it may be unachievable unless you're in a D/F level neighborhood. It would be extremely valuable for you to pull up your county assessor and see what people are paying for rentals in your area.
For example: Let's say you can see an investor bought a home for $100k and it was in rent ready shape. If that home is pulling $1000 rent you can determine the rule for your area. 1000/100,000 = .01 or 1.0% per month. I'd do this for 10-15 homes to get an idea or just call some of the investors in the area and ask.
In my case, the 50% includes PITI. Also, if you're not a good handyman then you need to find one. If you have my luck, things break frequently and you'll be using the money you set aside for expenses.
David Rundle, almost 8 years ago
When you say 50% for "expenses", and the rest can cover "mortgage", are you putting interest, taxes, and insurance in the "Expenses" and the "Mortgage" is really just principal?
Also, that 2% rule means I would probably never be able to buy a rental property in my area. There is a $150k condo that I am considering, but there is absolutely no way that it could get $3k in rent (2% of $150k).
Brian Lobb, almost 8 years ago
Excellent explanation. Unfortunately that worked in 2010. Now there is no way to find a property like that in Chicago. But I continue to search for this "unicorn"
Christian Ivanov, about 7 years ago
it does exist in Chicago
Dooreuhn Cee, almost 7 years ago
It might work in OK, not in the NY Metro.
Account Closed, over 5 years ago
Great synopsis! One more thing to make clear, is the 2% rule is most accurate in the $500/ month rent range. Too far past that and it's not as helpful. Lots of coverage on this in the forums.
Shane Woods, over 10 years ago
Great synopsis! One more thing to make clear, is the 2% rule is most accurate in the $500/ month rent range. Too far past that and it's not as helpful. Lots of coverage on this in the forums.
Shane Woods, over 10 years ago
One important caveat to the 2% rule is that it should include any immediate capital expenses you will need to put in. So for example your $1,200/month place needs a $5,000 roof when you buy it. Your purchase should be $1,200/0.02 = $60,000 - $5,000 = $55,000
Shaun Reilly, over 10 years ago
One important caveat to the 2% rule is that it should include any immediate capital expenses you will need to put in. So for example your $1,200/month place needs a $5,000 roof when you buy it. Your purchase should be $1,200/0.02 = $60,000 - $5,000 = $55,000
Shaun Reilly, over 10 years ago
This was a very clear and concise explanation of both rules! Thanks for bringing it all together.
Dawn Vought, over 10 years ago
I like. I do the 'Reverse' 2% rule like you stated above to figure out what I can offer on the house - repairs - other costs. To me, it's better than ARV when dealing in a high rental market and takes the stress of not having access to the MLS off the shoulders of new wholesalers. 2% is a great starting point (Still need to due your diligence!) What are your feelings on the 2% (1.5%) Rule vs ARV?
Taylor Jennings, over 10 years ago
Taylor, I just made a follow up post concerning ARV and the 70% rule. I'll just paste the link since I have no idea how to make one in a comment. http://www.biggerpockets.com/blogs/4454/blog_posts/32224-the-70-rule-explained-as-it-pertains-to-flippers-and-wholesalers
David Rundle, over 10 years ago
Perfect David Rundle! Thanks for sharing this stuff! You did a great job of breaking it down, nice and easy, for folks. Thanks!
Brandon Turner, over 10 years ago