Podcast Transcript: Brandon Turner
Here's a transcript of the conversation Mike Sante, managing editor of Interest.com, had with Brandon Turner, senior editor of BiggerPockets.com, a website for real estate investors.
Mike Sante: This is Mike Sante at Interest.com, and I'm speaking with Brandon Turner, the
senior editor of BiggerPockets.com, a website for real estate investors. And if rock bottom savings rates have you thinking about buying a house or condo to rent, then you need to know about the 50% and 2% rules. Brandon is just the guy to explain what they are and why they're important for anyone thinking about putting their hard-earned money into an investment property. Brandon, help us out here. What do we need to know about the 50% and 2% rules?
Brandon Turner: Sure. So the biggest problem that most real estate investors or people that want to get into real estate have is that they believe that the income of a property minus the mortgage is what the cash flow is going to be. That's going to be the final profit.
But it's kind of an incorrect way of doing the math, because people forget about all those other little expenses, like the fact that the property will sit vacant for let's say 10% per year, or maybe 5% per year; the fact that the kitchen sink's going to need a new faucet put in or that lawn care's going to need to be taken care of on certain properties. There's a lot of little charges that all add up over time.
So what we like to say is that we use a calculation called the 50% rule. And what the 50% rule says is that whatever your income is on the property, if you were to take 50% of that, basically divide it in half, that's your expenses that aren't the mortgage. So again, going back to the example of $1,000 a month in income, you could probably assume that $500 is going to go out over time. Five hundred a month will go out in expenses, and then add the mortgage on top of that, and whatever you're left with is probably actually going to be your cash flow.
And it's a conservative way of estimating, and it's not always exact. It's just a rule of thumb, but it's really, in my own personal investing, it's been very, very clear and very real. And so maybe if your mortgage was $400 a month, and you had $500 in expenses, now you're looking at $900 total and $1,000 in income. You're probably at $100 in cash flow. So that's, in essence, that's what the 50% rule is.
Mike Sante: And the 2% rule is about how much you should be earning on your investment, right?
Brandon Turner: Sort of. The 2% rule is a rule of thumb which basically also says ... Now this is very, very difficult to get in a lot of areas, and there's different investors who will tell you different numbers. But basically the 2% rule says that you shouldn't pay more than 50 times a month's rent for a property.
And so if there is a property ... or in other words, 2%. So assuming the property sells for $100,000, it should rent for $2,000 a month. That's 2%. And so that kind of tells you what kind of return you should be looking for and how much cash flow. Now again, that's very difficult to get. Some investors stick with the 1% rule, so a $100,000 property should rent for $1,000 a month. It just depends on what part of the country you're in and how aggressive you want to go after these properties.
Mike Sante: But the whole point is, is that helps you to decide whether or not you're actually going to make a return on your investment, which is the whole point of doing this in the first place. Right?
Brandon Turner: Correct. Yes. It's a good way to quickly ... You know when there's 1,000 properties on the market in your area, you don't have time to go through each and every one, one at a time on a spreadsheet, and spend an hour on each one. Both the 50% rule and the 2% rule are really good ways to look at a property within 10 seconds and decide if it's going to be worth actually sitting down with a pencil and paper and figuring out the return.
Mike Sante: Brandon, thank you very much. We've been speaking with Brandon Turner, the senior editor of BiggerPockets.com.