The 2% Rule Should Die a Horrible Death

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The 2% rule needs to die.

Now, before I go on, I’m well aware that no one would say that any rule of thumb, such as the 50% rule or the 70% rule, is applicable in every situation. A rule of thumb should be used as shorthand to figure out if a property is worth pursuing before a thorough analysis is done. That way you can cut out the clutter without wasting your time on dead ends. Most of the time, the 50% rule and 70% rule are good rules of thumb. The 2% rule is not.

The 2% rule—while rarely explicitly defined—states something like “to make a good profit on a single family home it’s rent to cost ratio should be at least 2%.” So for example, if a property rents for $1000 a month and you can purchase and rehab it for $50,000 total, it would have a 2% rent/cost ($1000 divided by $50,000 equals .02 or 2%).

There are two primary reasons this rule is bunk:

1) Rent/cost ratios are not a consistent measure of cash flow potential.

2) The rule, if followed, leads investors into areas only specialists should go.

Rent to Cost Ratios Aren’t a Good Measure of Cash Flow

I don’t mean that rent-to-cost ratios are useless.

In fact, I use them all the time.

But rent to cost ratios are only useful when comparing properties in like neighborhoods and price ranges. So let’s say I have House A and House B and both are in relatively similar neighborhoods (regarding average home price, income, crime rates, school rankings, etc.). I can buy and rehab House A for $60,000 and it rents for $900/month.  I can be all into House B for $50,000 and rent for $800/month. With this analysis, House A has a 1.5% rent to cost and House B has a 1.6% rent to cost.

House B is probably a better investment. “Probably” being the key word. There is still more analysis to do; a comparative market analysis, a pro forma, an estimation of the cash flow and perhaps cap rate, etc. And of course, you need to make sure you are being realistic about your rehab budget.

But let’s say House A was $25,000 and rented for $500/month and House B was $100,000 and rented for $1250/month. Oh, well now, it’s easy, House A’s 2% rent/cost ratio blows House B’s paltry 1.25% out of the water!

Not so fast.

Square foot for square foot, a roof costs about the same on a $25,000 house as a $100,000 house. You may go with vinyl or builders grade carpet instead of tile and a higher quality carpet to save costs on the $25,000 house. But in the long run, that will probably cost you even more because it’s much harder to do spot repairs on vinyl as compared to tile and I don’t think I’ve ever seen builders grade carpet last for more than one turnover. Used appliances go out much quicker than new ones. Same with HVAC. Ever tried to wash marks off a wall painted with flat paint? Good luck.

Yes, you shouldn’t be putting granite countertops and Brazilian hardwoods in a lower end rental, but cheap materials and/or labor is just going to cost you more down the road. Therefore your operating expenses will not go up evenly with price. Whereas a $50,000 rental may cost you $3000 per year, a $100,000 house may cost you $4000 per year. And even though the taxes are much less, a $25,000 house may cost you closer to $5000.

Why? Because houses that are that cheap are usually in rough areas. Houses in rough areas are more likely to be treated poorly and have more delinquency. In other words, you will likely have to turnover these homes more often and repair more damage each time.

And that doesn’t even include vacancy rates!

Vacancy rates are one of the key assumptions each investor must make when they are analyzing an investment. And vacancy rates vary dramatically from one neighborhood to the next. The 2% rule would have you believe the insane notion that you can hold vacancy constant.

What I’m basically saying is that really cheap houses don’t usually cash flow. Or as Ben Leybovich puts it,

“So… You bought this house for $18,000 and spent $12,000 to put lipstick on the pig.  You’ve had to work hard to keep it full.  The house was trashed more often than not.  You’ve evicted most tenants because people that are willing to live in this location and in a unit of this character are economically unstable…this doesn’t mean that they are bad people, just that they don’t have control of their financial lives, which often leads to evictions and frustration!”

Do you think you can honestly compare such an investment to a home in a thriving middle-class neighborhood? No? Well the 2% rule thinks you can.

The 2% Rule is Dangerous

When I first got to Kansas City, I was looking for apartments and one of the key numbers I was looking at was price per door. This is very similar to the 2% rule in that, quite obviously, the best (worst?) prices per door were in the roughest neighborhoods. Let me tell you that the first properties we bought have had much higher yearly expenses and much lower occupancy than the properties we later bought in blue collar and middle class areas.

What the 2% rule does is it pushes investors, particularly new investors, toward these rough areas. It says rent to costs equals cash flow and thereby you should go where the rent to cost’s are the best. “Hey, this property’s market rent is $600 a month and I can buy this house for only $30,000. It must be a great deal!

Then the property doesn’t rent for months while tenant after tenant with checkered past’s are turned down. Finally it’s leased, but the tenant stops paying after a few months. They trash the unit. Then you sink a bunch of money into it. Then the whole process repeats itself.

I have unfortunately seen this madness happen more than a few times to more than a few investors and it’s all lead to more than a few foreclosures.

This is not to say there are no good tenants in rough areas or that you can’t make money investing there. There are plenty and you can. But you really need to be a specialist to make money in rough spots. And most investors and all newbies are not specialists.

You Can Make Money if The Rent to Cost is Less Than 2%

You could say that this only applies to really cheap houses in rough neighborhoods, but the reverse is also untrue. You don’t need 2% for an investment to make sense. Our average rent to cost ratio is around 1.5% and our average all-in price is usually about $60,000 to $70,000. Yet our properties generally cash flow $100 a month over a fully financed 9% interest loan (we get private loans up front and then refinance later with banks at better rates). Here’s what a typical investment of ours looks like:

All in Price: $60,000

Annual Rent: $10,800 ($900/month)

Vacancy: $1,080 (10%)

Annual Expenses: $3000

Debt Service: $5400 (9% interest only)

Cash Flow: $1,320 ($110/month)

And it gets much better after the refinance.

So should we be avoiding these 1.5% rent to cost homes? The 2% rule thinks we should.

How You Should Look at Rent to Cost Ratios

The reason rent to cost ratios work on relatively similar homes but not across categories is because you’re basically assuming 100% occupancy and that operating expenses will correlate to prices perfectly. A better way to look at it is effective rent to cost. Namely, what is the actual rent you’ll be collecting. And this still only works when you account for annual expenses, which can only be held constant when looking at relatively similar areas.

We have different rent to cost targets for different areas. In the lowest end areas we’re willing to buy (usually $30,000 to $40,000), we aim for about 2% or better. In the best areas we look at it, we aim for about 1.2% to 1.3% or better. We call these “equity plays” because they don’t cash flow much, but they’re the one’s we tend to have the biggest equity margins in.

That’s how you should look at rent to cost ratios; as a metric to compare like and like (relatively speaking), not as a blanket rule. In fact, not as a rule at all.

Questions? Comments? Leave them below!

About Author

Andrew Syrios

Andrew Syrios is a real estate investor in Kansas City and a partner in Stewardship Properties along with his brother and father. Their company owns just over 500 units in four states.

65 Comments

  1. Frankie Woods

    Excellent article! Thanks for sharing this. I have two “pigs”, and I’m experiencing exactly what you outlined above. However, as I become more educated (specialized) in the area, the number of problems I’ve seen in the past are starting to decline. I know like to be diversified, but I think your article nailed it on the head!

  2. Mike McKinzie

    Well said, Andrew, well said. Just like I said on Ben’s Blog, a Water Heater costs the same whether the house rents for $500 or $5,000 a month. A paint/carpet/clean up is going to cost $3,000 to $5,000 per unit, whether it rents for $750 or $2,000. I just did two of them, one rents for $750 and one rents for $995. Which one will I recover my repair costs quicker? There are specialist’s who can make the 2% rule work well for them, but the systems you need in place are complicated and require a lot of experience. Give me a $130,000 house that rents for $1,500 a month, is less than 10 years old and is in a solid, 90+% Owner Occupied neighborhood, and I will not only make money, I will sleep well at night. I will also have a higher chance of selling it for $200,000 in a few years! On top of all that, the average tenant stay is 5 years or longer! NO VACANCY LOSS! Great Article Andrew!

  3. Jim Henderson

    Thanks for a great article. When I first started looking at rentals in my area, I tried to apply the 2% rule and found absolutely nothing. Yet the rental properties keep selling and the landlords here aren’t going bankrupt; they are buying more properties. I had to do a lot of head scratching before I finally started sitting down with other landlords and looking at their numbers. I’m still not happy with the returns but I can see how they make money even though the 2% rule would keep any investor from ever buying any rental property in my area.

    • Marco Santarelli

      The baseline (or benchmark) investor’s should consider is a 1% rent-to-value ratio. Call it the “1% RULE” if you want. That’s a good indication of a balanced market from an investment perspective. You could go as low as 0.7% but 1.0% and above will provide good cash-flow and rates of return.

      Contrast that to the more cyclical (bubble) markets where the R/V ratios are as low as 0.3% and you can understand the importance of this metric. On the other end of the spectrum you will often find many high R/V ratio properties in economically depressed or challenged markets (i.e. rust belt areas).

    • Brad Lohnes

      That’s the first thing that jumped out to me, since I’m in a completely different country. 2% is so far from what’s achievable here in New Zealand, it’s difficult to understand how it’s a “rule”. I treat all “rules” as mere guidelines, and cash flow analysis is usually the main way that I determine whether a property is worth it.

      But all of my properties would have had a ratio of about 0.7% at time of purchase. Yet all were cash flowing properties, all have gone up significantly in value, rents have gone up, and tenant stability hasn’t been too bad. These would be in what you would call class C neighbourhoods.

      House prices in this country are just too high for 2% to be an actual rule…and property is the #1 way people in this country become wealthy (not nearly as much focus on the stock market as in the US).

      Thanks for the article!

      • Katie Rogers

        On the other hand, we should be careful about throwing out guidelines because our own market cannot satisfy the rule. Perhaps our market is the problem, not the rule. As an analogy, should we redefine healthy weight guidelines simply because 67% of Americans exceed them? In my town, it is impossible to find even a 0,7% house. In order to even approach cash flow, landlords here offer crummy places at jacked-up rent. They get away with it in a market with 0.5% vacancy. Such a vacancy rate only means that people need a place to live and there is no competition to keep landlords in line. Landlords rationalize to each other that their crummy places must be acceptable because tenants accepted them, and wave signed leases as “proof.” My market is truly sick, and other landlords resent me because in their view, I undermine them by refusing to get with the program. Instead I would rather offer a place I myself would be happy to call “home,” at a rent within the means (as defined by HUD) of a typical renter in my community. Careful screening ensures high quality, grateful, long-term tenants.

  4. Al Williamson

    Andrew, you sure know how to shake things up around here!

    I agree with the weight you assign to the various short cuts tools.

    I encourage everyone to develop their own version of the 2% rule.

    Customize it so you can quick draw and pick winners from losers.

  5. Phillip Syrios

    I love this! Its amazing how much trouble the 2% rule can get people in when at the same the time rent to cost ratio can be such a helpful tool. LIke you said we use it all the time, and its one of the most important things we look at when evaluating properties, but just never look at it as why a property will cash flow or not. The rule itself just makes too many assumptions.

    • Andrew Syrios

      2% properties can be very good for sure. Some of our best deals are 2%. But some of our worst deals are as well (or at least were on paper). 2% deals in war zones don’t work while 2% in working class areas work fantastically. Which of course begs the question; what good is the 2% rule in the first place.

  6. Joe Scaparra

    I live in Austin, TX and never saw the 2% rule practical here. I own 6 duplexes and I was able to buy just one that met the 2% rule and that deal would be very hard to duplicate in Austin. Vacancy in Austin is non-existing, rents are skyrocketing, but property values are exploding, so finding 2% deals don’t exist now! I find that a 1% deal in Austin is good and can be profitable. My first duplex bought in Austin area back in 2005 was a duplex that cost $140k and rents were $1450. BOTH tenants are still there after 10 years…..no vacancy! Total repairs over the 10 year period, less than $2000. Now rents are $1850 (still below market) and property value is $220k.

  7. Joshua Nudell

    Great article Andrew! I think this should give new investors some pause about only considering the 2% rule as a measuring stick, and take into account the area as well as tweak their expense percentages (CapEx, Maintenance, Vacancy) when using their favorite analysis tools to see if a deal makes sense or not. I just listened to the podcast by the way, you were both informative and entertaining.

  8. David S.

    I agree, and think this is a great post. I do still like the 1% rule. Doing analysis on properties around here, if you’re not hitting at least 1%, it won’t cash flow(unless you defer maintenance or pay all cash).

  9. DP Patel

    Great article, Andrew. When I tried as a newbie, I realized in DFW market that it’s hard to get NEAR to 2%. I have bought few of them in this area and floating near to to 1%. Yes, the area/neighborhood and age of the homes are our primary concern. I am in process of doing a bit major repair and want to see how this gamble will pay out for rent. It’s a $135,000 home, where I am doing almost major remodel before rent. This is first time, I have gone that lower. Our typical range are between $150-$175K.

  10. Alan Mackenthun

    Good article. When I started, I read about the 2% rule, but I just wasn’t satisfied with it. Now I search for units I want and units that I can fix up to be what I want. Not a lot come up on my search and when one does that I want to consider, I put the details for the property into a spreadsheet I found and developed to determine the cashflow, return in cash invested, and all kinds of other metrics. It’s not the back of a napkin, but it’s really not that hard. There’s simply way too much that the 2% rule leaves out. Property taxes, HOA, fees, repairs and rehabilitation costs, property management costs, and even travel time to the property. I usually bought 4-8 year old units during the crash and as prices rose I ended up buying a 4-plex built in ’68. I’m finding that it requires 3 times the maintenance of all my other doors put together. I need to be more aggressive in pricing for maintenance on older buildings.

  11. Richard Flanders

    The 2% rule implies one should get the cost of the unit back in 50 months (irrespective of what happens after it is ready to rent in terms of income/expenses). That seems a bit aggressive to me. It is possible, I suppose, especially at the bottom of the downturn.

    • Andrew Syrios

      I’ve heard that too, but it doesn’t seem to make any sense since you have expenses in there too. So who cares what rent will make you you money back in 50 months in some fantasy world where there are no expenses? It all baffles me.

      • Link McGinnis

        Andrew, the 2% Rule does take expenses into account. It’s saying that if you can get 2% of the value of the home in monthly rent, you “should” (since it is a rule of thumb) have enough gross revenue to cover your expenses and debt service. It is a quick tool you can use as a guide. If you remain interested the property after using any rules of thumb, you would then go to the trouble to add up actual, individual expenses.

        I do, however agree with the overall premise of your article since I can’t seem to find any properties in my area that adhere to the 2% rule – unless they have “trouble” written all over them.

        Thanks for the article.

  12. Marco Santarelli

    Andrew — I’m glad someone finally wrote an article about this foolish “2% Rule”. I’ve thought about it myself but never found the time. It is foolish and you’re right that it can be dangerous. I’ve had to explain this to many investors in an effort to reverse the *brainwashing* done by it.

    Good job.

    Continued success!

  13. scott worland

    I think the qualitative intent of this post is spot on, but I do have some questions. Are you suggesting that all rent-to-cost ratios be abandoned? I think people like them because they can compare properties independent of financing particulars. Also, cost-to-rent ratios can be converted into each other. The 2% rule can be thought of as a 12% cap rate using the “50% rule” to account for all expenses. Which leaves cash-flow TBD by financing situation (and if you know your financing situation a priori, even better!) .

    For example, you mentioned in your post that you average a 1.5% rent-to-cost, and your annual expenses (including vacancy) is about 38%, leaving you an NOI of 68% of gross income. Without going into much detail here, you average around a 11% cap rate. See below (the $2000 and $100000 is a hypothetical rent and purchase price respectively):

    1. (0.62 * $2000 * 12)/cap = $100000
    2. ($2000/0.015) = $100000

    Because 1 and 2 are equal to the same constant, we can set them equal to each other and solve for cap:

    3. (0.62 * $2000 * 12)/cap = ($2000/0.015) = cap ~ 11%

    As you mention in your post, rent-to-cost can be great first-cut metrics to decide which properties to pursue further. Also as you mentioned, you need actual numbers before even considering putting something under contract. Maybe “Cost-to-rent rules should be sedated”, but I’m not quite on board with an official execution just yet. Thanks for the provocative post!

  14. Tommy DeSalvo

    I know I’m a new investor, but I think the 2% rule, when used in conjunction with the 50% rule, and any other metrics people use to determine good from bad properties, isn’t a horrible thing to figure out. On my spread sheets I include the 2, 1.5, and 1% marks along with a plethora of other items that other investors may not use. Sure, in every market the 2% rule might just be a dream, but is it wrong to see what that “mark” is and aim for it?

  15. Richard Flanders

    I ran the numbers on my properties. I was surprised to learn that 4/7 of mine were above 2%, and the lowest was 1.68. I did not know the 2% rule until now. Guess I got lucky. I will raise the rent on the three that were below 2% at the next renewal.

    I figured the expenses, for each full year the property was rented. Does anyone have a percentage target for Expenses to Cost? My average over all years is 12.74 (with one fire and two evictions).

  16. Richard Flanders

    My expenses do NOT include vacancy. My vacancy is low, except for the house with the fire. They rent within a month. Meaning the repairs are done and the house is re-rented within a month except in 2 cases over all the years owned. No Financing.

    • Marco Santarelli

      Having a low vacancy is great, but you should still factor in (budget) for vacancies because it’s not a matter of IF but a matter of WHEN. And sometimes that turnover can cost you more than you expect, especially over the long term.

      • Richard Flanders

        I agree. I posted before I read that the expenses should include vacancy. So, I posted that my vacancy rates are generally small. I jump on them as soon as they are vacated. The majority of them are 2100 or more miles from me, but I go there to cut expenses, and decrease vacancy times. Seems most HandyMen in California think they should get what lawyers and doctors get.

  17. Tom Cyr

    The 2% rule serves a very useful purpose, especially for beginner investors who don’t know all the expenses they are about to encounter. They will see how hard it is to buy well enough to make a decent ROR and not get trapped in a 0% ROR or losing investment. Experienced investors already know the corners they can cut if they plan to make up for low yield with volume. If you told a beginner investor that he was netting only $100/mo and not paying down principle and have all the landlord headaches, a lot would not even get started – that is s GOOD thing.

  18. Michel Lopi

    Hi I’m new to investing (first time buyer) and everything I’m looking at in my area is about .5% return or less. There’s no way for a 1-2% return cash flow here in Norther California. So I’m having trouble using these rules if home prices are anywhere between 350-450k and rents are about 1700-2000 excluding additional costs. Are there different metics to use to determine if it’s a good buy? I’m having trouble figure out what’s a good deal in my area. Any advice would be helpful. Thanks!

    • Nate T.

      Those kind of properties just aren’t very good deals. You might consider investing out of your area.

      The main thing to look at in that price range is cash flow. If your mortgage payment plus expenses equals $2000 and the rent is $2000, then of course you would never want to buy that property.

      • Michel Lopi

        Thanks for getting back to me! Yeah I’m new to this and I’ve been reading about cash flow and couldn’t find anything here with decent numbers. Guess I may have to look elsewhere or wait for an earthquake.

    • Marco Santarelli

      Michel — You are not likely to find a good deal that makes financial sense there in your market area because of the very low rent-to-value ratios. That’s the challenge with many over-priced markets, such as coastal California.

      You are looking at an R/V ratio of 0.3% to 0.5% in your area — that’s very low!

      You would be better off leveraging your investment capital into other (better) markets outside of California. It’s what I started doing back in 2004 and thousands of other investors do too.

      This may help you. It’s our “Ultimate Guide to Out-of-State Real Estate Investing”:

      http://www.NoradaRealEstate.com/Guide/

      Continued success!

      • Michel Lopi

        Thanks for the tip Marco! I’ve been reading about cash flow everything in my area is .3-.5% range. I also thought to wait until winter time when prices drop. I’m also thinking about renting it for awhile and move it later. So many things to think about! Thanks!

        • Marco Santarelli

          I wouldn’t expect prices to drop much between now and the winter time. There are small annual fluctuations, but even with a larger drop in prices you will NOT see the rent-to-value ratios that make sense there.

          My opinion is, if you’re ready to invest today then look elsewhere — markets where it makes sense. The markets are not hard to find, and I could make some recommendations for you too.

  19. Jiri Vetyska

    Another point to consider – The 2% or even 1.5% rule may work great in areas with highly affordable housing, so while it is normal for 50K property to have 750 rent, the same logic doesn’t work for 300K or 400K SFR, where you’ll be renting for perhaps 2000 – 3000 per month.
    So this made up rule of thumb is more of a localized habit.
    In more expensive market, you won’t even bother to calculate rent versus cost, because it’s irrelevant. What matters is cash flow and ROI.

    • Marco Santarelli

      Spot on Jiri.

      Although you can measure the rent-to-value ratio in any market, it’s a good thing to do as a quick litmus test. The higher the ratio the better your ROI will be.

      At the same time though, if you’re looking at a market with a high R/V ratio then you’ll want to seriously consider looking into other markets where the numbers make more sense.

      Like you said, it’s about cash-flow and ROI.

  20. Richard Flanders

    Using your example above, this is the result…
    50,000.00 750.00 1.50%
    300,000.00 2,000.00 0.67%
    400,000.00 3,000.00 0.75%
    Based on what has been said earlier, I would prefer the 50,000 house to the 300,000 houses. Here is why. Unless you are in Silicon Valley, or NYC, there are more renters who would elect a 50,000 house than a 300,000 house. Also, from above, I would be careful in the lower tiers to be sure you are not getting into a high turnover and eviction area, which is likely to be a slow if at all appreciation area. I think more money is to be made in the lower middle class areas for the buck than the lower class or higher middle class, and high class areas. Both on rent return and capital gains.

  21. Rami W.

    In San Diego the 2% rule is irrelevant. I picked up a duplex for 340k in 2010. A great deal then. Each unit rents for $1500. Or 0.88% according to the 2% rule. In today’s market rent would be the same but with the market way up. Maybe around 0.3 or 0.4%.

    This the the reality in So. Cal.

    • Michel Lopi

      I agree Rami. California is bit of an odd ball. .88% is pretty close to 1% which is still good in California. Right now where I’m looking it’s about .3 -.5% Going to wait it out. What goes up must come down right?

  22. Nate Richards

    As a newbie I guess I’m missing the point.

    If all of the methods, (50%, 70%, 2%) are rules of thumb, and “A rule of thumb should be used as shorthand to figure out if a property is worth pursuing before a thorough analysis is done”, then why is any one method superior? For instance, if this is a qualifier for further analysis, it is fairly safe to assume you want to disqualify a property quickly. I know i do. The 2% is without doubt the quickest method, giving it a distinct advantage over any other method.

    This is especially true, and I’m glad you point out that the rules must vary slightly by area/market. So if I know (and a diligent investor will) that I can get away with slightly more or less than 2%, or any other threshold set, speed becomes my primary concern. We have after all conceded that further analysis is going to be done, so why waste time in the beginning. Knowing that a detailed analysis is forthcoming tends to handicap the 50% rule significantly in favor of a 2% does it not?

  23. Where do these people come from? I own dozens of doublewide manufactured homes and singlewides on private lots, I have an average tenancy of 6.8 years now by keeping my rents 15% below market average for homes of similar square footage. I have never , ever paid more than 25k for a home and land and never spent more than 5k of fixup at initial purchase time. My average rents are 500 a month which is a 20% gross return before taxes! Appliance breakdown and replacement are less than 1% of my overhead costs- most of my tenants save enough on their rent they actually buy their own appliances! go ahead you buy( 2) 50k homes….ill buy 5 and spread my risk over 5- careful screening of tenants is the key folks- a single mother with no dog , who doesn’t smoke and has 2 years on the job is the holy grail….don’t listen to anyone who tells you to spend more and make less- not in Texas anyway.

    • Andrew Syrios

      I’m sure that strategy works, but is it the only one that works? Mobile homes on private lots is sort of a niche. I certainly didn’t say that deals don’t work if they are over 2%. I just said it’s not a good metric. If you’re buying stick built for that cheap, the only place to find the (usually) is in a war zone. Which most investors should avoid.

  24. David Stafford

    Thanks for the article Andrew.
    How long typically until you refinance for a better rate? Or, what’s the point that it makes sense to refi? Could you give me a numbers example of how that works with the private investor.

    • Andrew Syrios

      It’s taken almost two years, but that seems to have changed now that lending has loosened up. The normal period it takes a property to “season” when a bank will lend on appraised value instead of cash in is about one year. We try to refinance ASAP because the bank rates are so much better than private lenders and we can free up that private lender to use in acquiring another property.

  25. Matt Miller

    This is dead on. I started in this business without ever reading a book or really doing anything to learn. As I have learned this rule, I quickly realized the only place this rule works in my area is in neighborhoods I avoid. This post should be required reading for new investors.

  26. Brent O.

    Excellent article and analysis of the “all in” costs and returns on an investment. Where I invest, it is tough to even hit the 1% rule. However, our properties are newer with quality tenants, and with the financing we’re able to secure, they all cash flow quite well even after taxes, insurance, and reserves. I’ve just never found the 2% rule to be applicable in our market.

    • Marco Santarelli

      As markets appreciate around the country, the rent-to-value ratios will continue to drop. Markets that came close to a 2% R/V ration two years ago are now closer to 1%. That’s the ebb-and-flow of real estate, however there are still many markets where we find 1.0% R/V ratios and above…

      So the good cash-flow deals are still out there in the right markets.

      Continued success!

  27. Robbie Pratt on

    I have purchased several single family homes in the 1%-1.3% range in good middle class neighborhoods that give me solid 20%+ Cash-on-Cash returns (+ appreciation gains, which tends to be better in these neighborhoods as well). You don’t need to search the universe and risk your capital chasing 2% deals.

    • Marco Santarelli

      Well said Robbie. A balanced market will usually have a rent-to-value ratio of around 1%. If you’re in a good market and good neighborhood with a 1% R/V ratio then you’re doing quite well for income real estate.

      We see a LOT of great deals out there, and none of them are near 2%. That’s often fantasy-land.

  28. Katie Rogers

    “…cheap materials and/or labor is just going to cost you more down the road. ” I have difficulty competing with investors in my town because of this very issue. The vacancy rate here is 1%, nearly all landlords cut corners on the rehab. Therefore, they do not mind paying a little more to acquire the property in the first place.

    I want to do a good quality, durable rehab, but to spend more on rehab means I have to spend less on acquisition in order for the numbers to work. In addition, there is no landlord getting close to 20% returns in my town, unless they have owned the property many years and paid it off long ago, or inherited the property.

    • Andrew Syrios

      I think that’s a false tradeoff. In the long run, cheap materials will cost you more, so you’re not really making your numbers work by using them. You don’t need to get 20% returns so perhaps you should either 1) buy in a slightly higher end area and take lower returns, 2) re-evaluate your numbers and see if you are trying to get to a high a rent/cost to be reasonable and thereby aiming at lower end areas than you should be or using too cheap of materials or 3) Try to get fewer but better deals on the acquisition side.

      • Katie Rogers

        You misunderstand me. I am completely against cutting corners and cheap materials. I am also not married to a 20% return. But I have to compete with others with no such qualms. That is what makes saving on the acquisition side so difficult. Amateurs and hedge funds pay more to acquire, but less to fix up, and then put this garbage out there for rent or resale.

  29. Curt Smith

    Great article and comments. I have but one very important addition:

    Buy rentals based on great schools rating. Google: -the high school name – great schools.

    If you buy rentals in >= 5 great schools rating, then screen for families with grade school aged kids and parents who say I want your place to keep my kids in the school district you will not hear from them.

    That’s it! buy based on school rating. Buy the cheapest house in a top high school.

  30. Peter Boie

    great article!! Thanks for writing it! Being a newbie and not finding any properties that meet the 2% rule has left me frustrated. Having it explained like you have makes me feel like there’s still property out there that will cashflow. Back to hunting:)

  31. Troy S.

    Great article and I completely agree, especially regarding the 2% rule properties being in areas with high turnover and high maintenance.

    One question in your example from the article: I don’t see management factored in? If I’m missing it I apologize, but if I’m not, and you had to pay management at 10% ($90/month and that’s ignoring lease-up fees), your cash flow would drop to $20/month. Perhaps you’re figuring that into “Annual Expenses”? Again, sorry if I missed it but I truly want to understand the numbers.

    “All in Price: $60,000

    Annual Rent: $10,800 ($900/month)

    Vacancy: $1,080 (10%)

    Annual Expenses: $3000

    Debt Service: $5400 (9% interest only)

    Cash Flow: $1,320 ($110/month)”

  32. Kayla Lyon

    Great article! I’m a long time reader of the site, first time poster. I’ve always wondered about the 2% rule and how applicable it is across different markets, especially when you get into higher prices. I’m currently in HI and when I do 2% for my area it says that I should, in theory, be able to rent a $600k condo for $12k which I can assure you is absolutley not happening (the reason my investing career isn’t going to start until I get to Northern VA in a few months…). You could probably rent said condo for $3500ish (which doesn’t even cover mortgage + HOA fees). That obviously wouldn’t be a good investment property, but it’s hard even to justify buying now, living in it for a few years, then renting it when I leave the island. That’s why I didn’t do just that, but it’s still pretty frustrating when you get down to the numbers.

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