Investing in real estate is one of the best ways to generate wealth. In fact, over 90% of the world’s millionaires made their money by investing in real estate.
Thinking about jumping into the real estate game? There’s a lot to learn when it comes to finding profitable properties.
If you are just getting started with real estate investing, you’ve probably heard of the 2% rule. It’s a guideline that helps you ensure you are finding properties that will generate a profit, making it a good investment.
So what is the 2% rule in real estate? And is it the only rule to follow? Keep reading to find out.
Hold up, What About the 1% Rule?
When talking about the 2% rule, it helps to also understand it’s little brother, the 1% rule. The 1% rule states that the monthly rental rate should at least be equal to 1% of the home’s purchase price.
That means that if you buy a house for $100,000, you should at least be able to rent it out for $1,000 per month. While this may work in some situations, many long-term investors seek out properties that meet the 2% rule instead.
What Is the 2% Rule in Real Estate?
So what is the 2 percent rule in real estate? You guessed it. It’s like the 1% rule, but higher. The 2% rule encourages you to find properties that will rent for 2% of the total purchase price per month.
So if that same home that costs $100,000 can rent for $2,000 per month, it would meet the 2% rule. This is a much better scenario than the 1% rule.
The problem is that it’s much more difficult to find properties that meet the 2% rule.
How Important Is the 2% Rule?
When it comes to finding a profitable property, you first need to understand all of the associated costs. You’ll have the purchase price of the home. For most people, this involves getting a mortgage.
Your base monthly expenses can be summed up as PITI; principle, interest, taxes, and insurance. Both the principal and interest are wrapped up in your mortgage payment. Property taxes and insurance can either be paid on their own or also wrapped into your escrow account.
If you plan to be a hands-off investor and hire a property management company, you’ll add those costs into your monthly expenses as well. For more info on hiring a property manager, check out this informative article.
For a property to make a profit each month, your monthly rent will need to be greater than these expenses. Having a positive cash flow each month is much more important than meeting arbitrary rules.
The problem with the 1% rule and the 2% rule is that every real estate market is different. Investing in California is very different from investing in Missouri.
In the South and the Midwest, it’s usually much easier to find properties that meet the 2% rule. In some states, it’s impossible.
Do I Need the 2% Rule?
So what is the 2% rule in real estate? It’s a simple guideline that some people follow. But plenty of investors are growing their portfolio and building their wealth by ignoring this rule and focusing on finding properties that cash flow.
Should you keep these rules in mind as you search for properties? Absolutely.
But more importantly, you should learn how to accurately calculate the monthly expenses on a potential property and figure out if rents will cover these expenses or not.
And if you need more financial tips to build a better future, be sure to check out the rest of our blog today.
5 Essential Tips to Invest in Mixed-Use Property and Profit