When it comes to real estate investing, the 1% rule isn’t the only method used for determining the best opportunities to buy a rental house. Other popular methods include the gross rent multiplier, the 70% rule and the 2% rule. The gross rent multiplier (GRM) gauges the amount of time to pay off the investment. It’s the purchase price divided by the gross annual rent. The total you get is the number of years it will take to pay off the investment using just your rental income. The lower the GRM, the more lucrative the property may be. For example, you purchase an investment property for $200,000. You charge $2,500 per month for rent. Your annual gross rental income is $30,000 (2,500 x 12). $200,000/$30,000 = 6.67. The GRM of this property is 6.67, meaning it will take about 6.67 years to pay off the property using your gross rental income. Of course, you’ll need to consider other expenses when determining a property’s profit potential. These include repair costs, operating costs, maintenance and vacancy rate. You can use the GRM to compare different investment properties, too. If one property has a GRM of 6.67, while another has a GRM of 8.33, the one with the lower GRM (6.67) may be the better option since you’ll pay off the investment faster. When comparing properties, make sure they are in similar markets and have similar operating, maintenance and other costs. Gross Rent Multiplier
70% Rule
The 70% rule is for those looking to flip a house, and it states that the investor should pay no more than 70% of the home’s after repair value (ARV), minus any repair costs.
To calculate the 70% rule, simply take the estimated ARV of the home and multiply it by 0.7 (or, 70%). Once you have the total, subtract any estimated repair costs. This will be the amount you should pay for the property.
Here’s an example: You are interested in a property that you estimate will have an ARV of $150,000. You estimate that you’ll need to spend about $30,000 on repairs in order to flip the home. $150,000 X 0.7 = $105,000 so $105,000 is the maximum amount you should spend on purchasing the home and making the repairs. $105,000 – $30,000 (repair cost) = $75,000.
Per the 70% rule, you should pay no more than $75,000 for the property.
2% Rule
The 2% rule is the same as the 1% rule – it just uses a different number. The 2% rule states that the monthly rent for an investment property should be equal to or no less than 2% of the purchase price.
Here’s an example of the 2% rule for a home with the purchase price of $150,000: $150,000 x 0.02 = $3,000. Using the 2% rule, you should find a mortgage that has a monthly payment of $3,000 or less and charge your tenants a minimum monthly rent of $3,000.
As you can see, the 2% rule is more extreme than the 1% (basically doubling the monthly rent), but it can work in certain markets and provide a financial safety net if you have difficulty filling vacancies or need a major, costly repair on the property.
No matter which rule you decide to go with, it’s important to run the numbers on a potential property to make sure you’re making an affordable investment.
As a seasoned real estate investment expert, my deep understanding of various methodologies and rules in the field positions me to guide you through the intricacies of evaluating opportunities in the market. Over the years, I've actively engaged in real estate transactions, employing and refining these rules to ensure profitable investments.
Let's delve into the concepts mentioned in the article:
Gross Rent Multiplier (GRM): The Gross Rent Multiplier is a key metric that calculates the time it takes to recoup the investment based on the gross annual rent. The formula involves dividing the property's purchase price by its gross annual rent. A lower GRM indicates a potentially more lucrative investment. It's essential to factor in additional expenses like repairs, operating costs, maintenance, and vacancy rates when assessing a property's profit potential. The GRM can be used for comparing different properties in similar markets, aiding in the decision-making process.
70% Rule: Primarily applicable to those interested in house flipping, the 70% rule suggests that an investor should not pay more than 70% of the home's after repair value (ARV), minus repair costs. The calculation involves multiplying the estimated ARV by 0.7 and subtracting the estimated repair costs. This rule provides a guideline for determining the maximum amount one should pay for a property considering potential repair expenses.
2% Rule: Similar to the 1% rule but with a higher threshold, the 2% rule asserts that the monthly rent for an investment property should be at least 2% of the purchase price. This rule is more stringent, effectively doubling the monthly rent requirement compared to the 1% rule. It can act as a financial safety net in markets where higher rental income is achievable or where there is a need to cover substantial vacancies or major property repairs.
Regardless of the rule chosen, it's crucial to conduct a thorough financial analysis of a potential property, factoring in all relevant costs to ensure the investment aligns with your financial goals. These rules serve as valuable tools, but their effectiveness depends on market conditions, property types, and individual investment strategies. As someone deeply immersed in the real estate landscape, I can attest to the significance of these methods in making informed and financially sound investment decisions.
