2% Rule vs. Rule of Two

General Real Estate Investing
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2% Rule vs. Rule of Two

Justin Foster
Tacoma, WA · Member since 2013 · 67 posts · 1 vote

I'm reading a free book on REI from http://iloverealestate.tv/ in which the author talks about a rule she made up called the Rule of Two. In this, you divide the purchase price by 1,000 and multiple that by 2 in order to get the minimum weekly rent you should charge.

(Purchase price / 1,000) X 2 = Weekly Rent

In the 2% rule, we multiply purchase price by .02 to get the monthly rent that we should try to get close to.

So lets say a property has a purchase price of $200,000.

Rule of two gets us $400 weekly rent. Multiplied by 4.3 for the average weeks in a month, we get $1,720 monthly rent to use as a starting point.

2% rule of the same price shows us to get close to $2,000 monthly rent.

While these two results are close to each other, there's still a significant difference between them. Which one would be more useful to go off of? Or would it be useful to use both and go for a number in between the two?

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Don KonipolBusiness Member
Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
13y

The 2% rule is a very good quick analytical tool, but has a number of limitations. One of the most significant is that it does not take into account differences in property age and quality. So it assumes a ragged out property 40 years old poorly constructed with a high annual repair cost is worth the same to an investor as a brand new well constructed property - as long as the rental income is the same. This is because for the "rule" to work expenses for each property , i.e. repairs, depreciation, vacancy, taxes, insurance, management, etc. must add up to the same percentage of rental income.

In my experience real operating expenses have been anywhere from 38% to 65% of rental income. Further, the rule does not account for a risk factor, nor the probability of property value increases - or decreases.

The 2% rule seems to work best when utilized for lower blue collar type single family homes in stable areas. Outside this parameter, a different "rule" is needed.

While a good starting point - sometimes - strict adherence will cause the investor to pass on some good investments not fitting this criteria - and limit the investor to somewhat lower end properties. However, it will probably also keep the investor from making a serious mistake.

Private Mortgage Financing Partners, LLC
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  • Scott L.
    Broomfield, CO · Member since 2012 · 47 posts · 43 votes
    13y

    Hi Justin,

    The 2% rule applied to the sample property would be $4,000 monthly rent. So the difference between the rules is even more significant than what you thought.

    I don't know where the author of the 'rule of two' invests, and I don't pretend to know the Alaska market but do your diligence and talk with local investors (at a club) to get a better understanding of how your market behaves.

    Edit - the 'rule of two' link is broken.

    0Reply
  • Justin Foster
    OP
    Tacoma, WA · Member since 2013 · 67 posts · 1 vote
    13y

    Scott Limoges
    Wow, can't believe I made such a big mistake in the math. I just started learning about REI so I guess it shows.

    The author is Dymphna Boholt. She doesn't invest in Alaska, I just found the book online through the website I linked. She invests in New South Wales and i believe parts of America.

    I'm also not sure what's wrong with the link. It works fine for me.

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  • Ned CareyPro Member
    Moderator
    Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
    13y

    I would ignore her rule. The rent comes out to low, below even 1%.

    The 2% rule is a "rule of Thumb." There are situations when you can buy at prices higher that the rule suggests. I would not want to use a rule that has you buying at a price more than double the proven 2% rule.

    good luck - Ned

    1Reply
  • Justin Foster
    OP
    Tacoma, WA · Member since 2013 · 67 posts · 1 vote
    13y

    Ned Carey
    Thank you Ned. She also called her rule a "rule of thumb," but I wanted to run it by people here before I considered using it.

    0Reply
  • Steve Babiak
    Real Estate Investor · Audubon, PA · Member since 2009 · 13k+ posts · 8k+ votes
    13y

    "New South Wales" is in some other English speaking country, not the USA. Plus, there are 52 weeks in a year, so you can annualize the income number and then divide by 12 to get a bigger monthly number using the formula from this book's author. Figure out what "rules" work for you, and make sure whatever you use is simple enough that you can't screw up in doing the arithmetic; if it's complicated, use a spreadsheet to compute the math.

    1Reply
  • Justin Foster
    OP
    Tacoma, WA · Member since 2013 · 67 posts · 1 vote
    13y

    Steve Babiak
    I'm aware it's not USA, but to my knowledge, that shouldn't change how you determine how much rent you need to take in positive cashflow. Additionally, she refers to investing in America, giving the impression that the formula should work there too.

    Correct me if I'm wrong, but if I annualize the $400 weekly rent and divide by 12, I get $1733. This would only be $13 more than the number I provided in my post. I don't see how this makes a significant difference in comparing the two rules.

    I'm not yet in a position to decide for myself what works for me, so I'd like to use the rules that work for other first and then change later if I find something else works better.

    I apologize for messing up the arithmetic of a rule I just learned today. I'll be sure not to make the same mistake again.

    0Reply
  • Savannah Leigh
    Real Estate Investor · scranton, PA · Member since 2010 · 174 posts · 14 votes
    13y

    having never invested overseas i dont know...but i would be careful w any info from overseas.

    taxes, insurance..a whole host of stuff is different.

    for me 1k in income is roughly 40k in value. so i guess 2pct is close to my number. 40 to 50k for every grand in income. as a ballpark whether i look closer

    0Reply
  • Pat L.
    Rental Property Investor · Upstate, NY · Member since 2012 · 3k+ posts · 3k+ votes
    13y

    The 50%/2% etc definitely depends on your market/area.
    Around here I can get (min rehab work) duplexes for <$50k (CASH) pulling rents $1200/mo minimum (sep utilities, incl water).
    Taxes run $48/$1000, Ins $675/yr.

    An investor friend rehabbed ($5,400) a small 2brm 1bath unit with 'granite kitchen counter' & gets $800/mo (the entire kitchen has ONE drawer!!!), (lower unit is his office). The building cost $38,000 @ auction 4 years ago, & it's never been vacant.

    0Reply
  • Michael Lauther
    Investor · Hampton Bays, NY · Member since 2009 · 907 posts · 258 votes
    13y

    Justin Foster The area you choose to invest in has everything to do with how you apply the 2% rule.Taxes and insurance vary considerably from one place to another and will have a significant effect on expenses as do cost to repair which will impact maintenance as well. While we like to refer to this as a rule it is just a guide to use as a starting point when evaluating an investment.

    0Reply
  • Andrew O.
    Real Estate Investor · San Clemente, CA · Member since 2011 · 209 posts · 47 votes
    13y

    NSW is in Australia, it's a state, Sydney is the capital city. Rental rate ratios are terrible in Australia, you would put money in only for capital gains, as no properties truly cash flow. (Unless you bought in a mining town 10 years ago)

    1Reply
  • Don KonipolBusiness Member
    Investor · The Woodlands TX / Avon, CT · Member since 2009 · 6k+ posts · 10k+ votes
    13y

    The 2% rule is a very good quick analytical tool, but has a number of limitations. One of the most significant is that it does not take into account differences in property age and quality. So it assumes a ragged out property 40 years old poorly constructed with a high annual repair cost is worth the same to an investor as a brand new well constructed property - as long as the rental income is the same. This is because for the "rule" to work expenses for each property , i.e. repairs, depreciation, vacancy, taxes, insurance, management, etc. must add up to the same percentage of rental income.

    In my experience real operating expenses have been anywhere from 38% to 65% of rental income. Further, the rule does not account for a risk factor, nor the probability of property value increases - or decreases.

    The 2% rule seems to work best when utilized for lower blue collar type single family homes in stable areas. Outside this parameter, a different "rule" is needed.

    While a good starting point - sometimes - strict adherence will cause the investor to pass on some good investments not fitting this criteria - and limit the investor to somewhat lower end properties. However, it will probably also keep the investor from making a serious mistake.

    Private Mortgage Financing Partners, LLC
    WebsiteView Page
    2Reply
  • Ali Boone
    Real Estate Coach · Venice Beach, CA · Member since 2012 · 6k+ posts · 3k+ votes
    13y

    Don't ever go off rules like that. You can use them as reference, maybe, but not hers. It's not up to you or the property price to determine what rent should be charged. It's up to the market!

    0Reply
  • Marty Gibson
    NSW, NSW · Member since 2014 · 1 post · 0 votes
    12y
    Originally posted by @Ned Carey:

    I would ignore her rule. The rent comes out to low, below even 1%.

    The 2% rule is a "rule of Thumb." There are situations when you can buy at prices higher that the rule suggests. I would not want to use a rule that has you buying at a price more than double the proven 2% rule.

    good luck - Ned

    Hi Ned

    Just reading this old post...

    Ignore her rule , I think you are referring to Dymphna Boholts rule!

    I assume that most on here are what we call "negative gearing" -tax offset on properties..right?

    Dymphna has a very wealthy self made portfolio in fact.Her rule is to keep all properties as a positive cash flow property ,and the rule is a guide to keep them that way. Which over time , as a cumulative exercise,you could be well on your way to income replacement and beyond.

    Sometimes,look outside the square!

    not all rules that "you know" work. That's obvious here with the 2% rule all are speaking of.

    Read about others ,and invest in different areas if criteria isn't met.

    Invest without emotional attachment. Cheers.

    0Reply
  • Ned CareyPro Member
    Moderator
    Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes
    12y

    @Marty Gibson 

    My comments apply to my market and the US  in general.  Dymphna is from Australia and factors there may cause deals to work well there that would not work here.

    Your comments imply the goal is cash flow and as I understand her rule properties would not cash flow or cash flow very poorly using her formula.  

    The 2% formula mentioned here is designed to generate MORE cash flow and reduce risk. 

    The bottom line is Her formula and the 2% rule are essentially the same way to evaluate a deal (using the rent as a ratio of purchase price to evaluate a rental deal) It is just she uses an aggressive number that leads to lower cash flow and greater risk.

    I Don't know what you are referring to here

    0Reply
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