What is the 2 Percent Rule in Rental Property Investment?
The more you invest in real estate, the more you will develop your own rules of thumb that help you identify good investments and make desirable profits. One rule that you may have heard of in the world of rental properties is the “2 Percent Rule.” In this article, we will explain what this rule is and whether or not it is viable for all rental investments—if at all.
How the 2 Percent Rule Works
Basically, the 2 Percent Rule states that your monthly rent price should be no less than 2% of what you paid for the house PLUS your initial repair expenses. Sounds pretty simple, right? Well, the math is easy. Whether or not it is viable is definitely up for debate.
Let’s say you buy a single-family house for $200,000 and it costs you $30,000 to make the necessary repairs and upgrades that you want to make before renting it out. That makes your total upfront investment in the property $230,000. The 2 Percent Rule then says your monthly rent should be at least 2% of $230,000, which is $4,600. Just at first glance, this rent price seems rather high for a $200,000 home.
Some investors will say it should be more like 1%, which would be $2,300 in the scenario above.
Setting the Proper Rent Price
It’s nice to have rules of thumb like these to do a little simple math before committing to an investment. However, setting a proper rent price involves so much more than this. You have to look at what you are paying for the house. Cash investors are putting in more money upfront and can run the numbers for as long as they intend to own the property. Meanwhile, those financing the rental will need to look at their monthly mortgage payments as a benchmark. Then you have other ownership expenses like property taxes, insurance, HOA dues and upkeep that have to be factored in.
Factor in the Appreciation
The other thing to consider is appreciation. Not only are you collecting rent from your tenants, you are ideally gaining equity the longer you own the property. Rent prices will usually go up over time due to inflation and other factors. Simply saying that you should charge 2% of the upfront cost of the property is too simple. It doesn’t account for all the variables, especially time. How long you intend to own the rental property will make a huge difference in your overall ROI.
Location, Location, Location
Of course, you also have to factor in the neighborhood where the rental is located. A $200,000 house might be a relatively nice home in a bad neighborhood, but there’s no way you are going to rent it out for $4,600 a month if the average income of that area is low. On the flip side, a $200,000 home could be one of the lower-end properties in a nicer area. You will naturally be able to charge higher rent in a higher-end neighborhood, but you still have to find and keep tenants. No matter where the property is located, you have to worry about extended vacancy periods if your rent is just too high.
Running the Numbers
We will talk more about how to properly set your rent prices in future PropertyLark Blog articles. As for the 2 Percent Rule, there are some instances where it may be a decent rule of thumb. However, it should not be your only decision-making factor. For the most part, it oversimplifies what shouldn’t be a simple process. So much more needs to be done when evaluating a rental property investment and when setting your rent prices. One blanket rule of thumb will never apply to every circumstance. The more research and planning you do, the more successful you will be as a real estate investor.
If you are looking to buy rental properties that have already been identified as great investments, you will want to join the PropertyLark real estate buyer network. Let us help you find the best properties in the areas of your choosing, so you can make the most of your rental home investments. Apply now to become part of our exclusive home buying club.