Have you ever heard of the 2-50 rule? Then you need to read this blog.
Why Should You Learn This Rule
Getting overwhelmed with “prospects” (potential deals) hitting your email on a daily basis. Is it starting to get overwhelming? It was for me as it is a lot to swift through. You need to develop a quick rules or shortcuts so that you can weed through the unwanted prospects quickly and efficiently.
2-50 Rule To High Cap Rate Investments
The 2% rule says if you can find a property priced such that the gross incoming rent is 2% of the purchase price, it will produce a 10%+ cap rate. Note that you cannot use this to figure out what the rent should be. The market dictates the rent. Rather, you have to use it to determine how much you can pay. The 50% rule is an empirical rule developed from observations of many multifamily cash flow investors across the country. The rule states that a real estate asset either in New Jersey or other parts of the country will have average operating expense ratio of approximately 50% of collected rents.
These two rules do work together to find you that 10%+ cap rate deal. If you collect 2% of the rent each month, you're collecting 24%/year. If expenses cost you 50%, the prospect Net Operating Income (“NOI”) will be 12%/year (Cap Rate). So lets see this rule in action:
Scenario:
You receive a deal in your email or from a wholesaler that provides the following details:
Asking Price: $220,000
In-place Rents: $3,700 per month
Potential Rents: $3,900 per month
What should you pay for this piece of cash flow real estate?
2% rule: Max purchase offer should be $ 3,700/.02 = $185,000
50% rule: Your projected expenses would be $3,700 *.50 = $1,850 per month
NOI: $1,850 per month
Cap Rate: ($1,850*12)/$1850000 = 12%
Now remember these rules have been implemented to produce high cap rate returns but you as an investor might have a lower hurdle rate of return
Happy Investing
Ankit
Comments
yes.. extremely helpful I wish I knew this 7 years ago.. lol
Thank you , good post.