Do Rental Properties Have to Meet the 2 Percent Rule?

The 2 percent rule is a general guideline many investors use to determine if a rental property is a good deal. The basics of the 2 percent rule say the monthly rent from a rental property should be 2 percent or more of the cost of a rental property. I own 16 rental properties, but I don’t believe the 2 percent rule is a good judge of rental properties. The rule is too vague and does not account for many variables with rentals. Buying rental properties is all about the numbers in a particular market and the 2 percent rule assumes that all costs are the same with every property in every market.

What exactly is the 2 percent rule?

The 2 percent rule is very simple to calculate. If a home costs $100,000 with no repairs needed, the rent should be $2,000 a month. If the home costs $100,000 and you have to do $20,000 in repairs, then the repairs would make the cost basis $120,000 and you would have to rent the home for $2,400 a month.

If you think those are incredible rent to purchase price ratios you are right. If you think it is also virtually impossible to find properties that meet the 2 percent rule you are also right. I know 2 percent rental properties exist, but they are usually low-priced properties under $50,000. I think you can make money with low priced rentals, but I also know you can make a lot of money on more expensive homes that do not meet the 2 percent rule.

Related article: What is the 70 percent rule when flipping homes?

The 2 percent rule is too vague for rental properties

I do not like the 2 percent rule, because it only figures what rent should be based on the cost basis. There are so many other variables that need to be considered when buying rentals. The expenses from rental properties are what most people underestimate and the 2 percent rule was created to make sure investors don’t underestimate the expenses. If you use the 2 percent rule to buy properties you will make money if you can find properties that meet the guidelines. More likely you will never find a decent rental property that meets those guidelines unless you live in an area with very low prices or you buy a turn-key rental. The problem is the rule is so extreme that it makes it impossible for most people to buy a rental property.

If you live in an area with very low prices then the two percent rule may be a good guideline after you have run the numbers to see what costs are in your market. Taxes are different in every state, each rental property is different and even some homes that meet the two percent rule will have a tough time making money depending in the circumstances. My rentals don’t come close to meeting the 2 percent rule, but still make a lot of money. My rentals are much closer to the 1 percent rule, but I would not use any rules when trying to decide if a rental property is a good deal.

Here is a great article on how much money you can make with rental properties.

How much money do I make on my rentals?

It is getting harder to find great rental properties in my area. I even considered buying an out-of-state turn-key rental, because I could not find any great rentals in my area, but I recently got two rental properties under contract in the last two weeks.

The last rental property I bought (rental property 11) was purchased for 109,000, and I or about $12,000 of work into it. The 2 percent stated I should be getting $2,400 a month in rent, yet I am getting $1,400 a month in rent and I am ecstatic about it.

My mortgage payment with 20 percent down on a 5 year ARM is about $550 a month including taxes and insurance. When I account 10 percent for vacancies and 15 percent for maintenance, that adds another $350 a month. My total expense are $900 a month and my profits are $500 month. I had to invest close to $35,000 into this rental after down payments and repairs, but 17 percent on my money is a great return. That does not even factor the equity pay down, tax advantages, or possible appreciation. The biggest factor it does not consider is I bought the home below market value and I created $20,000 in equity as soon as I closed on it. In a recent article that I wrote about the advantages of rentals over the stock market, I found my one of my rentals produced almost a 70 percent return. That rental property did not come close to meeting the 2 percent rule.

Check out my cash flow calculator for an easy way to calculate the income on rentals.

Why do returns vary bases on the market you invest in?

There are many variables with rental property expenses in different areas of the country. These variables make a huge different in how much money a rental property will make or if it will make money at all. You have to know these expenses when you are deciding whether to buy a rental property, not use a blanket rule.

  • Property taxes taxes are different in different states and even different within towns in the same state. My taxes in Colorado are extremely low; a rental property that is valued at $100,000 has taxes around $500 a year. Some states have taxes ten times higher than Colorado. If my taxes were $400 a month instead of $50 a month, my cash flow would $150 a month instead of $500 a month. The 2 percent rule does not account for this factor at all.
  • Utilities are paid for by the tenants on many single family rentals, but on many multifamily rentals the landlord pays some or all the utilities. Who pays the utilities can mean the difference in hundreds of dollars each month, but the 2 percent rule does not account for this.
  • HOA fees are an cost for many investors on condos or newer single family homes. HOA fees can be $300 a month on some condos or much more on large buildings that offer many amenities. The 2 percent rule does not account for any HOA fees.
  • Maintenance expenses will be different on different types of rental properties. If you buy a brand new home and turn it into a rental property it will most likely have less expenses than a home built in 1900 that has older wiring, heating, roof, plumbing and foundation. When buying rentals you have to take these variables into consideration, which the 2 percent rule does not.
  • Vacancies are another variable that is not considered with the 2 percent rule. In my area vacancies are less than 2 percent, but I still account for 10 percent, because I like to be conservative. If vacancies in one area are 15 percent and they are 1 percent in another area that will affect the performance of the rental property.
  • Property management will eat into your profit as well and the 2 percent rule does not account for this. It is true that you will have to take time to manage the properties if you do not use a property manager, but you also won’t have that expense.
  • Expected returns are not considered with the 2 percent rule either. Some investors are looking for a 20 percent return on their money, some want a 5 percent return on their money and others may not even care about the returns, but have other motives for investing in rentals.
  • Mortgages are also not accounted for with the 2 percent rule. If you buy a potential rental as an owner occupant with 3 percent down and mortgage insurance you will have much payments than an investor who puts 25 percent down.

Here is a great article on how to calculate maintenance and vacancies.

If you buy a $100,000 rental property with low taxes, low maintenance, low vacancies, no HOA and manage it yourself and have a mortgage you might have $900 in expenses like myself. If you buy an older rental property with an HOA, property manager, needed maintenance, a mortgage and high taxes you might have $1,500 a month in expenses or more! In one scenario you make a lot of money each month and in the other scenario you are losing money each month.

Conclusion

This shows why it is so important to run the numbers yourself when buying a rental; do not rely on a rule. The 50 percent rule is another blanket rule that assumes the expenses (excluding the mortgage) on a rental property will be 50 percent of the rent. This rule can also be very misleading as we saw from the previous paragraphs expense calculations. If you want to know how much money a rental property will make you have to run the numbers yourself and you have to know all the numbers to run to be accurate. If you need a little extra help figuring those numbers and deciding which numbers are important, check out my Complete Blueprint to Successful Real Estate Investing.

12 thoughts on “Do Rental Properties Have to Meet the 2 Percent Rule?”

  1. It varies so much that anybody who uses a rule of thumb for their sole guidance, could easily end up in trouble. Some of mine don’t make the 1% at their current value, fortunately I didn’t buy them at their current value. Some recent purchases as part of a 1031 average about 1%. Its hard to find the perfect property in that 45 day window. The properties that I relinquished were better than 1%

    Taxes here are higher than your $1,000, wish some of mine were that low. One great property that I bought at $30,000, first tenant paid $2,050 a month rent. And the current taxes after appeals are still $2,500; but I bought a 10 cents on dollar.

    Another property was bought for $35,000 and rents for $1,250, previous sale was $95,000. And a third property bought at $36,000 rents for $995 and last sold for $108,000. If those properties had been bought at retail they would have been above or below 1%

    Local expenses, as you stated are a large factor in the ratio, but also buying below retail value also has a big factor in the “rule”.

  2. This is great information.

    I believe that you need to do your best to get the most when purchasing real estate. I am one that used something like the 2% rule back in the 90’s. Towards the end of the 90’s and the beginning of the 2000’s you could not find properties hardly at all that would follow the 2% rule. Investors started to lower there standards instead of just saying no to purchasing the property.
    Denver and a few other cities around the nation are now back in that time again (like the late 90’s and again 2006/2007} when property values were increasing fast and the vacancies were low. Everyone thinks they know how to invest in real estate when the market is on a upswing and this is when even good investors start to bend the rules to buy properties. Now if you are one who started investing in real estate during the down period and has been hitting home runs most of the time on the up swing then I bet you think you are good at this – well till the bottom falls out again.
    This was me in the 90’s when I lost almost everything during the dot com crash (early 2000’s). Lucky for me I did not get hit by the latest crash (2008+). But then I missed getting back into the real estate investment market on this last down turn. : ) I wish was better at reading the future. Last note: I think that Denver and a few other markets are somewhere in the peak again – so make sure you are not getting caught up in the frenzy and bending the financial rules of real estate investing. Just learn to say No instead of bending the financial rules. Good Luck to everyone……

  3. Mark – nice article. I don’t subscribe to rules of thumb, and as such wouldn’t necessarily argue up or down as it relates to 2% rule, 50% rule, DSCR ratios, and all the rest (although I have my opinions). I do, however, see some issues with the numbers in the given example. A couple of points:

    1. If the subject is 1990 or later, then perhaps 15% for maintenance is reasonable. If, however, it is older, your maintenance expense projected over a hold period of say 5-7 years will almost certainly average higher…
    2. Your property taxes will go up over time, and so will your insurance cost. Thus, unless you plan to hike your rent every year like clockwork, your CF will compress.
    3. Your numbers do not include turn-over costs. Unless you are planning those into the 15% maintenance, but I think we both know that it wouldn’t be nearly enough…
    4. You will once in while have to evict people, and that costs money as well; both in terms of un-paid rents and attorney/court costs. Credit loss and contract services didn’t make it into your pro-forma…
    5. I know that you pass the responsibilities of management to your team. In this case, it seems reasonable that some amount of the salary you pay them is allocated as an expense item to this property. Honestly – you should count it as such.

    The issue here is that your analysis is static – a snapshot in time, based on pro-forma numbers more so than actual operational averages applicable to long-term holds. There are a lot of other items and sub-items aside for those that I mentioned which really do cost us real money and are not evident in a snap-shot analysis such as this. And if you do include them, I think you’ll come to appreciate that rents of 2% of value are indeed where we need to be as much as possible in order to survive and make money long-term. And if that’s not possible in today’s market, there’s no shame in changing strategy or sitting it out. There are cycles in the markets, and while some points in the cycle are conducive to buying, others are conducive to selling or waiting…

    Thoughts?

    • Hi Ben, Thanks for chiming in!
      1. The home was newly remodeled with the major systems replaced. I think 15 percent is a pretty accurate figure based on my past performance.
      2. That is something to consider, but if my taxes do go up it would probably only raise a couple hundred a year at the most, which equates to $20 a month. Our taxes can only increase every two years and in the past our county is very conservative. Insurance costs are the same and rents do increase over time with inflation and sometimes much more due to other factors.
      3. Yes they do. I allocate 10% for vacancies and so far my costs have been much less in four years.
      4. See above
      5. That is a valid argument, if I allocate 8 % I would still have great returns without meeting the 2 % rule.

      I think your comment is a great example of why the 2 percent rule is not a good way to evaluate a rental. For you in the midwest, with low valued multifamily units your costs will be much higher than mine. On a quick search on Zillow for Lima, OH taxes, it looks like they are about 3 times as high as my taxes. Multifamily generally has more turnover, more maintenance and takes more management, plus you pay some utilities, yard maintenance and snow removal right? For you buying low cost multifamily the 2 percent rule may be where you need to be at. The midwest with stagnant prices, less than stellar economies also tends to promote more properties that meet the 2 % rule.

      It is true that this is a snapshot, but historically my rents have been increasing, my taxes staying the same, vacancy costs less than 2 percent and maintenance less than 15 percent. I have not used my historic performance, because I think I have been in a unique market with vacancies less than 2 % and huge price increases and rent increases.

  4. I agree with you Mark as well as John, 2% would be amazing and I’ve only heard of the 1% standard. Also, taxes in my area are MUCH higher with properties in that same $100k price bracket being a minimum of triple what you quoted. The unforseens such as taxes, vacancies, maintenance, and even flood insurance can siphon your profits quickly! Thanks for the article

  5. Whoa…2% would be amazing. The rule of thumb around here is that rental price = 1% of home value. I purchased my first rental for $68k and spent $12k in repairs so I have $80k in it. After repair value is approximately $110k. I was thrilled to get $1,100/month rent which is right on par for 1% of the home value. Compared to my actual investment I’m making 1.375%. My renters move out in 4 months and after they leave I expect my next renters will pay around $1,050 since it won’t be “like new” anymore.

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