1%-2% rental rule of thumb

[Gary Baker]

Hi Bigger Pockets - long time lurker.
Part of my procrastination in buying SFR rentals in 2016 has been that my calculations show negative returns, thus no cash flow. The DFW market heated up rapidly in 2013-2016 and has cooled slightly over winter. However, housing is still very expensive and rental value has not kept up. Whether sales have peeked or not is another debate.

How do landlords manage to buy and hold rentals if the rental returns are sub the 1% rule? Some area's the rental income is as low as 0.6% - 0.8% of value and if you do the due diligence there is not enough in the rent to set aside for keeping you at the recommended minimum 50% expenditures.
E.g.
Vacancy (8.133%pa)
Insurance (1% of value pa)
Maintenance (10% of rent)
Taxes (2.48% of purchase value pa)
Management (??? 10% of rent)

Granted some expenditure above is subjective, but you still need to set it aside and this excludes servicing your mortgage. Unless you have a lot of equity in the property the numbers do not stack up. Property is sold the day it hits the marketplace and I am yet to find discounted property for sale to satisfy the 1% rule.
So how do seasoned investors make money in this sort of rental market?

Thanks in advance,

Gary.

[Wes Blackwell]

Hi @Gary Baker! Great question!

In my opinion, the 2% Rule is really only useful for lower priced properties in the $50-100k range. If you have a $50k SFR that rents for $1,000 that'd be a killer deal and meet the 2% rule of thumb.

But like @Eric Marofske said, in California it simply doesn't work. You'd need to find a $400k property that rents for $8,000 per month! And the second you find one of those let me know because I'll be the first to buy it lol.

Once you get past a certain price point, SFR becomes out of the question. You'll need to start looking to 2-4 unit multifamily. That's the only way to make some decent returns on the monthly cash flow.

Here in Sacramento and the Central Valley (Stockton, Modesto, Fresno) you can expect 0.60 - 0.70% on average, with the better properties being in the 0.80 - 1.0% range. RARELY will you see something crack the 1% barrier (at least off the MLS) and usually it's gonna need some serious rehab and remodeling. Highest I've ever seen was like 1.33% on a fourplex in Stockton, CA.

Hope this information helps! Start looking into 2-4 units and you're sure to find some deals!