It is not unusual for me to get online and analyze properties. I was recently on Realtor.Com and analyzed a few properties using the 2% Rule. The 2% Rule is a quick analytic tool used to measure how well a rental property will cash flow. Under the rule, the rents on the property are divided by the purchase price of the property. If that number is greater than .02, then the property is considered a 2% property and is likely to cash flow very nicely. If the property is less than .02, then the property is not considered a 2% property.
For example, assume that a property is listed on the market for $80,000. If the rents on the property are greater than $1,600, then the property is considered a 2% property as $1,600/$80,000 is equal to .02 or 2%.
One of the downsides to the rule is that it is difficult to find a property that sells for $80,000 and that can rent for $1,600. Even, if one found a property that sells for $80,000, one it is more likely than not that there are major maintenance issues required to get the property ready for market.
Another example is to consider a property that is selling for $200,000. For the 2% rule to apply, a person would have to rent the property for $4,000. How many properties on the rental market are renting for $4,000?
As one can see, there are many factors to consider when examining the 2% rule. The rule also does not consider issues such as HOA fees, the property’s condition, the property’s location, the cap rate, or appreciation.
As an example, the closest I came to the 2% rule is when I came across a condo that was selling for $45,000. The rents on the property were $600. The cash flow on the property, however, was eaten away by the high cost of the HOA fees which were nearly $300. Once I visited the property, I saw that it was in poor condition and needed to undergo a major overhaul. The kitchens and bathrooms were outdated and needed to be upgraded. After examining the property, I decided it was not going to be a wise investment choice even though the initial analysis lent towards the purchase.
There are very few situations when this rule would apply, but it’s always worth pursuing an interest in a property if this opportunity would arise.
One way to test your analytical skills is to go to Realtor.com and determine which properties meet the 2% Rule.