BiggerPockets

I purchased a nice older home that is located on the same street as one of my current rental homes.

My original intentions were to flip the home and re invest the profits...

I'm confident it will sell, but I've also contemplated keeping it as a rental due to the location, and the fact that it would be a low maintenance home.. Brick/vinyl, new roof, New HVAC, New hot water, new appliances, new windows, solid surface floors.

I'll have $68,000+/- invested.

Rent will bring $1,000 monthly x 50%= 500

$68,000-----15% down payment-----4.5% interest rate-----20yr loan= $365 P&I

Cashflow of $135 monthly= 1,620 annual or 15% cash on cash return...

My question is... When using the 50% to evaluate properties should I be using a 15, 20, or 30yr mortgage???

If the 15yr mortgage is used the property is just cashflowing $50 per month.

20yr Cash flows $135.00

30yr = $200.00

Finding cash flow properties with a 30yr mortgage seems should be easy if my math is correct. 15 yrs gets to be a bit harder.

Is my math correct? It seems I'm missing something.

2% rule would indicate that the rents need to be $1,360 per month, yet when using the 50% rule it seem the property would cash flow at $1,000???

Is it because of the downpayment??

With 25% down and 5% interest at 30 years, the 2% rule becomes about 1.45% to earn 15% Cash on Cash.

If I remember right, the 50% rule was designed to generate $100 / door in returns at $500 rent. Buy a home for $50,000... rent it for $1,000 (2%)... $300 towards debt servicing, $500 towards expenses, cash flow of $200 ($100 x 2).

If you can find 2%, you're getting a VERY VERY good return with today's interest rates. But you can go much lower and still get healthy returns.

You also have to watch how banks value single family homes (hint, it's not income based). Quadplex I bought for $124k is rented at $2,050 a month (1.65%) which doesn't sound great compared to my Duplex I bought for $72,000 (+$5,000 in reno) rented at $1,600 a month... but the bank thinks the Quadplex is worth $170,000 and will let me refi at $130,000... I'll get paid $6,000 or so from the bank to have bought the property and get a cash flow of $250 a month from it. The rent % is far lower, but the cash on cash is significantly higher.

Personally, I'm not worried about maximizing cash flow on each property... I'm trying to stretch my initial $35,000 investment into as many properties as I can. Goal is to have 4 by the end of the summer (have about $14,000 of equity in the Duplex to try to cash out in June!)

You're confusing the 2% rule and the 50% rule. The 50% rule says vacancy, expenses and capital will eat 50% of the gross scheduled rent. End of story on that. The 2% rule is a quick and dirty check to see if you're even in the right ball park. It works for rents around $500 a month. Lower than that and you need a higher ratio. Rents higher than $500 will produce a return with a lower ratio. If rents are $300 a month, even a 2% ratio won't produce much return.

I'll quote myself

The 50% rule says vacancy, expenses and capital will eat 50% of the gross scheduled rent. End of story on that.

The 50% rule gives you an estimate of your NOI. Nothing more.

That's one step in evaluating a property. Its an important one. The information from sellers is often skewed. They may just plain be forgetting expenses, especially if its just an individual who only owns a few. They may be deliberately understating expenses. Or, they may have just been lucky or unlucky over the period they owned the property.

Having the NOI, you can now apply your terms to estimate your cash flow and cash on cash return.

A pretty common goal would be to generate $100 in true cash flow (not phony rent-PITI cash flow) per month. That's $100 for dealing with a tenant. Its easier to extract $100 from $1500 in rent than it is from $300. At $1500, 50% rule tells you NOI is $750. Subtract $100 in cash flow and you can afford a $650 payment. At $300, the 50% rule tells you NOI is $150. Subtract $100 and you're left with a $50 payment.

Those payments would assume 100% financing. Otherwise you're ignoring the cash you've invested. So use the PV function in Excel to compute the max loan from the payment. Then subtract your down payment (DO NOT add it back on), and recompute your cash flow. It will be higher. Part is from the property, part from your down payment.

I'll be doing a whole session on this at the summit.

I understand the idea behind the 50% rule is to come up with some target number but I really think it seems a bit too simplistic to accurately gauge expenses.

Its missing key variables that really make a difference.
1) How old is the property?
2) How big is the property?
3) How extensive was the rehab?

I've found that my more expensive rentals tend to need a lot less. So the houses renting for $1,300 to 1,400 need a lot less maintenance than the ones renting for 1,000 to 1,100.

To me, its because the nicer homes (that are getting higher rents) need less repairs and have less turnover than the lesser homes.

I just don't see the numbers adding up to support that my 1,400 rentals have 750 in expenses compared to my 1,000 rentals having 500.

Maybe if all my houses were of the same age, that may be true. But for me, the newer homes have a lot less repairs and very little turnover so the 50% rule just seems to be way off for using as a formula.

Hi Mike,

I understand what you are saying but the 50% rule is based on holding property for the LONG haul, not just the here anad now. While your newer properties may do well now and may not require 50% of gross rental income for expenses in time you will need a roof, a boiler, a driveway, some masonry work done, etc.. all big ticket expenses that will hurt your cash flow for the year of the repair/upgrade. The 50% rule has all these things already added into the equation/big picture.

There are also other things that come up, eviction, tenant doing major damage to the apt. requiring fixing etc...

I am in same boat as you as well, As my properties are smaller fairly newer with very low maintenance but I am in for long haul know one day these big ticket items will eat my cashflow.

hopew this helps!

regards,
Chris

Agreed, there are other threads where this topic has been debated. Please use those threads if you wish to discuss the validity of this rule and stick to Ed's question in this thread.

Purchase Price 100000 150000 100000 100000 100000
Down Payment (25%) 25000 37500 25000 25000 25000
Mortgaged Amount 75000 112500 75000 75000 75000
Mortgage ($5.37/$1,000) 402.75 604.125 402.75 402.75 402.75

Rent % to Purchase Price 1.45% 1.45% 1.40% 1.50% 2.00%
Rent 1450 2175 1400 1500 2000
NOI (Rent * 12/2) 8700 13050 8400 9000 12000
Cash Flow (NOI - Mort*12)3867 5800.5 3567 4167 7167
Cash on Cash (CF / P) 15.47% 15.47% 14.27% 16.67% 28.67%

1st Column to the 2nd shows that the calculation holds true regardless of Purchase price. Your CoC return, given a set DP % is solely dependent on the % rent to purchase price. Last 3 columns shows how the CoC varies as % rent varies.

Here's the equation if you want it:
NOI - Mortgage / DP = 15%
[50%*(PP * % Rent * 12) - (75%*PP * $5.37/$1,000 * 12)] / 25%*PP = 15%

This reduces to:
[6 * PP * % Rent - .04833 * PP] / 25% * PP = 15%

PP cancels out, multiply the top by 4 (or divide by 25%) gives you
24 * % Rent - .19332 = 15%

Move the constant and divide by 24 gives
% Rent = (.15 + .19332) / 24 = .34332/24 = .014332 = 1.43%

Given a 25% down payment (ignoring closing costs and reno), if rents are 1.43% of purchase price, you achieve a 15% cash on cash return assuming the 50% expense rule.

So what's the verdict on this particular property as a rental?

$68,000 Invested with only $1,000 rental income.

1,000 monthly just seems to be the glass ceiling for my rental market unless it's a 150K+ home... Those will bring 1000-1400..

My rental market seems to be 1% of retail value of the home. 100K house will rent for 1000

60,000 house will bring 600, 150000 will bring 1500...

1500 is like a 2nd glass ceiling... I've seen 200+ homes rent for 1500..