The 1% Rule is well-known among investors, but what about the 2% Rule?
Today, we’ll delve deeply into what the 2% rule actually is, how to utilize it, when to use it, and some potential pitfalls to watch out for.
What Is The 2% Rule?
The 2% Rule suggests that a property will probably provide a positive cash flow for the investor if the monthly rent is at least 2% of the acquisition price. This formula reads as follows: monthly rent / purchase price = X.
The property is not a 2% property if X is smaller than 0.02 (2% expressed in decimal form). If it’s 0.02 or above, you’ve discovered a 2% attribute. This might then help to clarify whether a property is likely to generate a profit.
Review the 1% Rule lesson if you haven’t before. There, we discuss how any of these heuristics should only be used to quickly identify traits that call for more in-depth research, prior to having precise statistics to crunch.
The sales price, the monthly or yearly rental income, and the selling agent’s phone number are typically the three numbers on the listing for the majority of investment properties when they are placed on Roofstock, the MLS, or any other listing site. If all you know is the price of the property and the monthly rent, you may immediately ascertain whether the rental property complies with the 2% Rule.
Are 2% Rule Properties Unicorns or Real?
Finding properties that satisfy the 1% rule is difficult enough for most investors; imagine how difficult it would be to locate one that meets the 1% rule’s stricter requirements. Investors should rejoice because 2% properties do exist! I’ve seen them and have even bought them.
To be really honest, I’ve heard of other investors buying much more than I have personally, but I’ll give you an example from my own experience shortly.
What I’ve learned about the 2% of properties is that while some of them can be excellent, positive cash flow properties, many of them—possibly the vast majority of them—can be rife with problems. Otherwise, why would the owner sell such a lucrative asset?
Furthermore, 2% homes are frequently on the more affordable end of any particular real estate market. In other words, I’ve never seen a $500,000 property rent for $10,000 per month. However, I’ve seen many homes that rent for $800 per month and sell for $40,000.
I want to set the record straight and say that I am aware that not every 2% of rental properties will be difficult to own before someone gets all worked up and runs to me to tell me how stupid I am because they paid $40,000 for a house that rents for $800 per month and has a fantastic tenant.
Furthermore, 2% homes are frequently on the more affordable end of any particular real estate market. In other words, I’ve never seen a $500,000 property rent for $10,000 per month. However, I’ve seen many homes that rent for $800 per month and sell for $40,000.
I want to set the record straight and say that I am aware that not every 2% of rental properties will be difficult to own before someone gets all worked up and runs to me to tell me how stupid I am because they paid $40,000 for a house that rents for $800 per month and has a fantastic tenant.
What The 2% Rule Does Tell You About a Rental Property
The rent to sales price ratio is the only thing the 2 percent guidelines tell you. There is no magic formula that can predict how a property will perform in the real world for investors. In order to determine whether or not we believe the property is a worthwhile investment, as investors, we must start with the information we do have, including the rent amount and the sales price.
Keep in mind that, given the property’s sale price, we can manipulate it to make it a 2% property by doing nothing more than changing the sale price.
What The 2% Rule Doesn’t Tell You About a Rental Property
While there are a number of additional problems that the 2% Rule does not address, it is useful in judging whether or not the property is likely to cash flow very well. “Where is the rental property physically located?” is one of them.
In order to calculate the vacancy rate for 2% properties, it is essential to take the neighborhood in which the property is situated into account. Even a 2% property’s cash flow can be completely depleted in a few short months of vacancy.
To make this concept clearer, consider the following math:
If a single-family rental property leases for $1,000 per month, the gross rent collected is $12,000 per year.
- Cost of 2 weeks of vacancy: $462, or 3.85% of your annual revenue.
- Cost of 2 months of vacancy: $2,000, or 16% of your annual revenue.
Recall that the lost revenue is only one component of the situation. The majority of the running costs continue to be paid on a monthly basis. Whether or not a renter is residing in the property, you will still need to pay property taxes, insurance, and mortgage payments (if you decide to finance the property).
While two months can consume 16% of your yearly revenue, if you are only hoping to generate $2,000 in positive cash flow per year, it can consume 100% of your annual profit. A good property manager should be able to explain the vacancy rates in various areas.
The 2% Rule also does not address the issue of how much upkeep is expected to be necessary given the property’s location. The cost of maintaining a property can be higher in areas with harsher weather or less desirable neighborhoods. When you run your calculations, this must be considered.
Finally, property taxes are not taken into consideration by the 2% Rule. Most frequently, property taxes are the biggest deal-breakers of all. Investors may be in for a harsh awakening if they don’t know how high the property taxes are for a property after it has been sold.
Can You Convert a Property Into One That Meets The 2% Rule?
You may be wondering why anyone would desire one of these items since we’ve discussed so many concerns relating to the 2% Rule and 2% properties. It’s crucial to remember that 2% of properties are organic, but sometimes you need to be able to view the big picture.
There may be more to “What makes it a 2% property?” than just the purchase price and rent per month. Some of you may be asking, “Doesn’t going deeper defeat the whole point of using the 2% Rule in the first place?,” and I understand your concern. Technically, the answer is yes, but we frequently need to delve deeper in order to locate and close solid deals, so bear with me.
- Listed as meeting the 2% criteria, a property is a reasonably secure investment.
- Although it is assumed that it will provide a profit, more research is certainly still required.
- The additional investigation should show a few things, including:
