BiggerPockets

Or is it just incomplete?

House 1:
Units: 2
Gross Rents: $1,000
NOI: $500
CF: $100*2 units = $200/m
P+i=$300/m
Max Offer @ 7% i = $45,092.27

House 2:
Units: 2
Gross Rents: $1,000
NOI: $500
CF: $100*2 units = $200/m
P+i=$300/m
Max Offer @ 7% i = $45,092.27

They are both fully rented/rentable.

House 1 is a much larger house in a worse neighborhood (think "hood" not "warzone"), and in decent shape. Painted wood or vinyl siding, hardwood floors, decent kitchen and bath, decent moldings, sound structure, and seperate utilities.

House 2 is ugly and in bad shape but in a very nice blue collar area. Crappy asphalt or abestos siding, crooked uneven floors with old hardwoods, baths with 12x12 self adhesive vinyl flooring and claw foot tubs, kitchens with about 5 SF of total countertop space, ok moulding, some walls are paneled over, ceiling height may be low in some areas.

Which house is better?



Long story short: The 50% rule does not adequately address property condition and location. Here is an example: two houses with equal rent, one is in bad neighborhood but good condition, while the other is in a better neighborhood but bad condition. Which house is a better deal? Which would you buy?


I hope that this thread stimulates debate over how to properly incorporate property condition into the 50% rule.

I would disagree with Jon's assesment. The home in the better area would (over time) appreciate better and in the long term have a better return. It would also be easier to sell a home in a good area than a bad one.

While the cash flow may be equal, the appreciation will not be. On top of that, you have an upside potential to repair the one home and "force apprecite" the investment.

Also, I don't care or choose to operate in bad neighborhoods as it does not fit within my business model. For others it does so that is just a personal choice.

You are correct, Will, that there could be other considerations that would drive the decision one way or another. Potential appreciation could be one. With the information given, however, I wouldn't hazard a guess about other considerations. In general, you're probaly correct that the nicer area has better appreciation potential. Could be, though, that something is happening that would make the worse area appreciate more. Or, that a few thousand dollars to improve the bad property would make a huge difference. Or, that the bad property is bad enough that its going to be an ongoing maintenance headache.

Bottom line, consider the simple evaluate first, then, if it passes the screen, do a more detailed analysis.

Please DON"T take this 50% rule as gospel!! It ISN"T. Use it as an approximation, but there are tons of variable from one area to another. Lets see how many of those there are. I'll start
1. Taxes in TX as compared to MS.
2. Insurance in El paso compared to New orleans
3. HOA fees compared to none
4. NEW const as compared to older.
5. Water rates in desert compared to Hawaii.
6.brick house compared to particle board.

Help me out here with others you think of. These were just rapid fire. My guess is I could create a model that would be 33% expenses or another one at 66%. Using 50 is JUST a #, imo.

naw...............not with cooler heads like Jon, MikeOH and Rich involved. They're to experienced for a heated thread.

I actually think this will become a productive thread.

I think everyone has stated good points so far

I also think the 50% rule is not always correct. In my area there are almost no SFH's that fit the rule. But that does not make them uninvestment worthy. My houses are in pretty nice areas compaired to hoods, and while they are not as cheap compaired to rents. They have lesser expenses, and easier tenant issues. This has made them easier to deal with while having a full time job.

Kirk,
You're being too logical for this board, and especially this thread. I'll stand by my post that I could make a property 35% or 65% simply by taking the highest and lowest #s in different areas.

Harrison,
You're always TOO damn nice. Mix it up sometime. Take a stance. Just kidding.

The 50% rule of thumb does not establish equivalency between two investment choices under consideration.

Kirk, in the example you gave at the start of the thread you listed all of the other information one should consider when choosing one investing option over another. All the 50% rule of thumb told you was if you bought EITHER of those and the revenue and expense numbers were in fact accurate, and you paid NO MORE THAN $45,092.27 you are likely to see positive cash flow.

That does not mean either of them is worth that amount; only that the rent and expense structure could carry that amount.

Where people sometimes get tripped up is with SFAs because there are really two entirely separate markets for SFAs. Well, three, but the third one does not lead to this confusion. The two of interest are the retail buyer looking for a place to call home and the investor looking for a house to rent to someone at a profit. The "at a profit" bit is the big clue. For an investor to ensure they will have a positive cash flowing property, the 50% rule of thumb is an important metric to understand.

The other thing to remember is the 50% rule of thumb is useful for analysis, not accounting. At any given period of time, your actual expenses may exceed 50% of revenue, but as a buy and hold landlord, we don't do acquisition analysis in small deltas of time. We are looking at the investment option as an investment that has an acquisition point, a holding time and a liquidation point. When considered over that entirety, the 50% rule of thumb is useful.

The Operating expense study summary report MikeOH referred to is available by clicking here. The study is based on over 33,000 rental units from 83 sources in 26 states. There are links to the more detailed report of the same study and to a discussion on using the 50% rule of thumb with other metrics in the summary report.

If you are a buy and hold landlord and you use the 50% rule of thumb as one of your tools for analysis you will be well served.