The 2% rule in real estate is a rule of thumb that suggests that rental property is a good investment if the monthly rental income is equal to or greater than 2% of the investment property price. For example, for a $200,000 rental property, the rental income must be at least $4,000 to meet the 2% rule. And the rental income for a $50,000 investment property must be at least $1,000, and so on.
The 2 percent rule is to multiply the purchase price by 0.02, in order to determine si a property investment is a good business. So, if you find a property listed for $100,000, you 'd need to generate at least $2,000 in monthly gross rent to meet the rule.
Conversely, you can use the rule to determine how much you should offer on a particular rental property by multiplying by 50 (inverse of 0.02). For example, if you find an investment property that currently earns a monthly rent of $4,000, the 2% rule says you're not supposed to pay more than $200,000.
The principle behind the 2% rule is if a property produces 2 percent gross monthly rent, it is almost guaranteed that it produces enough money to cover the cost and to provide coatings for vacancies and unnecessary repairs.
It can however be hard to find properties that in practice conform to the 2% rule, unless you buy a very distressed property or the immobilized market is extremely weak. Indeed, 2% is simply a more extreme version of the 1% rule, which is the most common rule in rental investment, to identify properties that generate sufficient positive cash flow.
The 2 percent rule can be thought of more as a guideline and less as a true rule. There are many immobilized myths and one of them might be the 2 percent rule. In terms of utility, rent can only be measured, but not much more.
The 2% rule is generally a good initial measure for an investor in cash flow. However, it has several drawbacks in that it tells you nothing about the condition of the building, the location of the property, net rental revenues, cash-for-cash returns, the cap rate or appreciation.
Naturally, not every investment property out there follows the 2% rule. They do exist, however, mostly in areas such as the mid-west and south of the US real estate market. But these investment properties can often become more difficult 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 and how much you can rent your home for. So if you're investing in Memphis, the 2% rule may be feasible and realistic, but if you're investing in LA, not that much.
In general, the rule is a good indication of the property price ratio rental income. As an immobilizer investor you can strive to achieve this, but you do not need to follow it strictly. The rent-to-costs ratio remains important to calculate, even if you do not wish to abide by the 2% law, so be mindful of it when looking for investments.
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