Chicago 2% and 50% rule

[Patrick Howe]

Does anyone have any thoughts on applying the 2% rule and 50% rule in the Chicago area? I know that cost of living and rents are higher in Chicago, does this explain why I am having a hard time finding properties that the 2% and 50% rule apply?

I am looking at multi-unit properties on the Northside.

[Mike H.]

I think what you'll typically find is that the 2% rule only works in the lower priced areas - i.e. houses under 80k or so.  Where maybe you can buy an 80k house for 50k and can get 1k a month in rent.

But when you start talking about houses that are selling in the 300k range you are not going to come close to hitting 2%.  Even if you steal that for say 200k, you are not likely going to hit 4k in rent on it......  Not saying its impossible. But if you are waiting to find that deal before you will pull the trigger, you may only end up buying one property in the next 5 years. :-)

If you really want to know whether a house is a deal or not, run the numbers.

Estimate your purchase plus rehab. Figure out how you're going to finance. i.e. 20% down plus rehab out of pocket? Hard money? 

Then look and see what that payment will look like once you rehab the house, get it rented and get your end loan financing on it. And then figure out how much money you'll be out of pocket total on the deal.

20k out of pocket.
Payments (principal, interest, taxes and insurance)  of say 1500/mo.
Estimate your rent. Say 2,400/mo

And now you have a gross profit you can look at to see if the deal makes sense for you. If you have a gross profit of 900/mo, what does that net look like (i.e. repairs, vacancies, capex). Say 500/mo? 400/mo?  That gross to net calculation is very subjective to investors.

But ultimately, now you have what you believe is your net. 400/mo which is 5k a year.
Is 5k a year a good return on 20k to you? Yes? Then take it down.

And don't forget. Not only would you be making 5k or 25% return on your money with the rental cash flow. But you'll have principal paydown on that mortgage of another 300/mo or so maybe? Add that in as well (3,600/yr).  Add in maybe 2 or 3% for appreciation or another 4 to 6k a year maybe?   

Now what is that investment really returning on that 20k investment?

Its not just your 5k in rental income. Its rental income plus principal paydown plus appreciation. Which may be closer 13k total per year.

And, oh by the way - don't forget that your princpal paydown will only go up over time as your loan gets paid off further. And don't forget that rents typically go up over time as well. And, yea, don't forget - appreciation will go up as well. 2% of 300k is 6k.  But in 10 years, if that property is worth 350k, then your appreciation will be 2% of 350k or 7k a year.

And, lastly don't forget that your depreciation will make that rental cash flow completely tax free. So even though you're cash flow will be 5k, that 5k in income will be tax free (at least for the first 10 or so years depending on how much rents go up).   What is 5k worth pretax? 7k?

But again. If you're in areas where the prices of the homes you're buying are over 100k, don't bother with the 2% rule. I focus on the LTV numbers and the gross cash flow. If I'm able to get all in at 70% LTV AND I'm able to have a gross cash flow of $400 to 450/mo or more, I'm going to jump at the deal because I know I'll have positive cash flow and I know I'll make a lot of money in the long run.