Author Topic: The Only Two Things You Need to Know to Analyze a Real Estate Deal  (Read 8105 times)

The Vacant Road

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Hello all!

So I've reviewed several real estate discussions, but rarely have I seen any mention of these two investing metrics- Cash on Cash Return & Return on Unrealized Capital Gain.  Real estate investing is ALL numbers and every single real estate deal can be measured by its cash on cash return and return on unrealized capital gain.  That's it.  Nothing else is needed. 

Just wanted to take a minute to explain these two terms using this example:

3 Bedroom, 2 Bath, 2 Car Garage Purchased with 20% Down, 30 Year Mortgage, 6% Interest

Market Value =                   $100,000
Repairs=                            $10,000
Closing Costs =                 $5,000
Purchase Price=                 $70,000
Down Payment (20%)=     $14,000

Total Cash out of Pocket= Down Payment + Closing Costs + Repairs
Total Cash out of Pocket= $29,000


Rent=                                $1300

Principal/Interest=            $336
Property Taxes (3.5%)=   $292
Insurance (1.7%)=           $142

Monthly Cash Flow=          $530

Cash on Cash Return = Annual Net Cash Flow / Total Cash out of Pocket
Cash on Cash Return= ($530*12) / $29,000
Cash on Cash Return=22%


Unrealized Capital Gain = Market Value - (Purchase Price + Closing Costs + Repairs)
Unrealized Capital Gain = $100,000 - ($70,000 + $5,000 + $10,000)
Unrealized Capital Gain = $15,000


Return on Unrealized Capital Gain = Unrealized Capital Gain / Total Cash out of Pocket
Return on Unrealized Capital Gain = $15,000 / $29,000
Return on Unrealized Capital Gain = 51%


Now this is a great deal.  We just used $29,000 to generate an annual return of $21,360, or 73%.  That's all legal tax-free income by the way.  We nearly doubled our net worth in one year, and more importantly gave ourselves a $6000/year raise, leaping us that much closer to financial freedom. 

So, if you need to evaluate a future deal, just break it down by cash on cash return and return on unrealized capital gain.  It's much easier to analyze a deal with those two metrics.

Hope this helps!  Be sure to check out my site for much more on this topic and others related.
[MOD EDIT: Spam link removed.]
« Last Edit: October 28, 2014, 08:43:40 PM by arebelspy »

MDM

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #1 on: October 27, 2014, 09:15:03 PM »
That's all legal tax-free income by the way.
Don't understand the two bolded words.
1)  How is rental profit from cash flow (even after depreciation) "tax-free"?
2)  How is unrealized capital gain "income"?

Overseas Stache

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #2 on: October 28, 2014, 03:30:11 AM »
Ok hold up, Cash on Cash return is a great tool if used correctly. You my friend are missing some very important numbers so your cash on cash return is not correct. When figuring cash on cash return it is wise to include projected amounts for maintenance, vacancy, and property management. to make this easy lets say in your situation we budget 10% of revenue for maintenance, 5% for vacancy, and 10% for management.
Real cash on cash return.
Income        1300

PITI               770
Maintenance  130
Management 130
Vacancy         65
Total Costs 1095

Cash flow     205/month

Cash on cash return $2460 (205*12) /$29000 = 8.5%

As you can see 8.5% is a lot different than 22%, I'm not saying it will be exactly 8.5% it could be less or more depending on how the year goes.

rusty

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #3 on: October 28, 2014, 06:43:43 AM »
Maintenance should definitely be added.  Having a couple rental properties (learning the hard way how not to buy), you need to allocate a good % for maintenance and vacancy.  Having owned two properties for 8+ years, I have replaced one water heater, one water pump, one roof, one blower, and one heating unit.  Much of which my brother and I did ourselves.  You are asking for trouble by not taking these into account.

I have several clients who own multiple units.  One I respect the most told me this..
"if you are going to finance a property (he only did one in his life), make sure your payment is 1/2 of the rent you charge.  Collect $1,000 rent, your mortgage, taxes, insurance should be $500.  Otherwise, you are asking for trouble, and believe me trouble will find you!"  Then he would jokingly say "I have bought a number of houses on the court house steps owned by people who thought they knew what they were doing..."

Good luck.
R

Louisville

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #4 on: October 28, 2014, 07:01:50 AM »
Ok hold up, Cash on Cash return is a great tool if used correctly. You my friend are missing some very important numbers so your cash on cash return is not correct. When figuring cash on cash return it is wise to include projected amounts for maintenance, vacancy, and property management. to make this easy lets say in your situation we budget 10% of revenue for maintenance, 5% for vacancy, and 10% for management.
Real cash on cash return.
Income        1300

PITI               770
Maintenance  130
Management 130
Vacancy         65
Total Costs 1095

Cash flow     205/month

Cash on cash return $2460 (205*12) /$29000 = 8.5%

As you can see 8.5% is a lot different than 22%, I'm not saying it will be exactly 8.5% it could be less or more depending on how the year goes.

Yeah. Check out the site he links to. I'll admit I haven't dug into it, but the whole tone makes me want to take any information from there with a big chunk of salt.

Another Reader

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #5 on: October 28, 2014, 07:03:02 AM »
"if you are going to finance a property (he only did one in his life), make sure your payment is 1/2 of the rent you charge.  Collect $1,000 rent, your mortgage, taxes, insurance should be $500.  Otherwise, you are asking for trouble, and believe me trouble will find you!"  Then he would jokingly say "I have bought a number of houses on the court house steps owned by people who thought they knew what they were doing..."

+1

kendallf

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #6 on: October 28, 2014, 07:24:43 AM »
All six of Vacant Road's posts on this site so far are essentially shills for his/her website.  This one is the most overt.

jnc

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #7 on: October 28, 2014, 08:26:53 AM »
Well hopefully it is just the Vacant Road and not the Vacant Property :P

Overseas Stache

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #8 on: October 28, 2014, 09:12:33 AM »
I checked out his blog and I am completely unimpressed. I guess that is why his here to try and up his clicks because I doubt he gets many repeat viewers.

MooseOutFront

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #9 on: October 28, 2014, 09:56:59 AM »
analysis like this is why it's hard to get rental properties bought right. the investors you're competing with on an 8% ROI deal think they're getting 22%!

The Vacant Road

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #10 on: October 28, 2014, 11:20:56 AM »
Ladies and Gentlemen,

I've reviewed the comments, and I can only shake my head.  I'm sorry you feel that way, but I assure you my metrics are accurate when real estate is managed properly.  That was my intention for taking to time to share that knowledge with you;   To help others properly evaluate a real estate deal. 

We don't pay management fees because we don't have property managers.  Unless your property is long distance, there isn't a need for a property manager.  Single family homes practically run themselves when run properly.  We just avoid long distance properties all together.

We don't have many maintenance expenses due to the fact that our tenants sign an agreement to cover the first $250 of any expense.  When you have the best product at the best price this is quite simple to accomplish.  Yes, this is very possible, and we do this for every deal.

We also properly inspect a property to detect any major upcoming maintenance expenses (ie roof, foundation, appliances, etc).  We repair what is needed up front, and usually sell after 3-4 years.  Then of course, capture the unrealized capital gain, roll it into a 1031, and repeat the process.  By doing this, we typically avoid major repair costs.

Vacancy does happen, but is very rare.  It is the investor's main priority to select the highest quality tenant possible up front.  This only requires some simple due diligence. 

Something else our commentators failed to comment on is that we wouldn't have purchased this property with a conventional loan.  We would have used a hard money, double-close loan, and would have only invested $15,000 into the deal.  If you find yourself asking "how" then I suggest you keep building upon your education.  Care to calculate those returns again?

Friends, I am only trying to help.

 

ioseftavi

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #11 on: October 28, 2014, 12:09:00 PM »
Your posts on your blog are 95% motivation, hype, and assurance.

The remaining 5% is real estate or personal finance info.  As people have pointed out, a good slice of your info is wrong, over-simplified, or dangerously misleading. 

Your biography, viewable here, is nice and vague on your qualifications to be a real estate guru of any sort.  Your writing could fill that gap and stand on its own merits - plenty of anonymous writers on the MMM boards have my respect because of their writing quality and thoughtful posts - but your writing, as I've mentioned, is pretty crap in terms of content.

These boards are full of people who post actual real estate investments, using actual properties, with actual numbers that aren't pie in the sky.  In the case of projections, they use conservative numbers and encourage people to poke holes in their logic.  Some of them have been investing in real estate and managing their properties for decades.

You are clearly trying to promote your blog to an audience of fiercely analytical and critical people who are very discerning as to what advice they take.  "Barking up the wrong tree" doesn't even begin to describe it.

Cheddar Stacker

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #12 on: October 28, 2014, 12:27:41 PM »
@ The Vacant Road, I'm trying to give you the benefit of the doubt. This is normally a welcoming place, but we tend not to like people "selling stuff".

I'll just give you this example of my first impression of you from a couple weeks ago in the hopes that it will open your eyes to why we haven't been very welcoming to your ideas.

Your first (or maybe second) post was in a thread where we were discussing the benefits of a traditional 401k. Two or three of us were guiding a member here to read about the Roth pipeline, the power of deferring taxes, the power of low taxes during the early retirement stages. You could tell the original poster had an epiphany, we had opened his eyes to this strategy, and he was excited. Then you came in and told him to stop all 401k contributions, and that the only logical choice was to invest in real estate.

There is more than one way to do this. I'm open to learning from you, but it needs to go both ways otherwise you will get no respect here.

Overseas Stache

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #13 on: October 28, 2014, 12:29:51 PM »
Ladies and Gentlemen,

I've reviewed the comments, and I can only shake my head.  I'm sorry you feel that way, but I assure you my metrics are accurate when real estate is managed properly.  That was my intention for taking to time to share that knowledge with you;   To help others properly evaluate a real estate deal. 

We don't pay management fees because we don't have property managers.  Unless your property is long distance, there isn't a need for a property manager.  Single family homes practically run themselves when run properly.  We just avoid long distance properties all together.

We don't have many maintenance expenses due to the fact that our tenants sign an agreement to cover the first $250 of any expense.  When you have the best product at the best price this is quite simple to accomplish.  Yes, this is very possible, and we do this for every deal.

We also properly inspect a property to detect any major upcoming maintenance expenses (ie roof, foundation, appliances, etc).  We repair what is needed up front, and usually sell after 3-4 years.  Then of course, capture the unrealized capital gain, roll it into a 1031, and repeat the process.  By doing this, we typically avoid major repair costs.

Vacancy does happen, but is very rare.  It is the investor's main priority to select the highest quality tenant possible up front.  This only requires some simple due diligence. 

Something else our commentators failed to comment on is that we wouldn't have purchased this property with a conventional loan.  We would have used a hard money, double-close loan, and would have only invested $15,000 into the deal.  If you find yourself asking "how" then I suggest you keep building upon your education.  Care to calculate those returns again?

Friends, I am only trying to help.

1. Even self managed properties should include some amount for a management fee, otherwise you are fudging your cash on cash return numbers with sweat equity.
2.You reduce, I highly doubt you eliminate all, of your maintenance expenses by having renters pay 250 per expense. However this is eventually being paid by you in a couple of ways. First, you reduce your price in order to encourage renters to take this gamble. Essentially  you are paying for the expense in advance by reducing the amount you can charge in rent. Secondly, renters now have a monetary incentive to let problems go unreported until they become even bigger problems, try to hide problems, or do shoddy patch up jobs. Then when you go to sell the place in 3 yrs you will have to fix all these hidden problems thus costing you money at that point. Basically maintenance needs to be accounted for in some way.
3. Vacancies should be accounted for as well, like you said it does happen even if it is rare. in your example if your house was vacant for just 1 month in the course of 2 years  that would still equal to 4% of your monthly gross rents.

Hey great cash on cash ROI's can be had in RE even if these numbers are included. So why not give the full picture to someone, let them know that there will be maintenance (even if it is "pre-paid"), management (even if it only costs your time), and vacancy expenses. That is why it is so important to get the property for the right price so that even when these expenses come around you have more than enough wiggle room to remain profitable. Then if you are fortunate and you have much lower than expected expenses your ROI will be even better.

waltworks

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #14 on: October 28, 2014, 12:58:00 PM »
Arebelspy, drop the ban hammer!

Seriously, this "analysis" is a bad joke. And the OP's website is awful. Contribute meaningfully and don't spam us, dude.

-W

Bobberth

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #15 on: October 28, 2014, 01:06:34 PM »
Hello all!

So I've reviewed several real estate discussions, but rarely have I seen any mention of these two investing metrics- Cash on Cash Return


If you have "rarely" seen Cash on Cash Return mentioned, you must have your eyes closed as it is mentioned everywhere. 

Why did you originally state $29k invested and then go back and say only $15k would have been invested?  Why did you quote a 6%, 30 year conventional mortgage at first and then go back and say you would be using hard money?  Who uses hard money for a property you plan to hold longer than 6 months, possibly a year? 


GrayGhost

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #16 on: October 28, 2014, 07:20:25 PM »
Don't be so hard on him/her, lads. We have been told information that we didn't know before, which is that a property purchased at $70k, when it's worth $100k, is going to make serious money if you can rent it out at $1300.

arebelspy

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #17 on: October 28, 2014, 08:43:43 PM »
Hah, what an amusing thread.

After getting correctly called out on their bull*, the OP decides to double down with more ridiculous statements, like maintenance doesn't exist because they pass the costs onto the tenant (duh.. that'll affect the rate you can rent it for - and the tenant will just defer maintenance until they move out), and vacancy is irrelevant, and other things made up on the spot, like:
Something else our commentators failed to comment on is that we wouldn't have purchased this property with a conventional loan.  We would have used a hard money, double-close loan, and would have only invested $15,000 into the deal.  If you find yourself asking "how" then I suggest you keep building upon your education.  Care to calculate those returns again?

Commentors failed to comment on it because it wasn't part of the scenario, but something you just made up, that contradicted earlier data.

Here's a comment though: using hard money to buy long term rental property (i.e. not a short term flip) is flat out stupid.

Yeah, this person is clearly spamming their site, with many of their initial posts straight up linking to their site. 

Thanks to the people who reported to moderators, we'll clean it up.

I'm leaving this thread intact as it's a good example of how to correctly analyze properties (the comments by MMM readers, not the OP itself), hopefully new investors can learn from it.

We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
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BPA

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #18 on: October 28, 2014, 09:07:26 PM »
Clever removing the spam link, but keeping the comedy, ARS.  :)

ETA: But the other post still has the link intact.  Just noticed that.  Or rather, it's in his/her signature.  Good gord, I need to go to bed.
« Last Edit: October 28, 2014, 09:13:25 PM by BPA »

arebelspy

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #19 on: October 29, 2014, 10:02:21 AM »
ETA: But the other post still has the link intact.  Just noticed that.  Or rather, it's in his/her signature.  Good gord, I need to go to bed.

Yup, I can't edit the signature.  And someone promoting their site in their sig is A-Okay.  But continually posting it in threads is not.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

BPA

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #20 on: October 29, 2014, 05:43:11 PM »
ETA: But the other post still has the link intact.  Just noticed that.  Or rather, it's in his/her signature.  Good gord, I need to go to bed.

Yup, I can't edit the signature.  And someone promoting their site in their sig is A-Okay.  But continually posting it in threads is not.

Gotcha!  I really needed sleep when I posted earlier. 

kendallf

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #21 on: October 29, 2014, 07:40:46 PM »
OK, I must be bored, because seeing this pop up again made me go and read his website.  Briefly.  A quick Google search later...

There are a fair number of guys named Jeff Jenkins, but the best fit to the vacantroad bio is probably this guy

I kind of hope it's this Jeff Jenkins though, because he  seems like a nice kid.   :-D

Foggier

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #22 on: October 30, 2014, 08:03:31 PM »
"if you are going to finance a property (he only did one in his life), make sure your payment is 1/2 of the rent you charge.  Collect $1,000 rent, your mortgage, taxes, insurance should be $500.  Otherwise, you are asking for trouble, and believe me trouble will find you!"  Then he would jokingly say "I have bought a number of houses on the court house steps owned by people who thought they knew what they were doing..."

+2

I followed this inadvertently when settling on the minimum I'd bid on. Definitely include maintenance estimate in the cash on cash - you can of course nudge the estimate down in comparisons between props if one you know was rehabbed recently with <4 year old roof and mechanicals. Also fight the urge to mark in improvements to the revenue because you think,say, they're currently rented way under market. That should be the case to even think about the property but don't go assuming it into the cash on cash figure.

Blindsquirrel

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #23 on: October 30, 2014, 08:25:19 PM »
 meh, refused to click the link. Need way more than that before you do a deal. By his math, Detroit was a great place to buy 25 years ago. Of course your 200k house now will not sell for 10k and the city has abandoned your neighborhood since only 1 lots in 50 is occupied.  All you need are 2 things. Cash and a clue.

Less

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #24 on: October 30, 2014, 09:57:26 PM »
haha. following for laughs

gimp

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #25 on: October 30, 2014, 10:29:45 PM »
Are you telling me that my large collection of rocks that sort of look like moon rocks won't help me analyze a real estate deal? Sir, I vehemently disagree.

Must_Stash

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #26 on: November 03, 2014, 01:02:47 PM »
Now I really, really want to see the website for the Moon Rock Real Estate Method.

gimp

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #27 on: November 03, 2014, 04:08:13 PM »
I already own four websites. Don't make me buy a fifth.

Here's the secret: what you need to do is put the rocks in a potato sack, shake it around, then slowly pick out the rocks (blindly.) A few ritual words and a quick toss, and three rocks land on the ground. Now, you need to inspect them: are the sides facing up lighter than the sides facing down? If so, it's a good investment. If not, reconsider. And of course, should the faux moon rocks actually be real moon rocks, and their razor-sharp dust fragments get into your lungs, the deal is terrible and you should avoid investing for precisely 13 days.

For just $19.99, you can buy my book which details the ritual words, and shows the best places to find the rocks. Just for you, though, I'll give you the real secret: abandoned uranium mines. Rocks with a small amount of radioactive ore are entirely safe to handle (but not to ingest.) Don't worry about the radon in the mine; if it kills you, you weren't suited for investing anyways.

EastCoastMike

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #28 on: November 04, 2014, 04:45:16 PM »
I have several clients who own multiple units.  One I respect the most told me this..
"if you are going to finance a property (he only did one in his life), make sure your payment is 1/2 of the rent you charge.  Collect $1,000 rent, your mortgage, taxes, insurance should be $500.  Otherwise, you are asking for trouble, and believe me trouble will find you!"  Then he would jokingly say "I have bought a number of houses on the court house steps owned by people who thought they knew what they were doing..."

Good luck.
R

That sounds a lot like how the 50% rule was explained to me.  I'm still confused by the 2% rule, but I'm reading up on it.

arebelspy

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Re: The Only Two Things You Need to Know to Analyze a Real Estate Deal
« Reply #29 on: November 05, 2014, 07:25:28 AM »
I have several clients who own multiple units.  One I respect the most told me this..
"if you are going to finance a property (he only did one in his life), make sure your payment is 1/2 of the rent you charge.  Collect $1,000 rent, your mortgage, taxes, insurance should be $500.  Otherwise, you are asking for trouble, and believe me trouble will find you!"  Then he would jokingly say "I have bought a number of houses on the court house steps owned by people who thought they knew what they were doing..."

Good luck.
R

That sounds a lot like how the 50% rule was explained to me.  I'm still confused by the 2% rule, but I'm reading up on it.

The 1% rule says you want your monthly rent to be at least 1% of the purchase price + closing costs + repairs.  2% is even better, but often you have to sacrifice location quality or something else for that.

If you understand the 50% rule, then it's just math from there.

1% of purchase price (and other closing costs)/mo. x 0.5 (half going to expenses) leaves you with a half a percent per month profit, times 12 months in a year leaves you with a 6% return on your investment.  If you get 2%, that's a 12% return.

Leverage can change that, of course.

But basically the 2% rule is to try and get decent double digit returns after expenses eat half the gross rent.
We are two former teachers who accumulated a bunch of real estate, retired at 29, and now travel the world full time with two kids.
If you want to know more about me, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.