What is the 2% Rule in Real Estate Investing?

The average cost of a home in the United States in 2019 was $277,000. A quarter of a million-dollar investment to buy a home is out of the reach of much of the population. This gap between renting and owning creates a growing opportunity for property investors. 

The 2% rule is not a rule in the traditional sense but more like a recommendation and guideline for investing. What is the 2% rule and should it always be followed?

Read on for what we learned in our research.

What Is the 2% Rule?

The 2% rule is a guideline for investing in rental properties. Real estate investing is mostly about buying the right place, at the right time, and at the right price to make a return on investment (ROI) as quickly as possible. Special care to which property you invest in is key to successful real estate investing.

The rule states that if a property is able to be rented at 2% or more of the purchase price than buying the property will make for a profitable investment. For example, a home that is on the market for $80,000 needs to be rented for $1,600 a month to qualify as a sound investment.

The Cost of Ownership

In the above example, the $1,600 a month would bring a return on the $80,000 purchase price in a little over 4 years. Except, we must not forget to calculate the cost of ownership.

Owning the property has certain expenses that will eat away at the rental income and slow down the ROI. The landlord is responsible for paying:

  • real estate taxes
  • insurance
  • damages to the property (in some cases)
  • ongoing maintenance of the property
  • cleaning and dump fees between renters

Other factors such as unpaid rent or periods of time when the property is not occupied also need to be factored in as all part of the cost of doing business. It is hard to say exactly how much the cost of ownership on a property is, but generally speaking, you should expect that 50% of the rental income will go right back into your investment.

Return on Investment

The real estate market fluctuates like any other market, but property investments remain one of the top well-known investments to maintain value over time. There are short term strategies and long term strategies when it comes to real estate investment.

The classic “property flipping” investment strategy where the property is purchased, renovated, and then resold at a profit is the perfect example of a short-term investment strategy.

The 2% rule is a long-term ROI strategy. Of course, a full ROI in the shortest time possible is always ideal. Most investors would be happy to see a 10 to 15-year return on investment and begin to enjoy higher residual income from their paid-off property.

According to the U.S. Census Bureau, the median asking rent reached an all-time high of $1,006 in the first part of 2019. Finding a property that will rent at a high enough rate to attract investors is even more common recently.

Residual Cash Flow

Franklin D. Roosevelt once said that real estate purchased with common sense, paid for in full, and managed with reasonable care is a safe investment. The 2% rule uses common sense to leverage an owned property to bring in consistent residual profits for the investor. 

Landlords that own several properties and contract the management of their properties earn true residual cash flow month after month year after year. Keeping your investment well-managed by professionals frees up valuable time to pursue other investments and enjoy the cash flow those investments create. 

image where a house is a tree

How the 2% Strategy Works

Long term real estate investing starts with patience and planning. There are several stages that you will go through when renting properties. Next, we take a look at each of these stages and handout some tips on how to make them work to the best advantage of the investor.

Find the Right Property

This first step is the most crucial. Finding a property that can be rented at 2% or more of its purchase price is not as easy as it sounds.

You are going to have to look for the deals and likely be ready to fix up the property before it is rented. There are a few strategies for finding real estate being sold below market value that stretch your rental income. We will take a look at a couple worth mentioning here.

Government Seizure and Bank Foreclosure Auctions

Governments and banks are not in the real estate business. They are in the financing business. When properties are sized or foreclosed they are usually sold at auction for the quickest cash return possible.

Real estate will often sell at auctions below market value, but not always. It all depends on the property’s popularity at auction. Bidding competitions between investors are common at auction, but so is the occasional slam dunk deal.

Multifamily Properties

Multifamily properties or multi-dwelling properties as they are often called, are an excellent way to increase your earning potential. Here are a few examples of these types of properties:

  • townhouses
  • duplexes
  • condos
  • apartment buildings

Having more than one renter on a property has the advantage of less exposure to renter risk such as non-payment evictions. Often times the per-unit rent for these properties is low enough to keep demand high and vacancy time low.

Manage the Property

Look after your investment with a commitment to keeping the property well maintained and attractive to renters. Professional property management will be key in seeing the investment through successfully.

Screen your renters carefully while maintaining legal and moral best practices. Take good care of your renters and respond immediately to property concerns. stay on top of preventative maintenance and never let the house fall into a state of disrepair.

Make sure that your rental contract covers all the tenant’s financial responsibilities for leasing the property to protect the integrity of your position as a landlord.

Sell at the Right Time

Although Real Estate has a strong reputation as a low-risk long term investment, houses do depreciate in value over time. Buying an older house means higher risks of losing equity before you sell.

Renting a property for 10, 15, or 20 years or longer can have huge returns on your investment, but don’t keep it too long and miss your chance to make a nice chunk of money on the resale. Evaluate your property for sale on the market often and when its time to sell, your experience will tell you.

The Difference Between the 1% rule and the 2% Rule

What is the difference? The 1% rule of real estate investing is just another guideline that investors sometimes follow. The 1% difference is only to say the 2% rule would be that more attractive of an investment.

Why not a 3% rule or 5% rule? Indeed, why not? The important thing to remember with these rules for real estate investing is this – get in the investment at the best possible position in order to maximize returns and minimize risk.

Some Final Real Estate Investing Tips

The 2% rule is only one “rule” of the game. From buying and renting to renovation and selling real estate investing has dozens of ways to turn a profit. Always be flexible. Up next, we have a few more pointers on how to navigate the world of property investments.

Never Pay Full Price

When buying the home you are going to live in yourself it is difficult not to fall in love with a home and pay market price or even higher if you have to. It is not the same when you are investing.

Be extremely picky with the properties you maintain ownership of and always be willing to sell investment real estate at any point if the opportunity is good to make a considerable profit. You can use the profits to invest in your next property.

Know the Location

The three most important considerations in real estate investing are location, location, and location. But seriously, it is important and sometimes we forget how important.

Study the city and how it is developing and changing. Look for new construction and planned construction in areas of the city. The property around these developments could be ripe for investment.

Ask for Help

Learn to leverage your time. It can be difficult to trust your investments to others, but at some point, you are going to need some help. You will need to strike up a healthy balance between managing your property and other investments as well as taking on new projects.

The Bottom Line

The 2% rule isn’t written in stone and, in fact, can be rather misleading to those hoping for real estate investment riches.  There is no doubt that buying and renting properties, when done correctly, has the potential to earn you consistent residual income returns. Take the time to carefully evaluate your investment options.

Do you have a property for rent? Nomadic Real Estate is standing by to assist you in your rental property management. Contact Nomadic Real Estate today and we will schedule a time to go over our services and conduct a free property management quote.

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