2% method flaws and observations

[Joel Benscoter]

As a new user to BP but someone who has done well with the three properties I’ve owned, I was taking a look through the forums seeing what screening tools others were using and thought it was interesting how much of an emphasis the 2% rule & 50% rule played out as a starting point for many. I wanted to voice my hesitations using these methods across the forum and see what others think about this.

Timeframe – It seems like many of the threads that use this guide line started 5-8 years ago… when interest rates were 5-8% and not the 3.5-4.5% that they have been hovering around the last couple years. Take a simple example

$250k home with 20%down @ 3.5% = $898/month of P&I (now)

$250k home with 20%down @ 6% = $1200/month of P&I (5-8 yrs ago)

Clearly there is a big difference of $300/month or $3600/yr… or to state it a different way the interest rate alone accounts for a 1.4% expense difference ($3600/250k). What I’m attempting to show is that someone utilizing the 2% rule 5-8 years ago they could now get the same return utilizing a new .6% rule (2% - 1.4%) assuming all other factors were the identical. Obviously you could argue that a little more that would come back to you via taxes (~1-1.2k in most tax situations) but for sake of explanation I’m just trying to show that it shouldn’t be a fixed 2% that you plug into your calculations…

Another reason I look at the 2% rule and chuckle a little is that while it may work in certain locations where the cost of ownership is low and maintenance is a much bigger percentage of the yearly picture it doesn't hold up well under many areas. Seeing as though I live in the SF bay area I quickly realized there's no way that anything close to 2% would ever happen in high cost of living areas… If I followed that rule here in the San Francisco bay area an average $900k SFR property would be need a whopping $18k/month in order to meet the 2% rule (900k*.02)… clearly there's no way you could expect to find a property that'll net you $216k/year at a 900k price point. But please let me know if you do; I'll buy it in a heartbeat! The 2% rule seems to be intended to protect against long term expenses (carpet, painting, roof, etc) but if the cost of the home is so much larger than the upkeep expenses it should instead get back to a cost per square foot to maintain-- Example 2000sq ft * $3/yr = $6k/yr for maintenance seems much more reasonable then needing to go achieve the $18k/month route to suggest cashflow. This leads me to my first question--

What do others plug into their cost per square foot to maintain different types of properties (condo/townhome/SFR, etc). Obviously this will vary a little based off of the area but should be much less variation then using the 2% rule to estimate.

-Joel