Rental Rates

[Bob Lowry]

I just read the "Ultimate Beginner Guide" provided by BiggerPockets and noted the investment rule of 2%, and find it may not be realistic in my humble opinion.

If I am correct using the 2% rule, a home that cost $200,000 should rent for $4,000/mth.

In California, the rental I have cost me $200,000 (low for CA) and I am happy to get $1650/mth or about 9% per year gross return per year on my investment. (1650/12=19800/200,000=9.9%). Trying to get $4k/mth is unrealistic, even in CA.

At the same time, homes in a Cleveland OH suburb that are selling for $60,000 should rent for $1200/mth using the rule but in fact according to Trulia they are renting for $550-800/mth.

Can this "2% Rule" be accurate or has someone made an error?
Getting 2%/mth would be 24% per annum and seems unrealistic.

What am I missing?

[Jon Holdman]

While I hate that rule of thumb, there's a kernal of truth behind it. It contains a bunch of assumptions, most of which aren't valid in your example. It assumes rents of about $500 and 6% rates on loans.

But you're applying it backwards. You have to start with market rental rates. You have ZERO control over that number. From there, you would divide by 2% to get the price you can afford to pay. So, if rents are $500, you can afford to pay about $25,000 for the house and still have a profitable rental.

A better rule of thumb is the 50% rule. That is, expenses, vacancy and capital will eat up 50% of the gross scheduled rent. From the remaining 50%, you have to pay your mortgage (if any) and get your cash flow. The rule of thumb assumes you're using a PM. Around here they charge 10% of collected rents plus half a months rent to fill a vacancy. That works out to 14% total, if you have one vacancy a year. You can earn that for your self, if you manage your own properties.

So, start from that basis, and the market rents in your area, and the interest rate and terms you can get and figure out what you can pay.