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