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Rental purchase rule of thumb
Can someone please tell me the 'rule of thumb' when evaluating a property for rental? Or better yet, what is the '2% Rule and the '50% Rule'?
I'm looking at a potential deal tomorrow and I'd like to get my numbers right.
Thanks in advance.
Arthur Banks The 2% rule says the price you pay for a rental should be low enough that the rent is at least 2% of the purchase price.
The 50% rule says that about 50% of the income from rents will go to expenses (not including debt service). In other words 50% of your income is left over to cover both financing and your positive cash flow.
Thanks! I should've used the Search function first. I found a good deal of topics on the same question.
Sorry.
The 2% rule is 2% of the deals you look at will make sense to get involved in. Actually, I have no idea what the 2% rule is. Possibly, it is the house must rent (monthly) for 2% of the purchase price? Good luck buying a house for $100K that will bring in $2K a month though! If you know where to buy those, please put me on your buyer's list.
The 50% rule applies to rentals and states that 50% of the income will be lost to expenses with the remaining 50% available to cover debt service and your pocket money. This is fairly accurate if you hold property long term. Long enough to have to replace a roof, hot water heater, A/C, etc. If you buy and hold short term, say less than 10 years, you can probably use something closer to 40% if you budget fixing everything when you close on the property.
2% rule... that's a new one to me. I think I've seen 1% which makes a lot more sense: Buy a $100K house and collect $1K per month in rent. That seems to work, but that is really a good rule for someone with a full time job who wants to pick up a rental or two on the side and fart around on the weekends doing the maintenance themselves. I can't imagine paying $100K for a house that only brings in $1K / month. Not unless I had some smoking financing terms.
I agree with Aaron on the 2% rule. I can't seem to find those anywhere
Todd Carel - go to Zillow and pull up the houses listed between $15 and $35K in Oklahoma County. (There are 65 of them.) These are the 2% houses. You can buy them at 90% of list (we'll say), put in $8k of rehab, and rent them out for 2% a month.
Now there's a good possibility that you won't want to own in these areas, and that is when you see the 2% rule for the ridiculous thing that it is, not sure where it came from. And these houses are TOUGH to finance, loan amts are too small and many bank redline the areas that they're located in, meaning they lower the LTV, raise the rates, or just refuse to make the loan. So no benefit of leverage.
So maybe you want to jump up to the $50-60k list-price homes, where you'll be all in for $60-70k and rent for $950/mth in a nicer area, amounting to around 1.5%/mth. Now you're getting more into the "sweet spot". These homes can be readily financed, tenants are better, less damage to your property, etc. You might see that you end up NETTING a higher yield than those 2% properties, with less hours spent. Certainly your cash on cash return is better due to the financing that is available.
And of course you can jump up to the $90-100k (after fixup) homes that might rent for $1,250. These will be in good school districts, much better tenant class, and likely the least anxiety and hours of your life managing tenants. Houses in this price range also allow you to better utilize the limited number of fixed-rate Fannie Mae loans you can obtain. (You can put more of your capital to work at these historically low rates.)
Your call.
Yea. I think the 2% rule is a bit misguided. It really only works on the lower end. I could see getting a 50k house that rents for 1k. But when you start getting in that 70 to 100k range, good luck. If that was what you needed to do to buy a property, you wouldn't be an investor, you'd be a bystander.
I will say though that your area really has a lot to do with that number. I would bet anything you can't come close to 2% in california on anything. But maybe in texas you can.
Here in Illinois, I'd say the magic number is more like 1.5 to 1.7%. Its close. But I don't see getting 2% unless its on the low end.
The 50% rule:
I've heard several things, can someone clarify. Does 50% of gross rent pay from just P&I and then $100/door...the other 50% going towards everything else, ie- maintenance, repairs, Homeowners Insurance, Taxes, Utilities???
Yes, Rick L., you have it.
Thanks David Beard It appears that I have been calculating a lot of rental properties I've look at all wrong.
So to further clarify:
Gross Rent * 50% = Net Operating Income(NOI)
NOI - P&I = +$100/Door
The other 50% of Gross rent will pay for ALL other expenses including:
Repairs, Maintenance, Improvements, Property Management, Homeowners Insurance, Utilities, HOA, Property Taxes, etc, etc
Aaron Mazzrillo the 2% rule really does exist and some people get more than that. But yes, it applies when you buy the houses really cheaply and can rent them out for decent rents. That's what I do, because it makes sense financially.
But YES, typically these are properties you would buy cash only, not financed.
And NO, contrary to popular belief, those low cost houses are NOT all in "warzones"! I personally buy houses in the same zip code that I live in.
And NO, you don't get bad tenants if you screen really well. You don't have headaches if you maintain the property well.
Originally posted by Dawn A.:
I still think it's like Sasquatch or the "Eastern Panther" ... lots of claims and stories, but I've never seen one in person ;-)
It really depends upon where you look. In most of Canada, any property you could find that would rent for >=2% of the purchase price would be in a declining area where there will soon be no one to rent.
Roy N. the difference between Sasquatch and the 2% rule is that those achieving the 2% rule can prove it with facts and figures. :)
there are some area you can hit 2%, not many not in warzones but it can be done. they may not appreciate as much &, yes, many banks have a minimum # to do a loan.
in my area, I'll never achieve 2%, and the way things are going up lately, buy & hold may be on the way out to flipping.
My two cents, http://www.biggerpockets.com/renewsblog/2013/04/14/the-2-percent-rule/
The 2% really is few and far between these days. That shipped is pretty much sailed.
Originally posted by Dawn A.:
There are plenty of people who think they can prove Sasquatch exists and they have photos and foot prints! LOL
I'm an equity buyer. I like things that go up in value. I'd rather be leveraged on a $100k house making $1000 / month in rent than all in on a $50k house making the same income. If we see 10% or more appreciation, like we are seeing right now out here in CA, I'm banking $10k per house per year. If I am highly leveraged, which in most cases I am and on many of the houses I've purchased in the last three years as I have less than $10k in on each of them, my return is quite significant to say the least.
Inherently, I see nothing wrong with buying affordable housing. An associate of mine made a lot of money buying houses from the farm association in FL and renting them to section 8. He had quite a few sets of 10 that put one heck of a big check in his pocket when he sold. However, as Mr. Trump said, "the only difference between a $100k deal and a $1m deal is a decimal place."
2% was possible on duplexes and up from '08 to '12.
90K for $1,800/month+ all day.
That 15 to 30K single family houses was also possible but I had no interest in those.
Haven't found 1 yet for '13 that is in an area that I want to be.
Time to start shifting gears to get the returns we were getting on purchased multi family.
I purchased a house in early June in a class B working neighborhood for $30,001. It barely needed any work. Paint, carpet, etc. When I signed a lease with a tenant on July 1 for $955, I was all in to the house for $32,821.23. This included the purchase of the house, materials, labor, etc. It only included a little bit of property taxes because our tax bills come out in July and December and the bigger bill is in July. Insurance is billed monthly in arrears, so that hasn't been paid yet either. (It's only about $40 per month anyway).
Still, it's almost 3% per month in a quiet neighborhood with little crime. Would I want to live there? No. Would I send my kids to those schools? NO! I would work 22 hours a day if I had to to avoid that. But for an investment, it's still a great return. Those are the kind of deals I look for. They are still out there. You just have to look really hard to find them.
Nice Deal Rob K, my capitalist buddy!
Originally posted by Rob K:
Awesome deal! Can I ask why it was $30,001 and not $30,000? What was the extra $1 for? Buying the pen to sign the deal? :)
Rob K - Are those types of deals strictly cash-and-carry, or are you tapping into bank or private financing of any sort.
Yes, great deal by the way. The Greater Detroit area seems to have the highest rent yields in the country for B to C+ properties, and I'm sure with your experience you track down the best of the best deals (outside of Detroit City, I presume.)
Dawn A. Good question. This was a short sale that was listed for $30,000 and had sold to an investor who had made more offers than he could buy. He ended up backing out of this deal when other short sales he made offers on were accepted by the bank. The day that it came back on the market, I called the listing agent and said I would pay full price cash AND let him have both sides of the commission. He said he had other potential offers. I asked him if he had a paper shredder and told him that that's the place other offers needed to go. I added the dollar just to make it "over asking". I usually offer a weird number like $30,111, but I was confident I could get this house for $30,001. Letting the listing agent have all the commission makes a lot of deals happen.
David Beard Yes, this is a good 6+ miles from the city limits. It's in a quiet area with good police presence. I'm trying to cashflow everything these days and grow my business without debt. I have some mortgages, but on track to get them paid off.
These deals are harder to find. The most recent purchase will only rent for about 2.5% per month. Still good numbers, but not like it used to be. When I hear that someone bought a house for $100K and rent it out for $1,000 per month, I cringe. With those numbers, I would rather invest in a 7-Eleven and clean Slurpee machines everyday.
The 2% is not going to work in a lot of markets so don't pick your market before seeing if the will have a chance if you want that as your investment criteria.
Now people who say it just can't be done mean it can't where they look.
Plenty of people have already talked about how they do it all the time.
If you want those numbers you may need to invest remotely. If you live in CA or in the Northeast don't count on buying much if anything.
I bought a place in Massachusetts last year that beat 2%.
Only took 5+ years of actively looking!
By contrast I can get in touch with a Realtor in my farm area in Pennsylvania and ask for a list of MLS properties $25k or less that rent for at least $500 and she'd ask me to be more specific.
There it isn't that hard to find listed properties that still can hit 3%.
Fyi these are mostly B/C level areas and there really aren't any war zones even if you wanted to go to the worst part of town to milk a tiny bit more cashflow out of a place.
Shaun Reilly
"Now people who say it just can't be done mean it can't where they look."
If they've even tried!
"Plenty of people have already talked about how they do it all the time."
I agree!
Wow, Newton - 213 SF sold in the last 90 days, average sale $1,116,851. DOM average 52. Hot market.
Yeah Mike Hurney Newton has blown up recently.
My wife and I were looking to move up here a few months back and got all our ducks in a row for it and all of a sudden the stuff that had been like $375-450K and sitting got snapped up and worse crap started coming on at $550K and going off in a few days.
Needless to say we aren't moving. :)