Investors: You Won’t Achieve the 2% Rule Unless You Do THIS.

by | BiggerPockets.com

Many investors use the 1 or 2% rule as a rule of thumb to do a quick evaluation on real estate deals.

In essence, you take the rent per month and divide it into the price of the property, which yields a percentage. The higher, the better, of course.

Everyone seems to strive for the 2% rule, but I have rarely seen many achieve it. People actually don’t realize how good of a deal the 2% rule is. In the first half of today’s video, I break down the 2% rule to show what cap rate and cash on cash return you are looking at if you are lucky enough to get a 2% deal.

Related: 2% Rule? 50% Rule? Here’s the #1 Real Estate “Rule” I Use to Assess Property

Do THIS if You Want to Achieve the 2% Rule

Many wholesalers and turnkey marketers will show their deals to be a 2% performer but be cautious. You should also consider the area, as properties in D-class areas or war zones can show high performance on paper, but come nowhere near projections in reality. The 2% rule is possible, but it takes a certain angle of attack to get there. In the second half of the video, I go over what you need to do to get to the 2% rule or close to it!

[Editor’s Note: We are republishing this article to help out newer readers.]

Please leave a comment below so we can have a conversation!

I look forward to hearing from you! Have a great and profitable week.

About Author

Matt Faircloth

In 2005, Matt founded The DeRosa Group along with his wife, Elizabeth. At the time, the two person company owned and managed two assets – a single family home and a duplex. Over the last nine years, they have grown the company to a 12 person team owning and managing over five million dollars in residential and commercial assets throughout the central NJ and Philadelphia area. One of DeRosa’s mantras is “to make money while making a difference.”

44 Comments

  1. Cindy Larsen

    Matt,

    I always love your videos. You present things so clearly, that you make seemingly complex issues simple and easy to understand. I really wanted to be able to invest passively, at some point, but every turnkey rental I’ve investigated has expenses underestimated or leaves out key expenses that have to be factored in. One firm was advertising 15% cap rate, but had no capex expense in their numbers, so if you figure 10% capex, it was really a 5% cap rate. Even if the turnkeys aren’t in war zones, they are usually trying to sell you a property a thousand miles away, which you are supposed to buy based on trusting the information provided by the seller, and then you are supposed to use a property manager that they either have in house, or one they recommend. How do you know what deferred maintenence issues you are buying? Do you really understand the market in the area the property is in? What if their expense assumptions are too low?

    NO, I don’t think I’m going to be investing my savings into a property in an area I am unfamiliar with,
    a property I’ve never actually seen, and then trusting a person I’ve never met to manage my investment for me. WAY too risky.

    For me, the solution is to invest within a couple of hours drive of home, in a number of areas I’ve selected after detailed analysis, fix up the properties myself, manage them myself until I can either train or find good property management, and essentially create my own turn key rental properties.
    It is not easy to find the great deals, but they exist, even on the MLS. I’m ok with a 7% cap rate, which I can leverage to make my return higher, and which I can force appreciation on by improving the property.

    The easiest way to pay way too much for what you actually get is to be too greedy and too excited by how great the deal looks, and not do thorough due dilligence. So, for turnkey properties, I say, “let the buyer beware”. Check the teeth on that gift horse.
    CJ

    • Christopher Neeson

      Your right on about avoiding turn key unless a person is truly ok with 2% or less! I don’t think 2% is a good number. I like 20% that fits my taste better.

      There are a lot of high quality trustworthy turn keys out there. There are also about 10 different levels of turnkey as well.

      My biggest financially bad decisions were buying close to home.

      A 4 plex listing back in 2013 caught my eye. It was going for $610,000. I was able to negotiate down to $527,000 to conform to an FHA at the time. Worst mistake ever, even without an FHA I pick up properties in the lower 48 of the same caliber for less then $120,000.

      Those same properties I’m currently investing in have comparable rents. Most between $800 and $1000 for 1 to 2 bedrooms.

      I recently acquired an 8 unit and a 5 unit that both (average) $900 a unit. I paid $200,000 for those with only $40,000 out of pocket.

      With $11,700 a month in income and more then $8,000 a month being cashflow after expenses in feeling solid in my decisions these days.

      Your greatest point was don’t get excited or anxious and rush a purchase.

      The numbers should be flawless, you should be dealing with someone wanting to sell because they are chasing bigger goals. The average person listing there property just wants too much. If your paying more then $18,000 per unit your crazy! Aim for $10,000 to $18,000 and you’ll find gems.

  2. Austin Clark on

    I would add college rentals to that list.

    Purchased and $80,000.00 Triplex. Put $20,000 into it.

    5 bed 4 bath.

    Stuffed a small sorority of 8 girls in there at $375.00 a piece

    $3000.00 a month. Even after vacancy, maintenance, and debt servicing made well above the 2% rule

    • Matt Faircloth

      Hey Austin,
      Thanks, I didn’t think about student rentals as a 2% rule option. I’m not a student rental investor so I’m not familiar. Question – what do you find your expense ratio to be on these deals? Curious.
      Thanks!
      Matt

  3. Christopher Neeson

    Love the presentation! I do have to say though that it’s a bit more complex then our method. You have also set a fairy tale setting calling deals like this a uniocorn.

    6 buildings 22 units later I have 4 of my buildings 16 units that I’ve done very well with now that I’ve set my own bar for investments.

    The biggest selling point I chase is that a property has to pay itself off within 3 years. Not only does it have to pay itself off, but it has to cover all expenses and pay me back my initial down payment within the first year.

    You don’t find these deals in A neighborhoods, it’s very difficult to find them in B neighborhoods. But C neighborhoods seem to be the best areas to invest so long as the historical economics of the area aren’t full of booms and busts. You want a slow and steady market.

    You also want consistency! A military base, a university, a population of 200,000 or more.

    All these features should be consistent!

    For numbers sake I’m going to throw this out there.

    $80,000 on a 5 unit
    $5,000 a month in rent collected
    High demand area, always rents could easily raise rents.

    25% down $20,000
    5 year ballon ammoritized at 30
    Mortgage $341 a month
    Insurance $291 a month
    Management $250 a month
    ($882 a month going out in expense let’s round to $1000)

    Cashflow $4000 a month
    It takes me 5 months to get my down payment back.

    Another 15 months after that my savings is built enough to pay off my loan.

    In 20 months I just created a paid off asset that has significantly high cashflow. And it only took $20,000 out of my pocket initially. What if you can do two properties like this a year or maybe 4?

    Biggest thing here is after you may this property off you now have an additional $60,000 annual income and $48,000 in annual cashflow!

    You just did that 1 property in 20 months…. what’s next ?

    4 of my buildings have this same percentage, my other 2 and in a stable market in A/B neighborhoods.

    I invested early going by the 2% rule and I can tell you it’s not as great as making sure your investment isn’t only solid but pays itself off in less then 3 years.

    It’s an investment, do your research and win big!

    • Matt Faircloth

      Hey Christopher,

      That sounds like a screaming hot deal! Don’t put the location on BP or you will get tons of new competitors, lol!! Your rent to price ratio is even less better than the 2% rule . If deals like that are easily found, curious why prices aren’t higher?

      You left a bunch of expenses out – real estate tax, maintenance (should be at least $300 per month on a 5 unit considering landscaping, pest management, emergency calls, unit turnover, etc…). I see you are paying 5% in management, what about leasing fees? What is your vacancy rate? Also any multi typically has some utility expense, even if it’s just water and sewer. I’m sure it’s still a good deal but curious how it cash flows with all these other expenses factored in? Are you near a 50% expense ratio?

      Still sounds like an awesome deal, good luck with it!

      Matt

  4. Cody L.

    I can get ~2% rule on apartments. Just bought an 80 unit. Average rents are $605. Paid $31k/door.

    Just bought a 110 unit (today). Rents are $620. I paid $34k/door.

    Not war zones. Near city center in houston. Totally full with blue collar Hispanic tenants. Turnkey. No issies.

    • Matt Faircloth

      Hey Cody,
      Wow, that’s great! With all the hype Houston is getting lately I’m surprised you are able to get deals at that low of a price per unit. What is your expense ratio? If it’s turnkey, do you have a plan to force appreciation in any way?

      Congrats on the deals!

      Matt

  5. Khaled El Dorry

    Matt,

    Great video and thanks for sharing with the community. Can you please elaborate on the wholesale Comstruction point you mentioned? You talked about a Home Depot club/membership. I’d be curious to learn more about this point in particular as that’s a big weakness in my business right now – efficient and quality construction work.

    • Matt Faircloth

      Hey Khaled,
      Wholesale construction means finding GC’s that work with investors regularly, not contractors that are used to getting high end retail prices for their work. Most of them work with homeowners exclusively and charge $25,000 to remodel a kitchen LOL. You can find them by searching BP for investors in your local area and asking them for references. With regards to Home Depot, you can get discounts on purchases if you sign up for a charge account, and if you buy more than $1500 at a time (I think that’s the magic number) you can go to the “pro desk” and ask them to put the order into the “bid room”. That will get you more discounts. Go to your local HD and ask the pro desk for more details.
      Matt

    • Matt Faircloth

      Hey Grant,
      It all depends on management. If you have a manger that is willing to manage in a War Zone, or if you are willing to do it yourself, the returns can be great. As you said, you have to factor in higher vacancy rates and unit repair costs. It’s not my cup of tea, but some investors do very well with these types of properties.
      Matt

  6. Andrew Syrios

    The 2% rule is often fool’s gold IMO. The only place I’ve seen you can consisently get it (even in a cash flow market like Kansas City) are in really bad areas. And you only “get” 2% on paper. Usually, in those areas, you lose money.

    • Matt Faircloth

      Finally a voice of reason, LOl. Thanks for jumping in Andrew! have gotten there on a few deals in the past but it’s far and few between. I more regularly see between 1.25 and 1.75% top end.
      Hope all is well!
      Matt

  7. Bill Dudley

    Ello-

    Wow thank you for the information. I’m a newbie and this is definitely helping me to categorize deals. Comments are very helpful as well. With a little more knowledge I’ll be ready to buy my first flip or rental deal!! THANKS again Matt and BP!

  8. Samuel Bavido

    Great information; I appreciate you taking the time to go over this. If I could offer a bit of criticism: you should be using PowerPoint. There’s no reason to waste time writing things on a white board. You obviously did all the work before shooting, so just take a few extra minutes to put in on some slides and hold a clicker in your hand.

  9. Steve B.

    Another great video Matt, thanks for posting. Very informative and easy to follow. I like this way of presenting as opposed to power point, may take a few minutes longer but easier to follow. In my area you can occasionally find th 2% rule but you have to wait a long time and be ready to jump on the deal as soon as it hits or you have to wait the seller out until they are willing to drop the price. Lower income area but not high crime.

    • Matt Faircloth

      Thanks for the comment. Glad to hear the 2% rule is around in your area, even if it’s hard to get.

      And I am not tech savvy or organized enough to do PowerPoint, so old school white board presentations will continue lol!!

      Matt

  10. Dirk Jackson

    Thanks Matt! So I just did a deal @ sheriff auction 3/1 about 1100 sf for 15k. I figure 15k in rehab and 600/mo in rent. So would the numbers check out? 2% rule check. 12% cap check. 24% CoC return check. Here is a link to the property on zillow https://www.zillow.com/homes/for_sale/10-Oakwood-Pl,-Lima,-OH-45804_rb/?fromHomePage=true&shouldFireSellPageImplicitClaimGA=false&fromHomePageTab=buy . I really don’t get why people always say that it must be in a war zone because of the price point I really don’t think that is fair to say. These deals happen here all the time. I think tenants are just bad if they are bad people. I don’t feel that just because you have a 100k property there is less of a chance for it to get destroyed or have vacancies. I maybe off on the rehab number but not by much. Thanks again!

  11. Kevin Kingsbury

    In my market the 2% rule is a unicorn. Auctioned properties needing some rehab can sometimes get you 1.25-1.5% on the high end, but the worthwhile deals are rare and typically snatched up quick or bid up too high. Honestly my area is saturated with investors willing to accept much lower returns and driving up the prices of investment properties.

  12. Josh Hooper

    Thanks, Matt. I really enjoy your videos and the valuable content you always provide.

    Am I aiming for too low of a return? My basement threshold is the 1% rule. I am looking at strictly SFH, but self-manage and manage expenses (typically between 30-40%, we use 8% for our vacancy number on SFH) as tightly as possible (meaning taking care of deferred maintenance items up front).

    I have never even come close to the 2% rule. My best to date is 1.34%. I have only done a handful at this point.

    Do you think I need to adjust my search criteria closer to the 2% rule?

    • Matt Faircloth

      Hey Josh,
      Your market may not allow the 2% rule. I find that 1.5% is a slam dunk in some areas. If you are strickly looking at SFH and self managing, you should target above your current return of 1.34%. Maybe try another area that’s still local to you? Sometimes the fringes of urban environments can produce solid returns in stable neighborhoods.
      Matt

  13. Arun Iyengar

    I am a multi-family investor in Silicon Valley, since 2014, and have found no deals that come anywhere close to 2% per month in rents. The multi-family units I purchased in 2014 are now getting close to 1% and the ones I bought later are well below 0.8%. On the flip side, valuation has increased by greater than 50% and I have refinanced and taken money out from my older properties to buy new ones!

  14. John Murray

    I have 8 SFH in metro PDX, I running about 8-9% on your calculations. When I built my model (thanks to my wife that has a BS math and MBA) our model would produce at least a 10% return on our cash outlay (25% down and renovations) . So the math magic is pretty close to your model with my model returning a bit over 10% and your model returning 8-9%. Well done!

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