Rule of Thumb for Buying Investment Properties
For decades the rule of thumb for buying investment properties was the 2% rule. Which meant that 2% of the price of the property would equal or be less than the rents in one month. Then as property prices rose, but not the rents, the Rule of Thumb for buying investment properties became the 1% Rule. This was the rule when I decided I would get into real estate investing. HOWEVER in in the beginning of the 2010 decade I could not find properties that would even earn 1% of the price in a single month. AND then I considered the price of finance and realized that the 1% rule no longer needed be.
Less than 4% finance charges on a 30 year fixed-rate mortgage creates a new Rule of Thumb for buying investment properties.
If you are considering a real estate investment in the housing sector, you may be wondering what the rules are today. When I started in real estate investing the common rule of thumb was the “one percent rule” which had replaced the “two percent rule”.
These two rules were basic math predictions on price compared to rent. The monthly expected rent should equal 1% of the price. If you lived in the fly-over states, you would be looking for the 2% rule of thumb. Which was that the expected monthly rent would equal 2% of the price. Which is better? From a pocketbook spectrum, the 2% equation.
This rule considered the high cost of mortgage, the high cost of upkeep and management.
But since I finally bought my first residential rental property in 2012, a 4-plex with two beds and one bath in each unit, the high cost of lending had plummeted to 4%, what seemed to me to be the lowest it would ever go. Today that cost is even lower. So, in my opinion I no longer needed to find a property that met the 1% rule standard. Why? Because the cost of money was half as much as it used to be when this rule was made popular!
That is still my only investment property, (I should say “our only investment property” as it is my husband and I that own it through a partnership LLC). Purchase price was just under $273,000, and the current rents at the time on average $640 for each of the 4 units. Today those units rent for $800 each. Even with the $400 a month HOA fee to manage the grounds and pay for the water/sewer, the units were making money, and still are today.
Do the math: in 2012 the purchase price was $273,000. Monthly rents coming in were $2560. And monthly management fee was $400. But my mortgage payment was only (and still is) $1226, including taxes and insurance. That makes a monthly net profit of $934.00 !
Today, in 2019 the monthly rents coming in are $3200, management fee = $440, and mortgage payment $1226. The monthly net profit when all are occupied = $1534. Wow!
You may be wondering, due to the low cost of money, if there is a new quick math rule that I would suggest. Hmmm. How about the .8% rule? This rule, depending on your cost of money, would still provide an income. Since rents almost always going up, your net income will increase.
By Grace Widdicombe