2% rule in California

[Florence Lecuyer]

Hi, 

I'm new in Real Estate, so I'm interested in your advice. 

I would like to invest in Real Estate in a "buy and hold" property, with long term gain objectives (I don't have much time to manage it, so can't flip houses, just a simple renting set up would work for me. I was thinking of a single family rent as the most simple thing to do - but I welcome your ideas.) 

I live in California, in the Bay area, and as I can't afford properties around here, I was looking at cities around (Sacramento, Bakersfield) but couldn't see any property where the 2% rule apply. 

I am looking for a property in California, so that I can access it by car if necessary. I know there are plenty of other states which offer better value, but as it's my first investment, I don't feel comfortable buying a place that I can't visit, and it would be quite difficult to choose a real estate agent or a property manager at distance. 

My question is, should I look for 

1) a property in a remote place in California offering a 2% ratio (but with the risk of higher vacancy if it's in a remote place) - if so do you know any? 

2) a property in a city like Sacramento, offering a ratio lower than 2% (is below 1% still acceptable?) 

3) something else? 

Many thanks in advance 

Florence 

[Justin R.]

Originally posted by @Nadine Lajoie:

Agree with @Edward, ROI and cash-flow are after mortgage, while the NOI is not affected by mortgage, because that ratio is before. @Greg, I would like to understand your point. Please clarify...

Gross revenues - vacancies and other expenses = NOI

NOI - Mortgage = cash-flow

Cash-flow / investment = ROI

Right?

I've seen very experienced brokers use slight variations on these things, especially between commercial and residential, but I'd offer an improvement like so:

• Gross Scheduled Income - Vacancy and Loss Factor = Gross Operating Income (GOI)
• GOI - Operating Expenses = Net Operating Income (NOI)
• NOI - Mortgage = Operating Cash Flow
• Cash Flow - Capex Expenses and Reserves = Free Cash Flow

Technically, depreciation should be counted in the Operating Expenses, though I never see people in REI do that. The above also ignores the impact of taxes, but I haven't seen a consistently accepted way to describe that (has someone else?). I personally then look at the following:

• Free Cash Flow - Income Tax = Take Home Pay
• Take Home Pay + Total Principal Payments = Annual Profit

The only reason I mention this is because there's so much unnecessary thrashing in the forums because people don't appreciate the difference between Operating Cash Flow and Free Cash Flow. They think that what matters is Operating Cash Flow - what's in your bank account at the end of the year. That can be manipulated in all sorts of ways, though, giving an inaccurate cash-on-cash or ROI calculation. If someone just says "Cash Flow," they're leaving a big opening for mis-understanding.