The 1% and 2% Rule
Many investors use these quick calculations when they first see a potential property. We explained the rule and the calculations in one of our previous blogs, “Should you Follow the 1% or the 2% Rule?” In this blog we will broaden the discussion. Successful investors work to a longer-term game plan, and they bring other factors into the purchase decisions. The 1% and 2% rule delivers a sort of “screenshot” – the purchase price and initial renovation costs times 1% or 2% equals monthly rent to charge. This rental figure can be compared to how much competitor landlords are charging for a similar property, and how the current market is responding to those rent levels.
9 Additional Factors to Consider
These additional issues help an investor to make a sound purchase decision:
- Will this property support, strengthen or weaken the total portfolio in terms of clear equity, future equity growth, and monthly cash flow?
- How will buying this property impact, say, sleeping partners or other financial commitments?
- Has the property inspection been done and, if so, has it exposed future maintenance or replacement costs that are not part of the initial repair/renovation expense used in the 1%/2% calculation?
- If the property has current tenants, what is their on-time rent payment and care-of-the-property track record?
- When do current leases expire, and how likely are they to renew or move out?
- Have current tenants made any unapproved or “unique” alterations that may need “correcting” should they not renew their lease?
- How is the neighborhood changing? Will future tenants be able to pay higher rents or expect to pay lower rents than current lessees?
- When are sitting tenants likely to vacate in the context of neighborhood changes and changes to market rent levels?
- Are current local employers moving into or out of the neighborhood, increasing or decreasing productivity and hiring practices? How will those economic shifts impact future rental levels and potential vacancy rates?
The 1% and 2% calculations are valuable for “right-now” decisions and to get an immediate screenshot of an investment opportunity, but they are just that. They do not, and are not intended to, enable a broad-based final decision to buy-and-hold or to pass. Investors who plan their investment strategy several transactions ahead, factor in some or all of the above nine points.
The one possible exception to just using the 1%/2% rule may be where an investor is nearing the 45 day deadline to name potential acquisitions in a deferred 1031 Exchange. When you are under the gun and must choose something to roll capital gains into, knowing you will flip it as soon as the time is right, the simple rule may be good enough.