We’re always hearing about different “rules” and guidelines in real estate. Whether it’s a real estate investing for beginners guide or an expert guide that you’re reading, rules of thumb are everywhere. Experts across the industry come up with these rules as a way to help real estate investors better invest. Many of these rules are indeed very useful and can help investors avoid negative cash flow properties, low occupancy rates, and other risks in real estate. But are all rules accurate? And are they useful?
In this blog, we’re evaluating the 2% rule in real estate. So stick around to learn all you need to know about it.
What Is the 2% Rule in Real Estate?
The 2% rule in real estate is a rule of thumb which suggests that a rental property is a good investment if the monthly rental income is equal to or higher than 2% of the investment property price. For example, for a $200,000 rental property, the rental income has to be at least $4,000 to meet the 2% rule. And the rental income for a $50,000 investment property has to be at least $1,000, and so on.
Is this a realistic goal for real estate investors to go after? Let’s break down the 2% rule in real estate to find out.
What Investment Properties Follow the 2% Rule?
Naturally, not every investment property out there follows the 2% rule. They do exist, however, mostly in areas like the mid-west and south of the US real estate market. But these investment properties can often become harder to find in cities like Los Angeles, Denver, and Boston. This is because the location of the investment property will determine both the purchase price as well as how much you can rent your house for. So if you’re investing in Memphis, the 2% rule may be achievable and realistic, but if you’re investing in LA, not so much.
Real estate investors can use the 2% rule when they’re looking for positive cash flow as opposed to appreciation. Conversely, if an investment property doesn’t meet the 2% rule, it could still be an opportunity to invest for appreciation. So before you even start to conduct investment property analysis, learn what it is that you’re looking to get out of a property. Is it long term gains like appreciation, or is it shorter term gains like cash flow?
Therefore, choosing to use or not to use the 2% rule depends on what you’re looking for in a real estate investment. It also depends on the area you’re investing in and the real estate strategy you’re following.
How Useful Is the 2% Rule in Real Estate?
Generally speaking, the 2% rule is a good initial measure for a cash flow investor. But it has several drawbacks in the sense that it doesn’t tell you anything about the property’s condition, the property’s location, net rental income, cash on cash (CoC) return, cap rate, or appreciation.
What does this mean? It basically means that the rule isn’t of much use if you don’t calculate other indicators when conducting investment property analysis.
What Does This Tell Us?
This tells us that there are no concrete rules when it comes to real estate investing. And that there are several factors to consider when learning how to find positive cash flow properties. Will you find an investment property that meets the 2% rule in real estate? It’s possible, yes. But remember to consider other factors when looking – such as expenses, vacancies, the type of property you’re buying, etc.
What Do Investors and Other Experts Think About the 2% Rule?
Some experts believe that the 2% rule should be disregarded completely, and state that it’s a bad rule of thumb. Others describe it as being too broad and restrictive, especially in today’s real estate markets.
Experts also argue that areas where properties match this ratio don’t even exist in the best places to invest in real estate. Additionally, for a rental property to achieve the rule, it would have to be cheaper – and cheaper properties may sometimes need more money invested in maintenance and upkeep, which can increase your costs as an investor, and affect your net rental income. So in the end, whatever you saved on property price, you could be spending on maintenance. This is why we usually advise running thorough inspections before buying an investment property.
Of course, the above are all general concerns that don’t apply to all 2%-rule-meeting-properties. All in all, even though the rule can help investors learn how to find positive cash flow properties, it cannot stand on its own as an indicator of how good an investment property actually is.
Final Notes on the 2% Rule
Overall, the rule is a good indicator of rental income to property price ratio. It is something you can strive to achieve as a real estate investor, but you don’t need to strictly follow it. It’s still important to measure the rent to cost ratio, even if you don’t intend to follow the 2% rule, so definitely do keep it in mind when searching for investment properties.