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What is the Real Estate Investing (REI) 2% Rule?

Real Esate Investing Rule of 2%

2% Rule, 1st Fundamental Rule of Passive Real Estate Investing

The most important part of real estate investing is making money, do you dare to disagree? Understanding the numbers is a crucial part of an assessment to determine if a property is worth the investment.

There are a number of rules and tools investors can utilize for initial assessments, including the rule of 2%. If an initial assessment indicates a property is worth an investment, there are a number of more robust calculations for investors to take a deeper dive into the numbers for a more detailed evaluationl

The 2% rule states that, to make a good profit on a single family investment property, the gross monthly rents should approximate 2% of the total purchase price of the property. For example, if you could charge $2000/month in rent on an investment house that costs $1000,000, this would satisfy the rule of 2% and would be a VERY sound investment. We will refer to the rule of 2% as INVESTMENT RENT PERCENTAGE for the remainder of this article.

2% Rule Formula & Calculations – Rent Percentage

Investment Rent Percentage Formula – Used to determine investment rent percentage, when rent and purchase price are known.

Investment Rent Percentage = (Monthly Rent / Purchase Price)

  • Example
    • Question: A house is for sale at a total cost of $80,000. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. The market value for rent for your house is $1600. What is the rent percentage?
    • Answer: Rent Percentage = $1,600 / $80,000 = 2.0%

2% Monthy Rent Calculation – Used to determine rent you should charge for an investment property, when purchase price and investment rent percentage is known.

Monthly Rent = (Purchase Price * Investment Rent Percentage)

  • Example
    • Question: A house is for sale at a total cost of $60,000. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. You want to maximize your investment and earn a 2% INVESTMENT RENT PERCENTAGE. What should you charge for monthly rent?
    • Answer: 2% Monthly Rent = $60,000 * 2.0% = $60,000 * 0.02 = $1,200

2% Purchase Price Calculation – Used to determine purchase price for a turnkey property for an investment property, when monthly rent and rent percentage is known.

Purchase Price = (Monthly Rent / Investment Rent Percentage)

  • Example
    • Question: You want to purchase an investment property, renters are paying $1,500 monthly rent for similar types of houses in this location. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. You want to maximize your investment and earn a 2% INVESTMENT RENT PERCENTAGE. What purchase price should you pay for the the property?
    • Answer: Purchase Price = $1,500 / 2.0% = $1,500 / 0.02 = $75,000

Rule of 2% Variations & Considerations

Truth be told, finding properties at a purchase price to produce an INVESTMENT RENT PERCENTAGE of 2% is very challenging. In the current environment (2017), many investors look for properties that return an INVESTMENT RENT PERCENTAGE of 1.5% because finding investment properties that return 2% are few and far between.

Let’s apply a 1.5% INVESTMENT RATE PERCENTAGE to the three examples above and see how it changes the calculations.

Investment Rent Percentage Formula for 1.5% – Used to determine investment rent percentage, when rent and purchase price are known.

Investment Rent Percentage = (Monthly Rent / Purchase Price)

  • Example
    • Question: A house is for sale at a total cost of $80,000. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. The market value for rent for your house is $1200. What is the rent percentage?
    • Answer: Rent Percentage = $1,200 / $80,000 = 1.5% (instead of  2% INVESTMENT RENT PERCENTAGE)

1.5% Monthy Rent Calculation – Used to determine rent you should charge for an investment property, when purchase price and investment rent percentage is known.

Monthly Rent = (Purchase Price * Investment Rent Percentage)

  • Example
    • Question: A house is for sale at a total cost of $60,000. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. You want to maximize your investment and earn a 1.5% INVESTMENT RENT PERCENTAGE. What should you charge for monthly rent?
    • Answer: 1.5% Monthly Rent = $60,000 * 1.5% = $60,000 * 0.015 = $900 (instead of $12,000 for 2% INVESTMENT RENT PERCENTAGE)

1.5% Purchase Price Calculation – Used to determine purchase price for a turnkey property for an investment property, when monthly rent and rent percentage is known.

Purchase Price = (Monthly Rent / Investment Rent Percentage)

  • Example
    • Question: You want to purchase an investment property, renters are paying $1,500 monthly rent for similar types of houses in this location. The house is turnkey (no additional repairs or renovations are required) and may be rented immediately. You want to maximize your investment and earn a 1.5% INVESTMENT RENT PERCENTAGE. What purchase price should you pay for the the property?
    • Answer: Purchase Price = $1,500 / 1.5% = $1,500 / 0.015 = $100,000 (instead of $75,000 for 2% INVESTMENT RENT PERCENTAGE)

The Takeaway – Rule of 2%

The rule of 2% is a fast method to do an initial assessment for an investment property to determine if the property is a good investment. This is NOT to say this is the gospel of real estate investing, rather a fast way to determine if you should investigate further. Other factors need to be considered as part of a detailed analysis, i.e. appreciation/depreciation, purchase price vs. market value, comparable investment RoR (rates of return), etc.

We will be publishing a series of real estate investing rules, tools and calculations throughout the week of 10/2/2017-10/5/2017. Subscribe to Bayside Home Buyers below to receive email updates for new tools, rules, information and investment properties.

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