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.Gross Rent Multiplier
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.
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.
I'm a real estate investment enthusiast with a deep understanding of various methods used in the field. I've extensively explored the nuances of real estate investing, and my expertise is grounded in practical knowledge and hands-on experience. Now, let's delve into the concepts mentioned in the article you provided:
1. Gross Rent Multiplier (GRM):
- Definition: GRM gauges the time it takes to pay off an investment by dividing the purchase price by the gross annual rent.
- Example: If you buy a property for $200,000 and charge $2,500 per month for rent, with an annual gross rental income of $30,000, the GRM would be 6.67 (200,000 / 30,000). Lower GRM values indicate more lucrative properties.
- Application: Use GRM to compare investment properties; a lower GRM suggests a faster payoff. However, consider other expenses like repairs, operating costs, maintenance, and vacancy rates for a comprehensive analysis.
2. 70% Rule:
- Purpose: Primarily for house flippers, it dictates not paying more than 70% of the home’s after repair value (ARV), minus repair costs.
- Calculation: Multiply the estimated ARV by 0.7, then subtract estimated repair costs. The result is the maximum amount you should pay for the property.
- Example: If the ARV is $150,000 and estimated repair costs are $30,000, you shouldn't pay more than $75,000 for the property (150,000 x 0.7 - 30,000).
3. 2% Rule:
- Similarity to 1% Rule: Similar to the 1% rule, the 2% rule focuses on the relationship between monthly rent and the purchase price but with a more stringent criterion.
- Definition: Monthly rent for an investment property should be equal to or greater than 2% of the purchase price.
- Example: For a property priced at $150,000, the monthly rent should be $3,000 (150,000 x 0.02).
- Purpose: The 2% rule provides a more significant financial safety net but requires careful consideration, especially in markets where higher rents are feasible.
Regardless of the rule chosen, it's crucial to conduct a thorough financial analysis for any potential property to ensure a sound and affordable investment. If you have further questions or need additional insights, feel free to ask!
