Help with the 2% 50% Rule

[Cheryl S]

Hello everyone,

This forum has been invaluable to me. Thank you for sharing your knowledge.

I live in CA, and I'm looking at a duplex out of state. No way could I afford anything around here.

Anyway, the duplex is $15K. One half is currently rented $475. The other is vacant and needs repairs.

So according to the 2% rule, I should be getting at least $300 in rent? I read on here that it is based on purchase price + repairs to make it rent ready. So if I put $10K into repairs for a total of $25K including purchase price, I should be getting at least $500?

I'm having trouble with the 50% part. What expenses does the 50% cover? The other 50% would be cash flow?

Sorry. I'm a newbie and tend to look at homes emotionally - since I want to restore them in the future. I hope someone can help me with the logic/numbers part.

Thanks!

[Jon Holdman]

I don't use the 2% rule. It works if rents are about $500. Otherwise, its too conservative. There are some $500 rent units here, but I never see anything priced low enough to meet that criteria.

I do believe the 50% rule is a good rule of thumb. I'm repeating myself (even in this thread), but any particular property in any particular year can vary widely, especially on the high side. You're bounded on the low side by your actual rent, taxes and insurance. It just doesn't get any better than that. And Mark makes a great point that it's really market rent.

If you're self managing and handling minor maintenance yourself, a ratio as high as 65% may be achievable. Again, for 1000 units over ten years, not for 10 units for five years. But it doesn't scale. I count on a vacancy every year. That's typically half a month's rent, or about 4% of rents. Plus 10% of collected rents. And a lot of maintenance is really minor stuff that I can spend $10 and two hours and fix or I can pay a handyman $100. But if I had 50 units, that would mean four or so vacancies every month. I figure it takes ten showings to get a tenant, and probably 50 phone calls. Now I always schedule showings all at once, once a week, unless I'm planning to be there anyway. But that pretty much translates to showing several properties every week. And handling four make ready's a month, rough one every week. That sounds like a JOB to me. I already have a JOB and it pays me better than 50 rentals, especially here in Denver.

To me, this is a way to build some long term wealth. Eventually, those rentals will be paid off. If I do buy such that they're at least break even assuming 50% rule, then I can turn them over to a PM and still be OK (i.e., not coming out of pocket when something goes wrong.) But if I hold for the long term, a furnace that was new in 2008 is going to be replaced in 2028. If you have 50 properties, you're replacing something like two or three furnaces EVERY WINTER. You're replacing a roof or two every year. ETC.

I get beat up, at least by implication, for being too focused on cash flow. That's absolutely not true. I do want people, especially new investors, to be aware of the reality of cash flow. True cash flow, not "rent - PITI" phony cash flow. I truly think that 20 years from now both rent and expenses are going to be higher, but my mortgage payment will be the same, or even zero if I pay off a property. But when someone says "this cash flows" and what they mean is the rent is higher than PITI, they are doing a disservice to their potential customers. I see that all too often in real estate listings and in e-mails from wholesalers. I pity the buyer who believes that only to get caught off guard when a big, unpredictable-but-inevitable expense crops up.