Any ever follow the 2% (or more) rule and NOT get burned?

Question

Hello BP.

A little about me.  I invest out of state, I've done 3 deals, 2 buy and holds, 1 flip.  All single families, all in Missouri.

I'm about to have a 5-unit apartment complex under contract.  Four, 1 bedroom units and one, 2 bedroom unit.  All electric, separate meters.  This is in a new area, new agent, new contractor, new property manager.

The returns would be over the 2% rule.  This summons all sorts of advice I've heard podcasts and forum discussion.  Statements like:

"Juice isn't worth the squeeze"

"Nightmare"

"Not worth it"

From the best I can tell the building is in a C part of town.  I spoke with (from what I can tell) a reputable property manager, and they agreed they'd manage the units.  Google maps doesn't look bad.  I'm waiting to talk to a local police officer, who isn't bound by real estate agent law, and can answer questions about the area.

I realize this area will command a lesser tenant.  Headaches will be more likely.  It may take longer to place a tenant.  In the end, if these are expected, and treated as numbers (say 12% for vacancy and 20% for repairs and cap ex), and the property still cash flows well, am I crazy?  It needs some rehab, I'd likely follow the "bombproof" philosophy.

I don't want to be greedy, but I don't want to pass on a deal just because it's too good.....

Experiences (good or bad) involving small apartments in C neighborhoods much appreciated!

Sam B. · Answer

Any multi trading at 2% is probably closer to D than C. You're probably more likely to lose money on the 2% rule than the 1% given the fact that it's going to push you into marginal areas in today's market. You can very quickly lose months or years of cash flow after a big theft or any number of issues that may arise with this class of property. There is nothing you can put in your spreadsheet to account for that in any reasonably accurate way.

There's a reason the locals aren't all over this deal, unless you are unusually lucky.

Anthony Wick · Answer

You said "from what I can tell", twice. I had a 2%+ rule a short drive away, in the next town. And I realized at 0% vacancy, that still doesn't mean you'll actually collect the rents. I've personally decided to stick in the best area around here, with a 1% rule starting point. I'd say right now, your biggest problems are you have never been there and you won't be in the area when things go south.

Larry Turowski · Answer

@Pat Jackson I have had success, but it has to be a deal when I buy.  There is no sense getting great returns if you are going to take a loss on the property if you sell in the next 5 years.  That's what I see a lot of investors doing.  If it is truly a great deal, and you could make money on it if you sold it after rehab, then I'd say go for it.  If you find it is too much of a headache to keep then sell it and take your profit.

Russell Brazil · Answer

The rent rent/price ratio should be viewed, just like a cap rate, as an indication of the risk of the asset and/or market. So a 2% property, in todays market is going to be an indication that it is a fairly risky property.  There are markets with higher ratios, like Baltimore for instance, which is indicative of a high risk asset.  Properties in coastal cities often will have a low ratio which is indicative of a low risk asset and/or market.

Pat Jackson · Answer

I appreciate all of these comments.  This will likely be a candidate for tenants with a HUD voucher.  I've avoided this before, but will consider it now.

Blair Poelman · Answer

I've had success, and have also been burned on properties that reach this so-called 2% thing - which really is not a rule (the 1% rule isn't a "rule"), it's just one of many metrics used to evaluate an opportunity and the performance of an investment.

Additionally, anything I've ever had that hits even close to 2% has been pretty hood-ey.  Don't get me wrong, I've done very well in C and D areas, but my 2%-ers have all been closer to F and F-.

one thing you mentioned that sticks out to me is that you're using google maps to check the area - which I think is a good thing to use to get an idea, but I believe relying on what you see on google maps is a devastating mistake.  Google maps will never give you the real deal on any area.  I don't buy anything, anywhere until I've been there and I'm familiar with the streets.

Sam B. · Answer

I wouldn't factor asking in at all. A seller can ask anything they want. You're not going to get 10% vacancy or management if this is D rather than C, which I would be very suspicious of.

Pat Jackson · Answer

@Sam Barrow@Ned Carey, thanks for the input.  I realize the 2% rule is course at best.  Using the BP calculator this is a ~14.5 cap, that's accounting for 10% vacancy, 10% management, and 15% repairs/cap ex.

This is a REO property.  The bank has come way down from asking.  We will see.

Ned Carey · Answer

@Pat Jackson I acquire properties all the time at the 2% rule or better. No I have not been burned. But I am in an area where 2% is common. Whether that is a valid rule in your area is a different question.

Keep in mind the 2% rule is the absolute most crude rule for evaluating properties. The a percentage can be a quick qualifier or dis-qualifier.  The actual percentage whether 1% 2% or whatever will vary by market and personal choices. I don't think the 2% number was ever intended to be applied to multi family either.

A better evaluation would be cap rate and how that compares to the market. My gut tells me that as @Sam Barrow says this is probably a higher risk property.

Any ever follow the 2% (or more) rule and NOT get burned?

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