2% rule and 50% rule

[Greg P.]

Hello, I know this has been mentioned many times on these forums, but I am still a bit confused, and was wondering if someone could help run numbers on a couple of scenarios.

Scenario #1- House is vacant, potential rent is $1250 and I could buy it for $52k and then it needs 12k to rehab.

Scenario #2- 4 plex , one unit occupied at $500 per month and the rest can be rented out at $500 per month so potential $1500 gross rents. Purchase price is $50k and 30k worth of work.

How would you calculate both formulas to these scenarios.

Thank you very much.

[Nathan Emmert]

So Greg, the 50% and 2% rules are used for analysis.

Essentially, the 50% rule says over the long term, a property managed rental will average 50% expenses. This is inclusive of all expenses short of your debt servicing. Your property taxes, insurance, maintenance, vacancy, legal fees, repairs, advertising, etc etc etc.

The 2% rule is an evaluation tool. It steers you towards properties that generate a monthly rent of 2% of the purchase price. At a $500/unit rental point, the 2% rule is designed to generate $100/door which is a normal target for Landlords. Note as your rents move from $500, up or down, you may want to adjust that 2% rule.

So lets look at your deals. House 1 would be $53,250. 2% of that would be about $1,065. If your rents are accurate, looks like a solid deal. Lets look further. Lets assume you mortgage $48,000 (just over 75% LTV) @ 5% for 30 years, your payment would be $258/mo (mortgage + interest). So with rents of $1,250 and the 50% rule, you would have $625 for debt servicing and cash flow. With $215 for debt servicing, your projected monthly cash flow would be $367. That's very healthy.

Deal 2, I'm assuming you mean it would rent for $2,000 a month (4 units * $500/mo). At $80,000, you would be looking for $1,600 a month in rent. Again, looks pretty solid. Your mortgage payment ($60,000 @ 5% for 30 years) would be $322. With 50% towards expenses, your cash flow is projected at $678 a month, about $170/unit which is very solid.

So lets look at cash on cash. Assuming you get to 75% LTV on either property after repairs (and ignoring closing costs cause I'm lazy).

$367 * 12 / $16,000 = 27.5%
$678 * 12 / $20,000 = 40.7%

Both deals are good. A single family house will likely appreciate faster and be less overall management. The multifamily home will appreciate slower but generate better month to month cash flow and CoC returns.