Formulas are important to understand. In real estate there are certain guidelines that we try to hit with every property. They are often referenced like shorthand and if you don’t have a grasp on them, it can get confusing. While I’m not going to go over all of them I am going to address some of the common ones.
The 2% Rule.
This is a goal to shoot for when purchasing rentals for the purpose of cash-flow. You are trying to purchase properties where monthly rent is equal to 2% of the property purchase price. So for instance if I have a $60,000 rental I am hoping to pull in $1,200 a month in rent. It should be noted that most properties do not achieve the 2% rule unless they are in more blue collar areas. The properties are cheaper and so the 2% is still a reasonable rent. Ex: ($600 a month on a $30,000 home) Two of my rentals actually are 2.7% properties but were bought dirt cheap.
The 50% Rule
This is how you should estimate your cash-flow when analyzing the purchase of a rental. In layman’s terms, 50% of gross rents will go to vacancy, repairs, property management, taxes, and insurance. This doesn’t include the mortgage payment and insurance. (Which is commonly referred to as debt service.) If a rental brings in $950 a month of that $475 is set aside. You then have $475 left to pay your mortgage and insurance. The remaining balance is your take home. Your cash-flow.
***Some people feel that the 50% rule is too conservative and set aside less each month. If you are a new investor I would advise caution in such an approach. It really comes down to the property. If it’s a brand new home, it’s going to have less issues then a 1920’s duplex. ***
The 65% Offer
We touched on this a little bit on the tale end of the wholesaling post. When making offers on properties real estate investors make their money when they buy. In order to do that, you need to have a system in place. Buying real estate can become an emotional process and as investors we need to have a logical equation. Enter the 65% offer. You take 65% of the ARV and subtract the cost of your repairs. If a home is worth 100k but needs 20k my offer would be as follows:
100,000 x.65=65,000
65,000-20,000=45,000
My offer = $45,000
If you are paying cash you can increase the percentage as you won’t have as high of a monthly holding cost. However even paying cash in a HOT market I do not like to pay more 72%. While this number works for me it may not for others. They say that if you’re not a little embarrassed by your offer, it wasn’t low enough. The worst they can do is say no.
