What Is The 2 Percent Rule
Simply put, the 2% rule states that the monthly rent for an investment property should be equal to or no less than 2% of the purchase price. Here’s an example of the 2% rule for a home with the purchase price of $150,000: $150,000 x 0.02 = $3,000.
Are 2% Rule Properties Unicorns Or Real?
While most investors have a hard time even finding properties that meet the 1% rule, let alone 2%. The good news for investors is that 2% properties do exist! Keep in mind that there are some that are great, positive cash flowing properties, but many of them, arguably the vast majority of them, are riddled with problems and issues. You have to ask yourself why else would the owner be selling?
Additionally, 2% properties are often on the less expensive side of any given real estate market. For example, I’ve never seen a $600,000 property that will rent for $12,000/mo. However, I’ve seen plenty of properties that sell for $50,000 and rent for $1000/mo. There are always exceptions to every rule and you often have to work very hard to sort through the bad ones to find that one good one. They are out there though, so happy hunting!
What The 2% Rule Tells You About A Rental Property
Really, the only thing the 2 percent rule tells you is the ratio of rent to sales price. There is no “secret formula” that gives any investor an insight into how a property will actually perform. You must take what information you have, both the rent amount and the sales price, and start to derive whether or not you think the property is a worthwhile investment.
What The 2% Rule Doesn’t Tell You About A Rental Property
Where is the rental property physically located?”
When analyzing 2% properties, it is very important to take into account the specific neighborhood in which the property is located. This is to determine what the vacancy rate will be, as a few months of vacancy will eat up all the cash flow from even a 2% property.
Here’s the math to help drive this point home:
The gross rent collected on a single-family rental property that rents for $1,000/mo = $12,000/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.
Remember, the lost income is only part of the equation because all of the operating expenses remain in effect as monthly expenses. Property taxes, insurance, and mortgage payments will still need to be taken care of even if your property is vacant.
Based on the properties location, another question not answered by the 2% Rule is how much maintenance is likely to be required. When running your numbers, be sure to take into account that properties in harsher climates or rougher neighborhoods often have higher maintenance expenses.
Lastly, the 2% Rule does not account for property taxes. Property taxes are often the biggest deal killers of all. You should always research and know how much the property taxes are for a property post-sale.
Can You Convert A Property Into One That Meets The 2% Rule?
Now, since we’ve covered a lot of issues surrounding the 2% Rule itself and 2% properties, you’re probably asking yourself why anyone would want to try this approach? It’s important to note that 2% properties do exist organically, but sometimes you have to be able to analyze and determine if a given property is worth it.
In order to find and purchase good deals, we often have to dig deeper, so if a property is listed as meeting the 2% rule, it’s a relatively safe assumption that it will have cash flow. However, as with most things you invest in, further analysis is obviously still needed.
What Did I Learn?
You often have to create the best deals because they can be extremely difficult or seemingly impossible to find or stumble upon. Remember, just because a property isn’t advertised as a 2% property doesn’t mean it doesn’t have the potential to become one. This is why some investors are such big advocates of buy and hold investing. While the price you purchased at obviously remains the same, fortunately, rent tends to increase over time.
Lastly, as you become a better investor, you’ll be able to see the potential in things rather than simply seeing them as they are today. This is not to say that you need to be a visionary or something to be a great real estate investor, but certainly being able to envision a property’s potential makes real estate investing a lot easier and profitable!