Does the 2% rule exist anymore? A case for aiming lower

It probably does, but I've adjusted my expectations, as have a lot of savvy buy & hold investors. A couple reasons why and then a quick case study on a property we recently purchased.

Price appreciation vs rent growth

If you rewind back several years, The 2% Rule was very achievable in many markets in B-C+ class areas. You could have your cake and eat it too; a decent tenant pool, a reasonable expectation of price appreciation and serious cash flow. However, as you'll see many people lamenting here on the BP forums or at your local REIA, prices are up, way up.

From $149k in January 2012 to $237k just last month (October 2019). a 55% increase over 7 years. These are national averages of course, so applying the 2% rule to these averages, if you could buy a home in 2012 for $150k, you could rent it for $3,000. Here's the question you need to ask yourself, have rents increased 55% in the same time period? Or can you rent a $237,000 home for $4,740 each month today?NO!

Rents in January 2012 averaged $1304 per month and in September 2019? $1573 per month or a 21% over the same time period. Keep in mind this is a national average and I'm fully aware that certain markets have experienced much stronger rent growth than others. This is an argument for adjusting expectations and continuing to make solid investments.

So do you sit it out until prices drop again?

I hear a lot of folks talk about how they're just waiting for the next big drop - look at Warren Buffet, he's stashing cash... blah, blah, blah. 

Say you've been stashing cash since 2017, waiting for the next big drop, and let's say it happens in 2021. But you're really smart, so you're going to wait until prices really hit bottom so you can tell all your friends how smart you are. That's 6 years of your money, best case scenario, staying stagnant if you've got a high yield savings account. And worse case scenario, deteriorating at a couple points a year thanks to inflation. 

So, what are we doing? Thanks for asking! 

We're continuing to make solid investments with a reasonable margin of safety and strong cash flow positions. 

A Case Study

We recently purchased a duplex on the east-side of Indianapolis in the Warren Park neighborhood(Before/After photos and more details here).

Purchase Price: $69,900

Rehab: $12,000

ARV: $100,000

Monthly Rents: $1500

If we purchased this property with our own cash, after refinancing we'd have roughly $10k left in the deal after a cash out refi @75% LTV. We happened to finance it with private money, as we do with almost all of our deals, so the numbers are even more advantageous. But for simplicity's sake, let's assume a standard investment.

Day 1, using the 50% rule, we're cash flowing $450 a month. $450 x 12 =$5400 in 12 months or 54% cash on cash return. Over the next 5 years, assuming very modest YOY rent increases, we'll see significant cash flow, principal pay-down and maybe some appreciation.

But watch this - even if there's a serious recession and property values drop 10-20 or even 30%, who cares? We hold through it, continue to cash flow very well and buy up even more when prices are down. Now, for all you cash stashers out there waiting for the market to turn. What exactly are you waiting for? Double digit returns? They still exist! Maybe not in San Francisco, New York or Los Angeles, but Indianapolis? You bet. Memphis, Columbus, Kansas City, ________ (insert mid-west market here).

David Greene wrote a fantastic book on Long Distance Real Estate Investing and many of you have heard the adage, "live where you want to live, invest where the numbers make sense". If you're not up for personally investing out of state, consider investing with a competent operator, and you can still achieve double digit returns without doing any work.

I'll conclude with this question: How great of an investment do you have to make to compensate for years of sitting on the sidelines? 

Even if we're averaging a meager 10% annualized ROI on today's active dollars, using the rule of 72, our investment will double in the time that many folks are waiting out the market.