Is the 2% rule still valid in 2022?

What is the 2% rule and does it still work in 2022?

two-percent-rule

Last updated on January 19, 2022

One common term heard in the real estate investing space is the '2 percent rule'. What exactly does this refer to, and is is it a valid lesson to keep in mind as we continue our real estate investing efforts through 2022? As usual, there's a lot of nuance to this oft-touted rule. Let's get to the bottom of this.

What is the 2 Percent Rule?

The 2 percent rule in the real estate context tells us that when trying to decide whether a particular investment property would be a good buy, see if the monthly rent able to be charged by the property would equal or exceed 2% of the purchase price of that property. If so, then that property can be considered a good investment. For example, if we have a potential property with a purchase price of $200,000, then as long as the monthly rent able to be charged is $4000, then this particular property can be considered a good investment.

There is another variation of this rule called the 1 percent rule where yes, you guess it - as long as the monthly rent equals or exceeds 1 percent of the property purchase price it can be considered a good investment. More on this later.

Is the 2 Percent Rule a good rule to follow?

While we were working the the above example, you may have had a number of thoughts flash through your mind. Maybe you were thinking, "Wow, that's an incredibly low price for a rental property in my area," or something like, "$4000 a month for renting a property that costs only $200,000? What universe do you think we're in right now"? And you'd be correct in thinking that. In recent years, the real estate market in the US has shifted dramatically from the days that the 2 percent rule was in its heyday. To put it plainly, real estate prices and rent prices have developed minds of their own and gone wild, skewing the relevance and accuracy of the 2 percent rule. For example, property prices in the certain high-interest markets have skyrocketed in the past decade and show little signs of slowing down, while rental prices often have not quite kept pace with property values. This makes the 2 percent rule not feasible in many cases.
And yes, that does mean that we don't recommend blindly using the 2 percent rule to decide whether to purchase an investment property or not. There are many other factors to consider as well as some nuances to keep in mind.

What are some other things to consider with the 2 percent rule?

First off, solely considering purchase price can be a grave mistake. For example, if the potential property is a condominium, then there's the matter of HOA fees which can make using the 2 percent rule wildly misleading when all things are considered. Furthermore, there are other factors such as property taxes, assorted fees, insurance costs, how much can the property be expected to appreciate in the future, and much more. Failing to consider all of the costs when calculating whether or not an investment is worth it is incredibly risky and not recommended.

To add on to this, there are other non-monetary things to take a look at when considering potential investment properties. Is the location good, or is it merely okay with great potential in the future? Is the condition of the property up to snuff, or will it potentially require significant updates in the near future? And is the area's tenant pool large and robust, or middling and inconsistent? All of these considerations are not a part of the 2 percent rule.

Does this mean the 2 percent rule shouldn't be used anymore?

After going over all of the considerations the 2 percent rule does not take into account, it's appearing that the widely touted rule isn't all that relevant. So is there really no place for the 2 percent rule in today's real estate space? Well, it could be a useful tool to quickly filter down a large list of properties as long as those exogenous factors are kept in mind, but there are other better methods for this. It could also be the basis for a more complex formula you can use to quickly rifle through a large group of properties, but that'll be up to you!

Remember we briefly mentioned the 1 percent rule? You may be wondering if that would be a more accurate and reliable method to weigh potential investments than the 2 percent rule. However, everything we've mentioned about the shortcomings of the 2 percent does apply to the 1 percent rule as well. The only difference is that the 1 percent rule may present numbers that align more closely to the the real estate market as of now, but remember, these rules are best used as rough guidelines at the very beginning of your property search and shouldn't be leaned on any further than that. Good luck!

Join us for more insights and special offers

We're NestEgg, the smartest single-family rental management app out there