As if I haven’t caused enough controversy this week (see my recent post Is it a Lie to Tell the Tenant I’m Not The Owner?) today I wanted to make a video explaining something that has caused a good deal of debate over the years here on BiggerPockets:
The 50% Rule.
In the following video, I explain what the 50% Rule is, and how you can use it to quickly estimate the cash flow you can receive from a buy and hold real estate investment.
The 50% Rule is:
Over time, 50% of your real estate investment’s income will be spent on expenses, not including the mortgage.
It’s just a simple way to determine cash flow – and something I use every single day, dozens of times.
Now, for those of you who are immediately up in arms about this “rule” – let me be the first to say it:
This is just a rule of thumb.
It’s use is not for deciding with 100% certainty if a property is going to be a worthwhile investment. For one thing, no one can ever know this 100% for sure. Secondly, I’m not going to take the time to analyze every single property that crosses my desk with my spreadsheet – like I did in my post How to Buy a Small MultiFamily Property: A Step by Step Case Study.
So the 50% rule is largely about speed and convenience, but it’s also about one more very important thing:
The 50% Rule is About Being Conservative
You see, when you normally run the numbers on a property (or when you get the pro forma numbers from a real estate agent) the expenses are FAR less than 50% of the property. However, most of these calculations don’t account for the “Oh crap, the furnace just went out” or the “Oh crap – the tenant is late again and now I have to evict.” So even if the 50% rule is “too conservative” – in my book, that’s just fine with me.
When I do an investment analysis, I always look at three expense figures:
- The historical expenses – what the expenses actually were
- My opinion of the expenses – my spreadsheet of what I expect the expenses to be once I buy
- The 50% rule – well… just watch the video below.
Then, I simply look at the highest number and use that in my calculations, being the most conservative in my estimates as possible by being the most liberal with my expense assumptions.
I’d rather miss out on a few deals for being too conservative than buy some deals that sucks more money out of my wallet than a Tall 180 Degree Non Fat Peppermint Hot Chocolate with Whip and 1 Pump Vanilla from Starbucks.
So why you are all watching the following 4 minute video, I’m going to head to Starbucks and get my little drink from heaven. Don’t judge me or my goofy look in the video photo below! 😉
Thoughts? Leave your questions and comments below!
I always respond! (try me!)