The 2% rule is the most brilliant ever
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Dawn AnastasiPro Member
Rental Property Investor · Milwaukee, WI · Member since 2013 · 6k+ posts · 4k+ votesI personally like the 2% rule for what it is. I don't like it for what it's not. It's definitely not the one and only metric for analyzing a property's worth. It's a good indicator of cash flow. But it's not a good indicator for a property's "headache value".
If a property scores high on the "2% rule" metric, and low on the "headache value" metric, then it's definitely worth an investigation.
What's the "headache value"? Would I want to walk the neighborhood by myself at night? If not, the headache value is higher because if it's a bad area I'm not going to be able to get good tenants and therefore that would give me a headache. There's a lot of crappy properties in Milwaukee and its important to know what would make a good solid rental versus what's just going to be a headache.
61 Replies
- Real Estate Investor · Silicon Valley, CA · Member since 2012 · 169 posts · 52 votes11y
I hear ya about the 2% rule not working on the left coast! My bldg is just a hair over 1%. I bought 8 years ago and the market is such here that I get unsolicited offers for double what I paid. I believe the rule must be applied in a very market/location specific way.
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
I can remember in the day when the first real big run up in Silicon valley happen middle 80's were houses literally doubled and tripled in 3 years.. My parents home that they bought in 1972 for 35k... for instance in Cupertino... We would literally get folks knocking on the door offering to buy the home.. it sold in 87 for just over 500k and off to Hawaii they went ! Many many millionaires have been made in the bay area by simply buying there
- Bowie, MD · Member since 2014 · 31 posts · 11 votes11y
Originally posted by @Bill Gulley:
Ned:
Horsefeathers!
Buy a calculator and sharpen a pencil. LOL
My area is nowhere near 2%! :)
have to agree with this. various factors determine if a deal is good (or if the 2% test is achievable/necessary).
property type has an impact. if we want a class a rental, we probably wont hit the 2% test. some properties in a lower class would be more likely.
what about larger apartment buildings? they tend to be hard to hit 2% with also.
for ex: we could put in an offer on a property with the following scenario:
offer price - 5M
avg mo rental income - 80000
avg mo expenses - 40000
avg mo noi - 40000
now this works out to be: 80000/5000000 = 1.60
with the right financing and specific factors with regards to things we can do to add value as the owners (as well as our business plans for it like how long we'll hold it or how much its worth after we add value), this property could cashflow very well and produce very good returns even though it's not a good property according to the 2% test. it doesn't seem to take enough factors into consideration.
so it doesn't meet the 2% test but could have good cashflow, dscr, grm, and roi and a profitable re-sale if we can find a way to add value.
regarding smaller properties, I also don't know of any that I could buy for say $100k TOTAL investment and rent out for $2k/mo. etc.
- Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes11y
@Jay Hinrichs you are obviously correct that many millionaires have been created in high appreciation markets but given the situation today where many higher appreciation markets have had large run-ups, are very expensive from an absolute dollar perspective and from a price to income basis (both rent to price and in terms of income of the population), would you still invest in those markets?
In other words to bring it back to this thread would you, assuming you were in an earlier stage of your investing like most of us, go after 2% markets or go after higher appreciation markets if doing so meant sacrificing any hope of cash flow after mortgage payments?
- Investor · Honolulu, HI · Member since 2013 · 3k+ posts · 1k+ votes11y
Originally posted by @Chuck B.:
@Account Closed - I think I understand your point about nothing selling under market value but doesn't that deny that there are wholesalers that have been doing exactly this (buying and selling same day for more) successfully and repeatedly?
Best,
- Chuck
Chuck, I don't see too many whole sellers in my markets.
First you'd have to define what market price is. Was the first sale under market or market? Was the second sale market or OVER market. If there are two sales on the same day which is market value? Is the difference in values attributable to added value by the whole seller and at what cost to him/her?
In my 40+ years of analyzing sales I'd say over market sales ratio to under market sales is probably greater than 20 to 1. (Thanks Grandma!)
- 11yJay HinrichsBusiness MemberReal Estate Consultant · Summerlin, NV · Member since 2014 · 45k+ posts · 66k+ votes
I guess I would do both... I would try to have some assets that I had pretty good indication that over a long holding time I could see appreciation and with cash flow I would be looking at the sturdiest buildings I could find in markets that made sense. I say sturdiest just because we do have functional obsolescence that needs to be taken into consideration if your going to hold the asset long term
I harken back to my earlier years 1984... I had hooked up with a Chinese investor in the Bay Area who wanted to get ahead of the wave of Chinese coming out of hong kong when the lease ran up... So we put together a collection of at the time cash flow homes in and around the north Bay Area were I am from..And off to Hong Kong I went.. I was trying to do Turnkey before we even knew what turn key was !.. Well Hong kong being Hong Kong I got right in to talk to many top RE companies they would look at the product.. And their comments were.. " These are built with Wood we would only buy properties that are built out of concrete" What was going to be a 2 week marketing trip ended in 3 days.. back to the drawing board.. I did not have access to properties like the Trans America building or Sears tower that's what they looked for they wanted stuff that would last hundreds of years.
So I do see a correlation I certain markets.. If your going to hold these assets for 20 to 3 years you want to make sure you buying something that will last that long without killing you cap ex wise. So I make that statement.
Genereally speaking though 2% rule in Turnkey is rougher areas usually.. and you will see that the premier TK companies like a Memphis invest or what Curt Davis does in Memphis as well they won't have anything to do with selling 2% they know the risks. But locals like David Krulac on this site make a killing at it.. But don't confuse passive with someone running a rental business. Just like owning any other type of business one needs to mind the tiller.
- Investor · Baltimore, MD · Member since 2008 · 17k+ posts · 13k+ votes11y
Originally posted by @Account Closed:
Originally posted by @Chuck B.:
@Account Closed - I think I understand your point about nothing selling under market value but doesn't that deny that there are wholesalers that have been doing exactly this (buying and selling same day for more) successfully and repeatedly?
Best,
- Chuck
Chuck, I don't see too many whole sellers in my markets.
First you'd have to define what market price is. Was the first sale under market or market? Was the second sale market or OVER market. If there are two sales on the same day which is market value? Is the difference in values attributable to added value by the whole seller and at what cost to him/her?
Market price is generally defined as something like "The price a willing and capable buyer and a willing an capable seller will agree to"
So lets just say a seller is willing to accept anything over $200K and a buyer looks at and evaluated the property and figures he is willing to pay up to $220K. They are of equal negotiating ability and come up with a price exactly in the middle at $210K.
No one would argue that is NOT market price. However what if we had the exact same situation but one party was a better negotiator and they decided on $205K? Same property but a different Market price.
In fact based on the definition above and that particular deal, it could be argued that Market price was anything between the $200K the seller would accept, and the $220 the buyer would pay. You might argue that my original premise is not at all typical, but I have occasionally bought properties for less than I was willing to pay and often sold for more than I was willing to accept.
OMG did Bob just admit that some properties do not sell at "market price" and in fact some rare ones do sell below market.
- Investor · New York City, NY · Member since 2015 · 808 posts · 417 votes11y
@Jay Hinrichs I used 2% more as a euphemism for good cash flow properties, most that I see as cash flowing in B areas with reasonable assumptions round to 2% but are not 2% (1.6%, 1.7%, etc.) so I should have clarified and are not sold by turnkey companies. I certainly did not mean lower income areas as I have read enough here to know how hard that can be from a management perspective.
Thank you though for your answer it is very helpful.
- Real Estate Agent · Las Vegas, NV · Member since 2015 · 2k+ posts · 1k+ votes11y
I think the rule so only be applied to multi units properties, single family homes (unit) very hard to qualify , example a $100k home would need to generate $2000 per month but a duplex triplex etc can better qualify , here is a prior post on this subject
http://www.biggerpockets.com/renewsblog/2013/04/14/the-2-percent-rule/
- Broker · Logan, UT · Member since 2013 · 1k+ posts · 1k+ votes11y
Where is the discussion of equity and appreciation vs the 2% rule?
I have done flips where i had 50-60% equity positions after repairs and they would have come in at about 1.4%.
I would argue that every market that has properties that conform to the 2% rule has been depreciating for the last 20 years. With the 2% rule, you trade cash flow today for equity tomorrow.
Never mind the headache factor--why is this a good long-term investment at all?
- Investor · Cincinnati, OH · Member since 2013 · 2k+ posts · 1k+ votes11y
@Ned Carey agreed - I like using the 2% rule to quickly evaluate a deal on a single family home. For the DFW market, I've found that in 2009 - 2012 I could get a 1.5% in a good, working class and appreciating area. Now, not so much as it seems to have gone down to about 1.25% in those same areas.
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