NEW: BP Podcast 66: Flips, Apartments, & Protecting Yourself From Professional Tenants with Michael Blank

Hide this

From the BiggerPockets Blog

 BiggerPockets Blog »

Jump to Forum View All

Click a category below to view different forum categories.

BiggerPockets

General Info

BiggerPockets Q&A, Site Questions, & Announcements

1516 topics, 14406 posts — Last Post 04/19/14, 03:56PM

BiggerPockets Exclusive PRO Area

117 topics, 839 posts — Last Post 04/18/14, 05:47AM

New Member Introductions

10895 topics, 85685 posts — Last Post 04/19/14, 04:52PM

Real Estate Success Stories

396 topics, 6161 posts — Last Post 04/19/14, 05:20PM

General Real Estate

General Real Estate

Buying & Selling Real Estate

5941 topics, 46813 posts — Last Post 04/19/14, 05:26PM

Renters

643 topics, 5817 posts — Last Post 04/19/14, 09:29AM

Get Foreclosure Help - Help Stop Foreclosure Forum

316 topics, 2557 posts — Last Post 04/16/14, 03:58AM

Home Owner Association (HOA) Issues & Problems Forum

237 topics, 1609 posts — Last Post 04/17/14, 08:53AM

Do it Yourself

654 topics, 6265 posts — Last Post 04/19/14, 10:16AM

Reviews & Feedback

Real Estate Deal Analysis and Advice

3683 topics, 29518 posts — Last Post 04/19/14, 04:59PM

Real Estate Guru, Book & Course Reviews and Discussions

1133 topics, 11562 posts — Last Post 04/19/14, 12:17PM

Ask About A Real Estate Company

741 topics, 7322 posts — Last Post 04/19/14, 04:25PM

Real Estate Investing

Real Estate Strategies

Wholesaling

5605 topics, 43748 posts — Last Post 04/19/14, 05:16PM

Rehabbing and House Flipping

3334 topics, 31003 posts — Last Post 04/19/14, 01:08PM

Real Estate Development & New Home Construction

553 topics, 4684 posts — Last Post 04/19/14, 12:13PM

Innovative Strategies

703 topics, 6027 posts — Last Post 04/18/14, 08:48AM

Tax Liens, Notes, Paper, & Cash Flows Discussion

866 topics, 6678 posts — Last Post 04/19/14, 06:06AM

Rent to Own a.k.a. Lease Purchase, Lease Options

693 topics, 4902 posts — Last Post 04/19/14, 04:53PM

1031 Exchanges

143 topics, 1054 posts — Last Post 04/18/14, 08:41AM

Foreclosure Investing

General Foreclosure & Pre-Foreclosure Forums

1687 topics, 11287 posts — Last Post 04/19/14, 02:42PM

HUD, VA, and Tax Sales

414 topics, 3089 posts — Last Post 04/18/14, 12:05PM

REOs

1214 topics, 10576 posts — Last Post 04/19/14, 11:48AM

Short Sales

1534 topics, 13120 posts — Last Post 04/17/14, 04:44PM

Landlord & Tenant Forums

Landlord & Rental Property Questions

7205 topics, 70769 posts — Last Post 04/19/14, 05:40PM

Mobile Homes & Mobile Home Park Investing

638 topics, 5141 posts — Last Post 04/19/14, 09:49AM

Investor Basics

Starting Out

7704 topics, 60484 posts — Last Post 04/19/14, 05:32PM

Investor Psychology

431 topics, 6104 posts — Last Post 04/18/14, 06:08PM

General Real Estate Investing

4718 topics, 37213 posts — Last Post 04/19/14, 04:55PM

Real Estate Investor Marketing

1731 topics, 14094 posts — Last Post 04/19/14, 06:39AM

Commercial Real Estate

Commercial Real Estate Investing Forum

1410 topics, 8994 posts — Last Post 04/19/14, 04:34PM

Multi-Family and Apartment Investing

1109 topics, 9235 posts — Last Post 04/19/14, 05:37PM

The Business of Real Estate

Real Estate Technology and the Internet

Real Estate Technology, Social Media & Blogging

642 topics, 4897 posts — Last Post 04/19/14, 11:10AM

Business Basics

Goals, Business Plans & Entities

831 topics, 7562 posts — Last Post 04/18/14, 04:25PM

Real Estate Finance & Legal

Financial, Tax, and Legal

Tax, Legal Issues, Contracts, Self-Directed IRA

2786 topics, 20013 posts — Last Post 04/19/14, 03:42PM

Property Insurance

309 topics, 2045 posts — Last Post 04/17/14, 07:41PM

Personal Finance Discussion

328 topics, 2731 posts — Last Post 04/18/14, 04:33PM

Loans, Mortgages, Credit Lines

Private & Conventional Lending Discussion

2834 topics, 19701 posts — Last Post 04/19/14, 05:16PM

Creative Real Estate Financing

1209 topics, 8769 posts — Last Post 04/19/14, 06:24AM

Crowdfunding Real Estate

35 topics, 461 posts — Last Post 04/18/14, 05:17PM

Real Estate Professionals

Real Estate Professionals

Real Estate Agents

1210 topics, 7989 posts — Last Post 04/19/14, 08:04AM

Bankers, Lenders, and Mortgage Brokers

442 topics, 1923 posts — Last Post 04/19/14, 03:56PM

Contractors

268 topics, 1678 posts — Last Post 04/19/14, 03:38AM

Local Real Estate

Local Real Estate

Local Real Estate Networking & Recommendations

1990 topics, 11612 posts — Last Post 04/19/14, 02:11PM

Americans & International Real Estate

161 topics, 566 posts — Last Post 04/14/14, 11:19AM

Foreigners Buying in the USA

62 topics, 409 posts — Last Post 04/10/14, 06:27AM

Canadian Real Estate

64 topics, 428 posts — Last Post 04/18/14, 04:22AM

Marketplace

Real Estate Marketplace

Real Estate Marketplace

15018 topics, 53958 posts — Last Post 04/19/14, 05:23PM

Real Estate Events and Happenings

164 topics, 2514 posts — Last Post 04/19/14, 01:13PM

Off-Topic

Off Topic

Off-Topic

2905 topics, 32411 posts — Last Post 04/19/14, 08:03AM

Housing News & Real Estate Market

914 topics, 8351 posts — Last Post 04/17/14, 08:41AM

BiggerPockets Real Estate Investing Summit

97 topics, 1751 posts — Last Post 04/10/14, 02:27PM

BiggerPockets Resources

50% rule

65 posts by 29 users

Signup

Real Estate Investor · Columbus, OH


noob here.....Can someone explain the 50% rule, 2.5% rule.....I can't seem to find a definition for it.

Thanks.

Jim



Inspector


50% of what you hear about real estate investing is crap.
Of that 50%, only 2.5% works in a down market.

Seriously, here's what it means. If you buy right - at least 50% of your rental income will be spent on expenses. The general guideline is that you want to get rental income that is at least 2% of the purchase price. I used to believe in 1% but 2% is certainly better....and 2.5% is even better than that. With REOs the way they are, I've been applying the 4-5% rule. :mrgreen:



Real Estate Broker · charlotte, NC


tim, i kinda liked your first scenario....



Real Estate Investor · Rowley, Massachusetts


Tim,

What do you consider expenses? I.e. does it includes your debt service, taxes, insurance, + the all the other stuff (maint, advertising, vacancies, etc.), or does the 50% rule mean that in addition to your PITI you'll have other expenses that total approximately 50% of your planned rent?

Sorry to ask a basic one, but I'm still in the early stages of learning the property analysis bit.

Thanks
Jeff



Inspector


No sweat Jeff.

For me, expenses are everything that goes out of pocket (including mortgage) before income taxes are figured. Yes, PITI is part of that when I have it on a property.

That's the hard thing with some areas. Properties just cost too friggin' much to cash flow properly. I scanned Virginia Beach and saw that your cheapest houses there start at 150k. Unless rents are $3,000/month that's hard to cashflow. On the other hand, I've seen property that sells as low as $6,000 per unit after repairs. Not hard to cashflow that. Don't expect it to be a hot appreciation market though....lol.

Tim



Real Estate Investor · Ohio


Jeff,

The 50% rule is nothing more than the fact that throughout the United States, operating expenses run 45% to 50% of the gross rents for rental properties. Operating expenses include all the expenses that are associated with operating your rental business, but DO NOT include the mortgage payment (Principal and Interest). Operating expenses include (but are not limited to): taxes, insurance, management, maintenance, entity maintenance, advertising, utilities (at least during vacancies), legal fees, damage done by tenants (over the security deposit), vacancies, setouts, lawsuits, and capital expenses (not technically an operating expense).

There is no 2.5% rule. The 2% rule is simply a screening tool that says that you need the monthly gross rents to be about 2% of the acquisition cost of a rental (purchase price + rehab). Very simple math will tell you that if the monthly gross rents are not about 2% of the acquisition cost, the property will not cash flow properly.

Good Luck,

Mike



Real Estate Investor · Rowley, Massachusetts


Tim, Mike,

Thanks for taking the time to answer my question. Tim, I've come to the same conclusion about Va Beach as well. The cheap properties aren't so cheap here.

Just to summarize my understanding. When I analyze a property, I should consider the following.

1. Can I set the rent at 2% of acquisition costs and have it be realistic/competitive in my area?
2. My cash flow analysis needs to consider....

Cash Flow = Rent - Debt Service (Princ and Int) - All other expenses (est at 50% of Rent)

So if you do a little math and want to figure a rough break even point on either the rent or the debt service, you can set cash flow = 0 and solve for one of the other variables.

e.g. 0 = Rent - Debt Svc - 0.5 Rent

0 = 0.5 Rent - Debt Svc

Concluding that .....

Debt Svc = 0.5 Rent OR Rent = 2 Debt Svc

Solving for rent will tell you what you need to charge given the acquisition cost of the home in order to break even. Or, solving for debt service will give you an idea (albeit subject to the details of your financing arrangements) of how much you can spend to acquire the property given the average/acceptable rents in a particular area.

I like bar room napkin math and this looks like a quick and dirty way to determine whether I should spend more time considering a particular property or not.

Please let me know if my conclusions are flawed.
Thanks again,



Real Estate Investor · Ohio


1. Can I set the rent at 2% of acquisition costs and have it be realistic/competitive in my area?

That would be great, but unfortunately you do not get to set the rent. The rent is set by the market. So, the real question is whether the market rents are at least 2% of the acquisition cost.

So if you do a little math and want to figure a rough break even point on either the rent or the debt service, you can set cash flow = 0 and solve for one of the other variables.

Why would you want a break even property? The point of being in business is to MAKE MONEY, not break even.

Or, solving for debt service will give you an idea (albeit subject to the details of your financing arrangements) of how much you can spend to acquire the property given the average/acceptable rents in a particular area.

THAT'S IT!

Good Luck,

Mike



Real Estate Investor · Rowley, Massachusetts


Mike,

I couldn't agree with you more. I see no reason to get into this game to break even. It's a statement I've made to my wife many times before. My point was just merely stating the obvious that you can quickly draw the line in the sand with the simple math rule of thumb to determine where the (+) cash flow is and where the (-) cash flow is.

Despite the other sources of building wealth via REI (appreciation etc), I think the cash flow aspect will probably be my number one requirement. No (+) cash flow, no deal. While I think there are probably many reasons why one would buy an REI at a break even cash flow, I believe that I need to start slow and get a few wins under my belt before going there.

Thanks again for the education,



Real Estate Investor · Ohio


Jeff,

I would draw the line in the sand a little higher - at about +$100 per unit per month.

Good Luck,

Mike



Property Manager · Honolulu, HI


MikeOH-

Do you include an exit value in the " income" side of your calcs? Why?



Real Estate Consultant


Jeff,

Personally, I'd rather distinguish (with rentals) like so, to create a method:

a. My policy: some parameters have to reach certain points before I buy.

b. My thumb rules: 2% is a bit higher but I've got mine, which I developed after a while and is still improving. The main thing about it is, let you determine if the property goes to step II - analaysing

c. Analysing - a complete analysis for the property that shows some scenarios, mainly the worse and exit strategies. Many times this varies a lot from what you have with the tumb rules. Analysis shows you what is your expected income, cashflow etc., but also shows you on a timeline at which point you are about to need a huge sudden amount of cash, and whether you've got it. It also shows you what's next.

d. Note: Important: your equations are correct but, most of the part of it are given! Of course, you can set cashflow = 0, but what does it mean, when the other parts are set by the market? So, you put everything in place and eventually get a couple of ratios. Then, you find the ones most important for you and check them. This is the right method.

e(and back to a - policy). What are these parameters? Depends on the scenario. Rental property usually what you are looking for is positive cashflow, of higher than X (personally, I'd rather include x in an early calculation and see if I got a positive value. This way I know I took everything into account, otherwise what's the meaning of this x?). You should also consider the following parameters as analysing basics: the return on invested capital ratio (it should be quite good, otherwise you could have invested elsewhere!), and the available financial resources left after considering the future plans.

Steve



Real Estate Investor · Ohio


Do you include an exit value in the " income" side of your calcs? Why?

No, because I don't intend to ever sell them. I'm in the rental business, not the slow-motion flip business. In addition, I can't eat future profits or go snowboarding with principal paydown, so they really aren't relevant to today's situation. If you doubt this, try taking a personal financial statement to Park City and see if they'll give you a lift ticket. I don't think so!

I am interested in only two things: CASH FLOW and EQUITY AT CLOSING. If you've got both of these, it's hard to go wrong.

Mike



Inspector


Originally posted by "MikeOH":
No, because I don't intend to ever sell them. I'm in the rental business, not the slow-motion flip business. In addition, I can't eat future profits go snowboarding with principal paydown, so they really aren't relevant to today's situation. If you doubt this, try taking a personal financial statement to Park City and see if they'll give you a lift ticket. I don't think so!

I am interested in only two things: CASH FLOW and EQUITY AT CLOSING. If you've got both of these, it's hard to go wrong.

Alright - EVERYONE MUST listen to this post. This post right here is the key to long term Real Estate investing success. Anyone who has made a successful career of real estate investing anywhere beyond 3-5 years and has been successful in both up and down markets employs these principles. Dynasties are built on these simple principles.

Ironically this is nothing new. Our system of real estate is built on the principles of feudalism that were founded by Charles Martel in the 8th century. These principles have been working for 12 centuries. (Where do you think we get the term " landLORD" ?.) It doesn't take a brain surgeon to see that they will continue to work another century or two.

Great post Mike - hopefully one or two will listen.

Tim



· Fort Myers, Florida


Originally posted by "TimWieneke":

That's the hard thing with some areas. Properties just cost too friggin' much to cash flow properly.

So when you run into that, do you just move on to the next area, or try to put down enough to make it cash flow? Or is it a waste to tie up that kind of cash?

Where I am, things are still too expensive to make it work in my favor - and the market IS down. I'd have to be able to acquire something for ~40% below market value to get the numbers in the ballpark.




This post has been hidden.


Real Estate Investor · Ohio


**********,

Here's an example of a property purchased for $50,000 with gross rents of $1,000 per month

Gross rents: $1,000
Operating Expenses: $500
NOI: $500

Mortgage Payment ($50K, 30 yr, 7%): $332

Cash flow: $168 per month

Hope this helps,

Mike




This post has been hidden.


Real Estate Investor · Ohio


Cash down doesn't affect the quality of the deal at all.

Mike



Inspector


Originally posted by "FtMyersMike":
Originally posted by "TimWieneke":

That's the hard thing with some areas. Properties just cost too friggin' much to cash flow properly.

So when you run into that, do you just move on to the next area, or try to put down enough to make it cash flow? Or is it a waste to tie up that kind of cash?

Yes. I go somewhere else. I don't fish for trout in a bass pond. Do a radius check of about an hour and a half to two hours drive out from your location. Chances are you'll find a town that cashflows. If not, stretch a little further. I seem to recall some decent cashflow potential in Gainesville.

Tim





Sign up