“Buy low, sell high.”
Property investing pretty much revolves around this golden rule. And it’s true. To make a profit, you simply have to sell your investment at a higher price than you bought it.
However, there is so much more than buying, selling, and timing. Especially with property investing, there are taxes, capital gains, income, and many more numbers to consider.
To make things a little less complicated, there are some rules of thumb that investors follow to help make sense of the numbers and to make property investing a little less complicated to understand.
Keep reading to learn more!
The 2% rule
Otherwise known as the 2% test, this rule is popular with investors who rent out their properties.
This rule helps investors quickly figure out whether a rental property can make a positive cash flow.
Here’s how it works: Divide the monthly rental fee by the total price of the house. Then multiply it by 100. Using this formula, you get the percentage of cash you can make relevant to the total price of the property.
According to investors, you should get at least 2%. This is a sign that the property is going to generate positive cashflow for you, which means it’s a good investment.
For example, say you are checking out an apartment worth $250,000 in an area where the average rent is around $2500 per month.
Will the deal be worth it? To know, apply the 2% test.
The average rent is $2500, so divide this number by the total price of the property which is 250,000. Multiply what you get by 100, which will give you 1 percent. This means that this property does not pass the test.
Move onto the next apartment deal in your list. Never settle for an investment property unless it can make 2% of the property value in rent.
The 50% rule
This rule says that operating expenses required to run a property must be half the amount of the rental income it generates.
Looking at it another way, it could also be a basis for pricing monthly rent. Compute all expenses, then multiply it by two to get the rent you should be charging.
Take note that the payment for the mortgage is not covered in the operating expenses. It must be covered by the other half and the surplus is what counts as your net income.
It helps to keep track of your loan payments with the help of your mortgage broker.
When calculating for operating expenses, you should also include vacancy in calculating the operating costs. You must take into consideration the amount of money lost when your property is vacant.
Operating costs include:
- Maintenance fees
Why is it important to include even the larger operating costs in the monthly rent? Well, it’s true that you don’t have to repair your heating and ventilation systems as often as you need to duplicate keys, but it sure is a one-time large expense. As early as now, you have to be ready for such massive needs. After all, one key skill you must have in property investing is foresight.
House flipping is part of the property investing game, and this rule is for this venture. Basically, when you flip a house, you should only buy a property at 70% of its final price. The final price refers to the price at which you plan to sell. Including all renovation costs.
If you estimate that a property’s value after repairs is $250,000, and repairs cost around $50,000, the 70% rule demands you buy the property at $125,000.
The remaining 30% is assumed to cover the profit, taxes, commission and other fees.
Now, this works in average-priced properties. However, if a property is on the low side, following this rule means your profit margins are low.. As far as high-cost properties are concerned, buying at 70% of the post-renos value means you have little to zero chances of closing a deal.
Of course, there are limitations to these rules. After all, they’re just general guidelines meant to give you a quick idea of how a deal will roll out. After enough experience, dealing with investment properties will become much easier.