BiggerPockets

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:

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

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

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

Jeff,

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

Good Luck,

Mike

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

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

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