3 Rules of Thumb Every successful Property Investor Uses.
Property investor! Here are some rules of thumb that you can use to quickly screen deals to make an educated decision. These are the 2% Rule, the 50% rule, and the 70% rule.
If you are a new property investor you need to know these rules (which are basic maths equation) to quickly estate the cash flow of potential real estate investment properties.
Rule of Thumb #1: The 2% Rule
The 2% rule also known as the 1% rule or test. This rule states that the real estate investment or property should rent for 2% of the purchase price.
That is the monthly rent divided by the value of the property (purchased price) expressed in percentage.
For e.g.: If a property is offered N8,000,000 (N8m) property, it should rent for N160,000 per month as this would be 2% of the purchase price.
That’s simple enough.
Purpose – This rule is to ensure you can get enough rent from the investment property to cover expenses and produce a cash flow.
Sometimes it could be tough to find deals that will rent for 2% so you may have to settle for less than 2% such as 1.5% but you shouldn’t go below 1%.
Let 1% be the minimum price floor in order to avoid getting into negative cash flow properties.
Let say the above example is a block of flat with 4 units. The monthly rent for each unit should be N40, 000. If it’s a bungalow, that means the monthly rent must be in a rang that will guarantee 1 – 2% (i.e. N80,000 to N160,000). Anything less will generate negative monthly cash flow-bad investment.
As a property investor who wants to buy a rental property, once you have known the selling price, make sure you that you know the average rent in that area so that you can do the 2% rule
Disclaimer: never buy a property based entirely upon one of these methods and financial ratios. These methods are a way to filter out 99% of properties that are not good deals and only focus on the best. Do further due diligence once a property passes initial screening using these rules of thumb.
You also need to know What Causes Increase In The Market Value Of Your Real Estate Or Property and 10 Tips For Real Estate Investing. Please, you must do your due diligence, I can’t overemphasise this.
Rule of Thumb #1: The 50% Rule
The second on our real estate investing rules of thumb list to analyze is the 50% Rule. The rule states that the total expenses for running a rental property (taxes, repairs, insurance, property management, turn-over costs, eviction costs, etc.) will average out to about 50% of the gross rent. That’s for a real estate investment on average and over time 50% of the income is spent on operating expenses. Operating expenses include every other expense except loan or mortgage.
Say as a property investor you own a rental property that brings in N20,000 per month in rental income, for example. The 50% rule states that you can probably assume that this property will cost you N10,000 per month in rental expenses (excluding loan or mortgage payments) over the long run.
The purpose of this rule for property (real estate) investors is to:
Allow them to look at cash flow over the long run and ensure not buying an investment property that actually costs more than what it generates –negative cash flow. This one thing every property investor must avoid.
Ensure that they leave 50% of the rental income to cover loan (mortgage) payments. If a loan costs more than 50% of your gross income each year, then this rule would advise not to buy the property because the real estate investor will risk having negative cash flow after paying all the operating expenses.
This rule of real estate investing is like a shortcut to estimate the costs and Net Operating Income (NOI) of a rental property – the revenue minus the operating expenses.
However, you must keep in mind that the 50% rule only gives a very general idea of what your expenses will look like. Moreover, investment properties are different from one another and include different expenses. Thus, property investors should NOT use this rule in place of an actual expense history!
Rule of Thumb #1: The 70% Rule
Now the final rule of thumb for this week is the 70% Rule. This rule is most appropriate for flippers and whole sellers. This rule states that your purchase price plus repairs should be 70% of the ARV (after repair value).
The after repair value (ARV) estimates the future value of a distressed property after it’s been repaired. ARV is not a property’s current value when purchased but rather the estimated value of the property once improvements are made. ARV is commonly used by fix and flip property investor who purchases, renovates, and sells properties within 1 year.
Once you know this ARV comp, you can multiply it by 0.70 and subtract out your estimated cost of repairs to come up with a purchase price.
The purchase price usually ends up around 45% to 55% of the ARV depending on how much repairs are needed.
For example: If similar homes have recently sold for N100m and you estimate repairs to cost N20m on your potential investment property, then multiply 0.70 by N100m to get N70m and subtract out your N20m in repairs to get a max purchase price of N50m.
Purpose – to ensure you have room to profit from the flip after purchase price and rehab costs. Closing costs and realtor commissions will also eat into that 30% margin you are leaving yourself so your net profit might not be the whole 30%.
If like this article please subcribe to get more updates.