How we ditched the 2% Rule, & started making serious money.
Key takeaways
Debunking the Myth of the 2% Rule in Real Estate
The 2% rule states that the income generated from a single rental property should equal 2% of its purchase price. Sounds simple, right? If you've done the mental math, you've likely concluded that achieving this in expensive markets like Los Angeles is nearly impossible. And you're not alone; that was my initial reaction too.
The Reality of Expensive Markets
In Los Angeles, where the median home price hovers around $800,000, expecting to earn $8,000-16,000 per month from a single property is unrealistic. However, with some recalibration, you can find success in expensive markets by simply modifying your metrics for success. In fact, living in an expensive market can offer even more earning potential if you're willing to dig deeper.
Redefining 'Good Deals' in Your Market
In 2017, my wife and I set out to buy our first home. We decided to ditch the 2% rule and set our own criteria:
- Immediate Rent Reduction: We aimed to reduce our rent by 25%. Our rent was our biggest expense, costing us around $2,500 per month for a 2-bedroom, 1-bath apartment in the city. A 25% reduction would save us nearly $8,000 per year.
- Location in the Path of Progress: We mapped out our frequently visited neighborhoods, most of which were unaffordable. We decided to look in 'in-between' or 'wealth-adjacent' areas, betting that their proximity to pricier neighborhoods would eventually drive up their value.
- Income Potential: We looked for properties with underutilized spaces that could be turned into income-generating assets. We included search terms like "ADU," "basement," "flex," "unpermitted," and "garage" in our search criteria.
The Outcome
We ended up buying an 800-square-foot, 2-bedroom, 1-bath single-family home. On paper, it failed the 2% rule, the 1% rule, and even the 1/2% rule. However, after some negotiation, our mortgage came down to $1,750 per month, saving us $750 or $9,000 annually.
Six months later, we legalized and renovated the basement into a rentable studio apartment for about $15,000. We listed it for $1,750—the cost of our mortgage.
The Takeaway
If we had adhered strictly to the 2% rule, we'd still be at square one. The key lesson from our journey is that in an expensive market, simple formulas are often just that: too simplistic.
- Find Exceptional Deals for Your Market: Every market is unique. What works in one neighborhood may not work in another.
- Go Beyond the Numbers: Look for unique features that can add value to a property. Maybe it's proximity to a major highway, an underutilized space, or even "unconventional financing" options.
Your investment journey starts with your unique perspective, so ditch the hard and fast rules and discover what works for you!
