There are several metrics you can use to evaluate whether a rental property investment has potential, including the 2% rule. The 2% rule in real estate dictates that a property’s rental income should be at least 2% of the purchase price. Understanding this rule can make it easier to evaluate whether a particular rental property might be right for you. A financial advisor can help you create a financial plan for your real estate investment needs and goals.
What Is the 2% Rule in Real Estate?
The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.
For example, say you plan to purchase a property that costs $200,000. Using the 2% rule, that property should generate at least $4,000 per month in rental income. If you could only collect $2,000 in rental income then it wouldn’t pass the test.
The 2% rule is a variation of the 1% rule, which says that a property’s rental income should be at least 1% of its purchase price. If you were applying the 1% rule to the property in the previous example, then the property would pass with flying colors.
How to Calculate the 2% Rule
To calculate the 2% rule for a rental property you just need to know the property’s price. You could then take that number and multiply it by 0.02.
For example, say your budget for purchasing an investment property is $175,000. If you multiply $175,000 by 0.02, you’d get $3,500. That number represents the minimum or the base amount you’d need to rent the property for.
The 2% rule is by far one of the simplest calculations you can make to evaluate the projected return on investment for rental properties. You don’t necessarily need to know the property’s operating expenses or factor in any debt service if you’re planning to borrow in order to buy it.
What Does the 2% Rule Tell You?
The 2% rule tells you where to set the bar when establishing rental rates for an investment property. Essentially, it’s a measure of the projected rent versus the property’s sale price. It does not, however, tell you whether you’ll actually be able to collect that amount of money.
For example, say you want to invest in a luxury property that has an asking price of $600,000. In order for it to qualify as a good investment using the 2% rule, you’d need to be able to collect at least $12,000 per month in rent.
That may or may not be possible, depending on the rental market where the property is located. If rents for comparable properties are in the $7,000 to $8,000 range, then $12,000 might be an unrealistic goal. At that point, you’d have to consider how much you’ll need to invest in the property and how much of that might be returned to you in profit.
Where the 2% Rule in Real Estate Falls Short
SmartAsset: What Is the 2% Rule in Real Estate?
The 2% rule can be helpful in measuring a property’s cash flow potential but it’s just one small part of the overall puzzle. There are several things the calculation cannot tell you, including:
How vacancy rates for a particular may affect the property’s ability to generate rental income
What you’ll make in profit after deducting operating expenses and debt service
How much you might need to invest initially to get the property rental ready
The amount of maintenance and upkeep the property requires
What you’ll pay for property taxes and homeowners association fees, both of which may adjust annually
While the 2% rule can be a good starting point, it’s really just the tip of the iceberg in determining whether a rental property is a good investment. It’s also important to look at how much money you’ll invest upfront and on an ongoing basis in order to get a better sense of how much profit you’re likely to realize.
How to Evaluate Rental Property Investments
Finding a good investment opportunity isn’t an exact science and there are several things to weigh when choosing a rental property. If you’ve done an initial 2% rule calculation and found a property that looks promising, the next step is taking a closer look under the hood.
You can start by looking at the condition of the local market. For example, are rental rates increasing or have they stabilized? What’s the typical going rent for properties that are comparable in terms of size, age, condition and features? It’s also helpful to consider vacancy rates for the area.
Rising rents and low vacancy rates can indicate strong demand for rental housing, which is a good thing if you’re concerned about the property sitting empty for long periods of time. Aside from that, you can look at the desirability of the area and what type of renters it’s attracting.
Good schools, low crime and convenient access to shopping and other amenities can be strong attractors for renters. The more appealing an area is, the more you might be able to charge for rent. However, it’s important to weigh all of that against your costs. That includes what you’ll pay for a mortgage if you’re not buying a property with cash, how much it’ll cost to maintain the property and the going property tax rates.
Finally, consider what’s happening with the housing market and the economy as a whole. Renting and commanding higher rental rates is typically easier to do when the economy is booming. If there are hints that a recession might be waiting in the wings or inflation is pushing up the price of maintaining a rental property that could affect the level of profits you’re able to bring in.
The Bottom Line
SmartAsset: What Is the 2% Rule in Real Estate?
The 2% rule is just one guideline you can use to decide if a rental property investment is worth your time and money. It’s important to remember that while a property may look good on the surface, you’ll still want to perform your due diligence to confirm that it’s a worthwhile investment.
Investing Tips
Consider talking to your financial advisor about how to use the 2% rule to evaluate rental properties. If you don’t have a financial advisor yet, finding one doesn’t have to be complicated. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
If you’d like to reap the benefits of rental property investing without owning property, there are a few ways to do it. A real estate investment trust (REIT), for example, owns and manages rental property investments. When you invest in a REIT, you can collect dividend income passively without having to worry about managing properties firsthand. Real estate crowdfunding allows you to pool money with other investors while leaving the management of the property to someone else. Finally, you might consider exchange-traded funds (ETFs) or mutual funds that concentrate their holdings on real estate investments.
TORONTO – The Toronto Regional Real Estate Board says home sales in October surged as buyers continued moving off the sidelines amid lower interest rates.
The board said 6,658 homes changed hands last month in the Greater Toronto Area, up 44.4 per cent compared with 4,611 in the same month last year. Sales were up 14 per cent from September on a seasonally adjusted basis.
The average selling price was up 1.1 per cent compared with a year earlier at $1,135,215. The composite benchmark price, meant to represent the typical home, was down 3.3 per cent year-over-year.
“While we are still early in the Bank of Canada’s rate cutting cycle, it definitely does appear that an increasing number of buyers moved off the sidelines and back into the marketplace in October,” said TRREB president Jennifer Pearce in a news release.
“The positive affordability picture brought about by lower borrowing costs and relatively flat home prices prompted this improvement in market activity.”
The Bank of Canada has slashed its key interest rate four times since June, including a half-percentage point cut on Oct. 23. The rate now stands at 3.75 per cent, down from the high of five per cent that deterred many would-be buyers from the housing market.
New listings last month totalled 15,328, up 4.3 per cent from a year earlier.
In the City of Toronto, there were 2,509 sales last month, a 37.6 per cent jump from October 2023. Throughout the rest of the GTA, home sales rose 48.9 per cent to 4,149.
The sales uptick is encouraging, said Cameron Forbes, general manager and broker for Re/Max Realtron Realty Inc., who added the figures for October were stronger than he anticipated.
“I thought they’d be up for sure, but not necessarily that much,” said Forbes.
“Obviously, the 50 basis points was certainly a great move in the right direction. I just thought it would take more to get things going.”
He said it shows confidence in the market is returning faster than expected, especially among existing homeowners looking for a new property.
“The average consumer who’s employed and may have been able to get some increases in their wages over the last little bit to make up some ground with inflation, I think they’re confident, so they’re looking in the market.
“The conditions are nice because you’ve got a little more time, you’ve got more choice, you’ve got fewer other buyers to compete against.”
All property types saw more sales in October compared with a year ago throughout the GTA.
Townhouses led the surge with 56.8 per cent more sales, followed by detached homes at 46.6 per cent and semi-detached homes at 44 per cent. There were 33.4 per cent more condos that changed hands year-over-year.
“Market conditions did tighten in October, but there is still a lot of inventory and therefore choice for homebuyers,” said TRREB chief market analyst Jason Mercer.
“This choice will keep home price growth moderate over the next few months. However, as inventory is absorbed and home construction continues to lag population growth, selling price growth will accelerate, likely as we move through the spring of 2025.”
This report by The Canadian Press was first published Nov. 6, 2024.
HALIFAX – A village of tiny homes is set to open next month in a Halifax suburb, the latest project by the provincial government to address homelessness.
Located in Lower Sackville, N.S., the tiny home community will house up to 34 people when the first 26 units open Nov. 4.
Another 35 people are scheduled to move in when construction on another 29 units should be complete in December, under a partnership between the province, the Halifax Regional Municipality, United Way Halifax, The Shaw Group and Dexter Construction.
The province invested $9.4 million to build the village and will contribute $935,000 annually for operating costs.
Residents have been chosen from a list of people experiencing homelessness maintained by the Affordable Housing Association of Nova Scotia.
They will pay rent that is tied to their income for a unit that is fully furnished with a private bathroom, shower and a kitchen equipped with a cooktop, small fridge and microwave.
The Atlantic Community Shelters Society will also provide support to residents, ranging from counselling and mental health supports to employment and educational services.
This report by The Canadian Press was first published Oct. 24, 2024.
Housing affordability is a key issue in the provincial election campaign in British Columbia, particularly in major centres.
Here are some statistics about housing in B.C. from the Canada Mortgage and Housing Corporation’s 2024 Rental Market Report, issued in January, and the B.C. Real Estate Association’s August 2024 report.
Average residential home price in B.C.: $938,500
Average price in greater Vancouver (2024 year to date): $1,304,438
Average price in greater Victoria (2024 year to date): $979,103
Average price in the Okanagan (2024 year to date): $748,015
Average two-bedroom purpose-built rental in Vancouver: $2,181
Average two-bedroom purpose-built rental in Victoria: $1,839
Average two-bedroom purpose-built rental in Canada: $1,359
Rental vacancy rate in Vancouver: 0.9 per cent
How much more do new renters in Vancouver pay compared with renters who have occupied their home for at least a year: 27 per cent
This report by The Canadian Press was first published Oct. 17, 2024.
