rental property investing

The 2% Rent Rule for Buying Rental Property

The 2% rule is simply a rule of thumb that is used as a screening guideline for determining how much you should pay to purchase a rental property for.

If you’re going to purchase a $100,000 property, then the rent should be $2,000 or more to satisfy the 2% of the purchase price rent rule.

I first learned about it from the BiggerPockets real estate investing forum as well as the other rules of thumb: 50% rule, 70% rule, GRM, etc. and it helped me find the confidence to buy my first rental property at the age of 20.

The importance of using the two percent rule is when you have hundreds of deals to screen through in your market.

If you took the time to review every deal in-depth, it would take months and you’d be too late making offers on good deals you didn’t get to in time.

I’ve created a whiteboard video lesson sharing exactly what the 2% rent rule is and how it works. I’ll even show you some math examples!

Click here to watch the 2% rule tutorial on my YouTube Channel

The 2% Rent to Price Rule Tips to Consider

When analyzing a rental property, ideally you want to charge 2% of the purchase value as your monthly rent.

This helps you make a decent return on your investment after factoring in your expenses for property taxes, insurance, maintenance, property manager, and possibly a mortgage.

In today’s rental markets, it’s a lot tougher to find properties that meet the two percent rule because it’s gotten harder to buy them cheap!

Prices have doubled and even tripled in some markets compared to what they were back in 2011 at the bottom of the market.

But for those of you who can still find a property in a good location where rents are rising and has a high demand to live there, go for it! It’s definitely do-able!

Just make sure it comes close to the 2% rent rule so you can cover your costs of owning the property and still return a healthy cash flow each month.

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Problems with the 2% Rule

Certainly the 2% rule can help landlords quickly eliminate overpriced properties, but it also has its downfalls that many critics will argue against using this rule to analyze investment real estate.

  • Deals in Bad Locations Meet the 2% Rule
  • Condition and Age of Property Hurts Long Term Cash Flow

Most of These Deals Are in Bad Locations

The opposing argument is that investors and beginner landlords trying to follow this rule of thumb will likely end up in the sketchy, unsafe parts of town.

This can make it tough to sell the property in the future and limit your pool of potential buyers as demand won’t be as high as other areas in your city.

These areas are often high crime and feature properties in run down condition that bring down the overall appeal of the neighborhood. This hurts your investment long term as property prices will likely go up in value much slower than the better neighborhoods in your city.

Usually the best neighborhoods to buy investment property are also more expensive by default as everyone wants to live there. This makes it tough to find a property that meets the 2% rule.

It Fails to Consider Expenses & Cash Flow

The two percent rule only looks at the gross income of a property and not the net income, aka cash flow, you’ll be taking home to your bank account each month.

Most of the deals that meet the rule are outdated properties in terrible condition and are what investors call “money pits.”

You may find yourself frequently paying for plumbing issues, A/C and furnace issues, as well as hidden issues like mold or flooding when it rains.

All of these expenses add up and hit your bottom line, taking away cash flow you could be spending on traveling and other family activities.

With newer homes, the appliances and mechanical systems of the home are likely to last longer before needing replaced, saving you money each year and increasing your return on investment.

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Should You Follow the 2% Rule?

As we conclude our Q&A on the two percent rule in real estate investing, I think it’s important to simply view it as a quick screening tool.

Start off targeting good neighborhoods in your city. Then look at all of the deals for sale and screen their rent to property price ratio to quickly screen out deals that are way too expensive.

In other words, if 5 different properties are all renting for $1,500 per month, you obviously would be attracted to the rental property that is cheapest in price considering all other things are similar (neighborhood, monthly expenses, etc.).

 

Secondly, if you have 5 properties that all have varying rents and varying prices in the same neighborhood, you can quickly use this rule to determine which one is offering the best rent to price ratio by dividing the rental income and asking price.

Lastly, make sure you analyze the market and determine what market rent would be.

When I bought my first rental property at age 20, the landlord was only charging the tenant $450 per month. We knew that this same property could be rented for at least $900 and maybe $1,000 per month.

Then using the 2% rule, we quickly determined that $900 / 0.02 = $45,000 as a max purchase price. We ended up buying the deal for $30,000 with a $15,000 estimated rehab budget.

You can find deals out there still that meet the 2% rule, but it will take patience and lots of screening your market for every deal that comes for sale each week. Now go find your deal!

P.S. Check out this 5 star rated investing course that you can complete in the next 7 days. It will help you get motivated and build confidence to do another deal this year. Don’t miss out.

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