The 2% rule does not apply to every market, does it?

Question

Hello BP gang!

I've heard quite a few investors talk about using the 2% rule as a general rule of thumb when evaluating for buy and hold deals for cashflow. However from analizing the rent to value ratio of residential properties in my particular market (San Diego), I am finding that the 2% rule would place the asking rent way above what comparable properties are rendlting for in my area. If someone were to apply this rule here in this market, the home would stay vacant for months on end and the holding costs would kill the investment. In doing the numbers on a few San Diego properties, I find that the ratio falls more in the neighborhood of 0.5% RTV. So as a wholesaler marketing properties to buy and hold investors, would such a yield be considered the norm when analizing a deal? Could an experienced buyer please comment? Thx.

Frank Jiang · Answer

San Diego is an amazing place to live.

That being said, it's a pretty terrible place to invest in buy and hold single family if you're looking for cashflow.

The people who do buy and hold SFRs in San Diego fall under a few categories in my book:

- People who bought back long ago or during the crisis and are able to maintain good rental cashflow

- People who are speculating on appreciation and can afford to eat the risk and negative cashflow

- People who can't do math

Mark Shaffar · Answer

@Javier Osuna

I think the 2% rule put places like Milwaukee on the map- listen to BP Podcast 29 from 2013. But even in Milwaukee it's tough to find these days for a rehabbed property in a decent neighborhood.

Shawn Couch · Answer

Yeah, no way does the. 2% time work in San Diego. You will be hard pressed to find many 1% properties unless.they are condos, and in that case, the HOA dues will cut in deeply even to the 1%.. It's always relevant to the area you are investing in. 2% is attainable, but most likely in areas with less appreciation. Tit for tat basically. Happy investing

Account Closed · Answer

I'm with Jesse--the problem with the 2% rule is it ignores anything but pure return.  I have two rentals that are "only" getting me 0.7% but, with fellow military officers in them, their families are taking better care of the properties then I would!  Low-maintenance tenants more than make up for "low" returns.

Jody Rouse · Answer

The lower the cash flow then there should be higher appreciation and therefore equity capture to refi into a new purchase.  coastal communities offer this as purchases go for high premiums.

Assaf Furman · Answer

As a wholesaler, you actually CAN force numbers in order to make it work. Since (I hope) you're dealing with owners on off-market sales, you can put an offer that reflects numbers that work for your B&H investors. When evaluating an opportunity you can use the x% rule to quickly come up with a purchase price that should work, and tweak it according to the specific situation (repair costs, taxes, neighborhood class etc.). But than again, you need to figure out what's that x%, and the best way is simply asking your fellow investors what numbers do they look at.

Javier Osuna · Answer

Great suggestion Aaron.

Although I'd probalby still have to use the ol' numbers,l on a napkin method lol! Math in my head was never my forté. That level of skill will likely come with more experience and tepetition. Yes, higher rent yields can make or break the deal. One must be ready to walk away if need be. If it doesn't make sense, don't force the numbers forcthe sake of making it work. It won't and there will always be other deals. Its all about the RTV ratio your market can sustain. Gotta get some rent comps as part of the analysis.

Javier Osuna · Answer

Yes Matt., I agree completely! Its all about knowing your particular market. San Diego is really a high-priced market and so, the rule will have to be tweaked considerably. Rents are expensive by comparison as opposed to other areas of the county and even then, RTV here still hovers around the .5% give or take two decimal points, depending on the area of town. I will be checking out your link in more detail.

Thanks so much for contributing. :)

Matt R. · Answer

@Javier Osuna Much has been said about this topic. Some of 1% or 2% is merely a function of where you invest. Some areas with lower percentages provide the best returns is something to keep in mind. Zillows senior economist illustrated some of this....

When one considers all factors of investments you will see the picture changes dramatically with adding in all the fundamentals. Good Luck!

http://www.zillow.com/research/landlord-profit-735...

Aaron Montague · Answer

@Javier Osuna

The x% rule is just a sliding scale that will give you an idea of how profitable the deal is probably going to be.

Almost all 2% deals are going to look good once you take the actual expenses and put them in your spreadsheet.  Some 1%, more 1.5% almost none below 1%.  Obviously there are exceptions, but think of it as a scale, not anything more advanced.

My thought process goes something like this:

Ah, new property.

Price 220, 4 unit.  550 each? (1% part of the scale kicking in)  Time elapsed: ~15 seconds

Scenario 1: rents 475/475/500/500... new decent price target 195.  I know my area, 150k.. not happening, onto the next

Scenario 2: rents 625 each!! excellent.  (pick up the phone and call the seller realtor to get actual expense numbers)

total time: less than 1 minute.

Don't dwell on the x% scale.  Just use it (them) as a quick barometer of the building you're looking at.  Get to the important, and more accurate, numbers quickly.

The 2% rule does not apply to every market, does it?

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