Fudging the 2% and 50% rule

[Mike McKinzie]

As has been discussed quite heavily on these forums, as investors, we look to 'gross' 2%+ of the purchase price and expect 50% of the rent to pay for all expenses except the financing.

Do any of you 'fudge' on these parameters? For instance, would you take 1.5% on a newer house in a low property tax state? Do you use different rules when you buy CASH vs. MORTGAGE? Is there a 'value' in buying a house with an established tenant? A fixed Section 8 rental rate? Is there value in buying a home in a 'nicer' neighborhood vs a low income neighborhood?

I would appreciate any and all thoughts on this matter, thanks.

[Bill Gulley]

Hi, Good Post Trace!

I never used a ratio like that in my life on any property! While these ratios are close to making certain strategies work generally sought after by investors, there is much more to consider in investing, especially long term. All the points you made are valid. It's my opinion that ratios were established as a guideline for people who lack the ability to judge an opportunity on it's own merits. Can you imagine some guru selling the idea that ANYONE can make a million and have a couple hundred pages each on topics such as economics, regression analysis and forecasting, accounting, and appraisal techniques? I don't think they would have sold many books, do you? It's hard to teach the skills necessary to make good investment decissions, in any investment arena.

Stock brokers use the acid test-quick ratios, earnings per share and ratios based on a snapshot in time of an investment. Ratios work for the initial appraisal of a deal, but it takes other skills to identify a real winner. If you get a real winner from using only ratios, I'm sure that's one of the definitions of luck!

Being able to identify a great property goes beyond ratio analysis for a rental or a quick flip. I've acquired many properties that were changed in use or function. As an example, I bought a mixed use zoned building at 15K, put 2K in it, and held on to it for three and a half years, never rented it, never really used it other than for storage. Sold it for 65K. It was public knowledge that the city was going to acquire a railroad right-of-way, remove the RR spurs and connect a greenway right behind the property. There is no ratio for due diligence, imagination or seeing potential in a property!

Ask any stock investor if they bought Wal-Mart, Google or Microsoft when they went public based on investment ratios alone.

Now, some might call that speculation, I disagree. Speculation is when you buy and have no evidence or reliable data available to base your expectation of profit upon. In the example I just gave, I could have sold the property several times for a quick profit. It wasn't until people were walking along the greenway path that the property was sold.

If you have the skills to identify good deals, don't follow the crowd, that's how everyone else is viewing the deal and why they didn't buy it! IMO Bill