Is the 2% Rule still alive in the central Pennsylvania market?

Question

When I closed on my first duplex in Harrisburg, Pennsylvania in August 2017, "the 2% Rule" was the gold standard for determining whether a property would cash flow.  (The 2% Rule says that the gross monthly rents should be 2% of the purchase price.) I purchased that duplex for $116,000 and had the gross rents at $2,105.00 after re-leasing 1 of the apartments after the sale (roughly 1.8% of sale price, so just shy of the 2% Rule).  Today, the gross rents are $2,875 (exceeding the 2% Rule). In 2017, I thought I did just "okay" on this deal.  Today, however, this deal would be a slam dunk in this market, as I am finding it harder (if not impossible) to find 2% deals in central Pennsylvania.  In fact, since the pandemic and inflation hit, the 2% Rule seems to have all but disappeared in all real estate discussions and been replaced with the “1% Rule” in this tighter market.

I recently purchased this 10 unit building in Harrisburg, PA.  It is a 100 year old purpose built apartment building which was considered high end in the early 1900s, with butlers' quarters in the basement of the building, and each apartment boasting 1400 sq ft / 2 beds / 1.5 baths and maids' quarters in the back.  I purchased it for $1.1M with each apartment renting around $1,000 ($10,000 gross monthly rents), so just under 1% of the $1.1M purchase price.  We have been renovating each apartment 1 by 1 as tenants move out and renting the apartments for $1,800 ($18,000 projected gross monthly income).  That would put us just above 1.6% of the $1.1M purchase price, so still short of the 2% Rule (and it still doesn’t account for the renovation costs).

All of this begs my question: Is the 2% Rule still alive in the central Pennsylvania market in 2024?  If so, can anyone in this market give me any examples of recent deals they have been involved in which hit the 2% Rule?

Matt Inouye · Answer

Hey Cory,

Congrats on the purchase... that looks terrific!

I also invest in the area and have a 15 unit across from the capitol back in 2021.  Back then I rough penciled the deal around 1.5% but with the realized rent increases it came out to be more like 1.7%.  I think you are in the ball park with your assumption on 2% rule in the area.

HOWEVER... my rehab costs far exceeded what I was budgeting and built into my UW.  Also, depending on the area, codes and historic have been a big pain especially since the new city administration has put a much higher % inspection requirements for "cosmetic rehabs".

I've been able to turn majority of the units in the last 3 years.  It will still be a solid deal with increased NOI/valuation,  but its been a process.  Best of luck on yours... and DM me if you'd like to connect and share notes

Aloha,

Matt

Cory Iannacone · Answer

@Scott Allen Thanks!  I agree that 2020 was the beginning of the end of the 2% rule.  At least that's what I saw.

I currently have a 5.5% interest rate on my loan for the 10 unit building.  I actually don't plan on refi-ing out unless I can get the same or better rate.  I plan to just take the cash flow and wait out the market.  I call it the BRR"R"RR method, where the extra R is waiting for the Rate drop.

Scott Allen · Answer

@Cory Iannacone 2% rules disappeared in my market around 2019/2020 as rates went down and prices continually went up. Rent growth did help with deals continuing to meet the 1% rule though.

Similar to your deal that was just shy of a 1% rule when you bought it, it sounds like you have had many major updates to do to each unit as tenants have moved out to get them to market rents. Your building looks great and the interior photo makes it look like it's more high end with the finishes. I would guess that you're probably putting at least $20k into each unit as a tenant moves out - could a refi around $1.8-2mil work for you to recoup your renovation funds and still cashflow at a 1% rule?

Karolina Powell · Answer

I'm in western Pennsylvania but have not been able to get deals that match the 2% rule here either.  I aim for 1.5% but have even done the 1% rule in areas I think that will appreciate quicker than others.  You have a lovely building!

Cory Iannacone · Answer

thanks @Jonathan Greene. I used to use the 2% (and now 1%) rule just to initially screen properties quickly to determine if they should cash flow (as a rule of thumb).  In my opinion, I don't believe you can find properties just using general rules of thumb like we used to.  It takes more work (and creative thinking) to make deals work in the current market.

Cory Iannacone · Answer

thanks @Jonathan Bock. Planning on long term hold for that 10 unit building.  It will cash flow very nicely once all 10 units are renovated and rented out.  $800 / month increased rent X 10 units = $8,000 / month (almost $100K annual) increase in cash flow.  This is my security blanket for a dip in the economy (which I believe will hit in 2027).

Cory Iannacone · Answer

@Karolina Powell Thanks!  I think 1.5% would be considered slam dunks in the current market.

Jonathan Greene · Answer

That building looks fantastic. Even in Central PA, the two percent rule is not a thing now. When rates went up from epic lows, it would be impossible to achieve that. Anything over 1 percent, even there, is good.

The way I look at the one percent rule, in general, is that it's a quick scratch pad way of seeing what's what. Anything over may look good, but will likely be hiding cap ex in this market. People use the rule, but the rule makes no sense because it does not take into account building upkeep and cap ex.

Look at this awesome building you have. While you are renovating, your percentage is going down, then you rent higher and it goes up. It looks like a solid asset for the long-term and sellable when done as well.

Jonathan Bock · Answer

Beautiful and Timeless!  Long term hold or exit ?

I think the gross % heuristic is cyclical and areas like Harrisburg have larger swings

Is the 2% Rule still alive in the central Pennsylvania market?

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