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 investor with a proven track record of successful ventures, I bring a wealth of knowledge and hands-on experience to the table. I've navigated the dynamic landscape of real estate, employing various strategies to identify and capitalize on lucrative investment opportunities. My expertise goes beyond theoretical understanding, as I've successfully applied the principles discussed in the following article to build a robust real estate portfolio.
Now, let's delve into the key concepts outlined in the article:
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Gross Rent Multiplier (GRM): The Gross Rent Multiplier is a crucial metric for evaluating the profitability of an investment property. It is calculated by dividing the property's purchase price by its gross annual rent. A lower GRM indicates a more financially attractive opportunity. I have employed this method extensively, analyzing not only the GRM but also factoring in additional costs such as repair expenses, operating costs, maintenance, and vacancy rates to ascertain the true profit potential of a property. Moreover, I've used GRM to compare different investment options, ensuring a comprehensive assessment of each property's viability.
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70% Rule: Primarily applicable to those interested in flipping houses, the 70% rule emphasizes not paying more than 70% of the home's after-repair value (ARV) minus repair costs. Drawing from my experiences, I have successfully implemented this rule to determine the maximum amount I should invest in a property, factoring in both the ARV and estimated repair expenses. This approach has been instrumental in ensuring profitability in house-flipping endeavors, a niche within real estate that demands a distinct set of considerations.
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2% Rule: The 2% rule is an extension of the 1% rule, suggesting that the monthly rent should be at least 2% of the property's purchase price. I've applied this rule judiciously, understanding its potential to act as a robust financial safety net. By setting a minimum monthly rent based on the 2% rule, I've navigated markets with varying dynamics, ensuring a resilient income stream that accommodates unforeseen challenges such as difficulty in filling vacancies or unexpected major repairs.
In conclusion, irrespective of the rule chosen, a meticulous financial analysis is imperative. My extensive experience underscores the importance of running comprehensive numbers on potential properties to guarantee sound and affordable investments. These rules are not rigid but serve as powerful tools when adapted to specific market conditions, helping investors make informed decisions and thrive in the dynamic realm of real estate.
