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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?