50% rule

7 Replies

Does the 50% rule apply to everyone? The reason I ask is I have notice numerous people pay for utilities for their property when renting it out. Here in California this is not common as the renters themselves are responsible for paying utilities, in most cases. The 50% rule seems ultra conservative and very difficult to obtain in the ca market.
Thanks

I'm not a fan of the 50% rule or estimating expenses based on percentages. The best way, in my opinion, is to use fixed numbers. On lower end properties, it very well may be much more than 50% (and that goes too if you're paying utilities). If they have an operating statement, that certainly helps (don't believe pro formas). But try to fill in the following:

- Taxes

- Insurance

- Utilities

- Maintenance

- Contract Services

- Recurring CAPEX

- Payroll (if there are people on staff at the apartment)

- Advertising

- General Admin (again if you have a leasing office at the apartment)

- Management Fee

It's tougher for houses, because so much of it depends on whether or not you have a turnover, but I still try to use an estimate of expenses instead of a percentage of income. Income and expenses are unfortunately, not necessarily correlated.

There's an existing extensive discussion about the 50% rule.

The 50% rule is simply a way to estimate how much you will spend on capital and expenses plus how much you won't collect in rent due to vacancy. Its not something you obtain. It is an estimate of what you will experience. It is true that if you do experience 50% of your gross scheduled rents going to expenses, capital and vacancy, and then you have to pay your debt service payment that you will be cash flow negative on many properties. But that calculation is telling you what's going to happen.

Based on experience provided by people with a number of rentals over a long period of time this estimate is NOT "ultra conservative". Rather, it is what you will experience over the long haul if you do a good job of managing your properties. For any particular property in any particular year your results may be somewhat better (taxes and insurance at the very lease, property management if you're using that) but can also be much, much worse.

Owner paid utilities can make your actual results worse. As can extensive deferred maintenance or the need to make a number of big capital improvements over a short period of time. But even if the house has, say, a brand new roof, 20 years from now its going to need replacement. So, you need to budget for that as you go along.

Originally posted by @Brandon Cooper :
Does the 50% rule apply to everyone? The reason I ask is I have notice numerous people pay for utilities for their property when renting it out. Here in California this is not common as the renters themselves are responsible for paying utilities, in most cases. The 50% rule seems ultra conservative and very difficult to obtain in the ca market. Thanks

Brandon, an investor should know that all markets are local. If you invest in a 50% rule market then the 50% rule applies. If you invest in a 70% rule market then the 70% rule applies. Rather than being concerned if another markets rule is applicable in your market it is better to understand WHY your market rule is different.

The rule is more of a guideline when evaluating a property. If you are planing on managing or doing some of the Maint yours may be lower. As

@Jon Holdman mentioned Budget for capex. Rule or no rule you have to work at it to find deals in CA

It can be difficult, or even impossible in some areas to get the 50% rule to work. It is a good guideline to see how profitable a rental property can be, but other factors should be taken into consideration when deciding if a property will be a good investment or not. I wouldn't say it's ultra conversative, especially not in the long run.

Someone doing the math might see a property that can generate $2k per month rental income, and say that the expenses will be much less than $1k. But is that person taking into consideration a broken water heater, or a new toilet, or a long term vacancy or squatter or other unexpected expenses that will come along?

Its like this. Cost of certain items are relatively fixed. For example a plumbing call costs the same whether your house is renting for $3000 or $300. But as a percent of the rent, it varied dramatically. Other expenses are more proportional. For example changing a roof on a larger 300K house will cost more than on a $50K house. PM costs may also vary. For a low end rental PM will cost 10% plus up to a months rent for vacancy filling but at a high end rental the ratios would be less. Property taxes vary greatly by state from as low as 1% in CA to higher than 3 or 4% in other places. Overall, for lower end rentals (up to 1000/month rent) the 50% rule of thumb seems to work well. I get costs pretty close to that on a portfolio of 8 homes over the last 2-3 years. On other rentals in CA with very high rents, the ratio is far less. You need to look at the market segment you are in and understand what quick ratios apply. Most people here seem to talk more about the sub 1000/month rental in midwest or southern states where the 50% rule of thumb seems to work fairly well. Other markets, probably not.

Everyone has their own opinion.  Personally I like to evaluate a deal based on its cash on cash returns after taxes, mortgage and insurance before maintenance cost. That is the easiest way to look at it.

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