can someone please explain this 50% rule to me?
Member since 2008 · 155 posts · 2 votes
I have heard from people on these boards that I can expect the operating expenses of the house I purchase to rent out would be about 50% of what I can get for it monthly. I could be misunderstanding it, but how is this so?
For example: because of the tax rates here, we can expect to generally pay in rents about 1% of the home value. this includes insurances, taxes, interest, etc. SO - a working example:
If I buy a $100k house for $70k (assuming i can get in at 70% value), and I can rent at $1k a month, how would $500 of that each month go to operating expenses?
That's exactly the way it is in my area also (and in many areas of the country). Rents generally run about 1% of the home value here. However, your statement that this includes insurance, taxes, interest, etc is meaningless. There isn't necessarily any correlation between what the tenant pays in rent and what the landlord pays in insurance, taxes, interest, debt, etc. That's why the vast majority of newbies fail in this business. They take in less money than they pay out.
What you pay for a house has ABSOLUTELY NOTHING to do with the operating expenses. In your example, it would make absolutely no difference whether you paid $70,000 for the house or only $10 for the house - the operating expenses would be exactly the same! Operating expenses include everything you spend to operate the business, but do not include the mortgage (principal and interest).
The 50% rule simply reflects the fact that throughout the United States, operating expenses run 45% to 50% of the gross rents. That includes taxes, insurance, vacancies, advertising, utilities paid by the owner, management, maintenance, entity maintenance, legal fees, evictions, damage done by the tenants in excess of the security deposit, capital expenses, lawsuits, etc, etc, etc. (I could go on and on). Some of these expenses don't occur on a regular basis (such as excessive tenant damage), yet the effect on the bottom line is still profound.
What type of business are you in? Whatever it is, you should still have operating expenses and the principle is the same (although the numbers may be different).
Mike
I am just thinking out loud. Since none has it nationwide (may be worldwide), why not we START IT?
Cheers
Ram
Ram, That's a great idea. Can you start working on putting it together and programing the code for it? I know Josh would love to have that feature on the site but his hands are overflowing with all the work we have going on here as it is.
Mike fails to understand that a large majority of mebers here are not full time investors requiring cash flow in order to put a roof over their heads. The creator of the site, Josh, has said he is not a full time investor, infact has said he considers himself a newbie. James C., a large contributor to this site is not a full time landlord, Wheatie has stated he only owns one SFR and he is a top contributor and moderator. He has also stated that he uses a 40% rule in his evaluations and I do not hear Mike jumping down his throat and claiming that Jon is ridiculous and pretending 10% of expenses do not exist. The reality is "in the real world" that there is no national OE average and evry investor should consider the investment on it's own data, and not any rule of thumb or averages. Averages mean nothing. Media quote: On a national average, real estate is down over the last 12 months by 11.3%. This means nothing as it pertains to each individaul investor investing in one particluar neighborhood.
Nationwide, unfortunately you're simply wrong again. As I've posted MANY times before, you can find the data from the National Apartment Association, IREM, many other large landlord associations, etc. The fact that you haven't done your homework doesn't mean that the data doesn't exist. The National Apartment Association publishes their annual survey EVERY YEAR and it covers the operating expenses of hundreds of thousands of units across the country (just as I said)! LOOK IT UP FOR YOURSELF!
So, your claim is that you don't know that your duplex will have maintenance, vacancies, capital expenses, legal fees, etc over time? I don't find that very believable.
Let me get this straight - you have some magic trick that prevents maintenance, capital expenses, vacancies, legal fees, etc? C'mon, the newbies that you market properties to might believe that, but I certainly don't.
So, you don't know whether maintenance expenses, capital expenses, or many other expenses exist with 100% certainty, but you want people to crunch the numbers (using numbers that don't exist).
So that's your argument. My operating expenses could be higher than 50% because they might be wiped out by a flood? What if a meteor hits the earth and wipes out all my rentals? OUCH! Seriously, I only have one property in a flood plain and I have flood insurance on that one.
I don't want to put words in Wheatie's mouth, but I believe that he has said that he manages the property himself and doesn't include management in his calculation. If we assume that the management expense (that he's donating to his business) amounts to 5% to 10%, that brings his operating expenses to 45% to 50%.
Once again, this just shows your lack of understanding of the business. Furthermore, I have said repeatedly that evictions here take 5 weeks, not 45 days. Unless there is damage, that doesn't translate to 5 weeks of lost rent. I always have a security deposits for all my tenants and the security deposit will cover the first 30 days of non-payment. Of course, I will have the eviction costs, the attorney fees, and cleaning the apartment, so, in reality the loss is more like one month's rent.
That must be some of that "new math" that they're teaching these days. Here's an example. If a person had 100 rentals in January and evicted 1% of his tenants, that would be one eviction and one vacancy. If the eviction took 5 weeks, that unit could be vacant January and February. If the landlord evicted another tenant in February, the landlord would now essentially have 2 non-paying tenants during February. If the landlord evicted another tenant in March, the landlord would essentially have 2 non-paying tenants in March, because the rental which had the eviction in January would once again be filled. The bottom line is that you would have 2 non-paying tenants each month out of 100 rentals, WHICH IS A VACANCY RATE OF 2%, NOT 12% AS YOU STATED!!!
In addition, and for the record, I do NOT use 10% as a vacancy rate for my business. We've had vacancy rates higher than that during parts of the past 5 years and much better than that this year. I have stated over and over that I don't list individual expenses because I have absolutely no idea what the vacancy rate will be for a given unit for a given year.
I could go on, but you just really don't seem to understand the basics of this business.
However, this is a very good discussion. New investors need to understand the vacancy issue associated with evictions; the reality of which operating expenses actually exist; and that many flippers do not include all the expenses in their cash flow projections. All of that has been covered here and therefore this is a worthwhile discussion, even though it has run very long and been somewhat redundant.
Mike
I am new to this forum but old to landlording. When I first started reading about this 50% rule I thought "that's crazy". I was even annoyed that some poor newbie in Florida was talked out of a pretty nice duplex that cash flowed, had long term tenants in place who wanted to stay and were taking care of the place, all based on this 50% rule. Now that I know Mike's business I understand why the 50% rule is what he uses. He has to with evictions, vacancies, property destruction with those type of tenants.
I have owned more and currently still own those exact kind of properties as well as many that are not like that. My husband goes armed to pick up rent (we live in Arizona so he goes armed to the grocery store too,haha), it is the "rough" part of town. One 4-plex has govt housing across the street and the sex offender halfway house the next block over.We used to have the same type of tenants that have been described in this thread. It was horrible, crackheads, lazy-asses, drunks, even had one ho. The stories I could tell.
Lots of people own these types of properties, lower income people need a place to live and in larger cities these parts of town are where you find most multifamily properties. Unfortunately those properties attract many "undesirables" too. We had to use the 50% rule too (didn't know it had a name). The kind of tenants described that Mike has are what you get in those areas if you don't think outside the box and come up with a different strategy.
Out of believing "there had to be a better way" we decided to take control and have these types of properties run our way and not the tenants way. Now we have no property destruction, not one eviction in five years, tenants who always pay, extremely low vacancy. Much lower expenses.
The 50% rule should not apply to every property in every part of town in every city, but if everyone uses it you will always make a safe deal, but in some markets you may never make a deal at all. For newbie advice, those who are in markets where sales prices rose faster than rents, they can make a good deal on the right property and be below that 50% rule. They take what some of you say as gospel and if they think they always have to use the 50% Rule they will never buy anything.
OK, so what is your "different strategy"? Please don't tell us that this is a "SECRET" that costs $129 to discover!
Mike
You really have a way with people don't you?
I am actually glad you asked because sounds like you could really use something new if what I have read is all true. Dealing with that kind of tenant day in and day out wears on you. Obviously gives you a bad attitude too.
If you seriously want to know and ask nicely I will tell you.
MikeOh Wrote:
azlandlord wrote:
Thanks for the advice. Our website is pretty clear what the stategy is anyway. I am changing a couple of things to make it even clearer. I am here to learn and to share what I know and hopefully help, not to fight with anyone or to be insulted. My husband always had a bad attitude when he was dealing with all those icky tenants. It will make you nutty!
Nationwide,
I have not insulted or badgered you. You have repeatedly posted inaccurate information and I have corrected it. In the rental property business or any other business - THE FACTS DO MATTER! It would be absolutely immoral on my part to allow inaccurate information to stand without being challenged.
You have posted:
1. that you have no maintenance, no cap expenses, no vacancies, etc over time, AND THAT IS WRONG!
2. that there is no national data regarding operating expensese AND THAT IS WRONG!
3. that a monthly eviction rate of 1% per month translates to a vacancy rate of 15% AND THAT IS WRONG!
4. that you "prevent" operating expenses (such as maintenance and cap expenses) from having an effect on your business AND THAT IS WRONG!
5. your website lists (or did list) properties with cash flow numbers that do not include some of the BASIC operating expenses - such as maintenance. I'll leave that to others to decide whether that's right or wrong.
The bottom line is that you don't seem to understand the basics of the rental business.
I have very little patience with people that are teasing their product and don't publish anything of value. This forum does not allow advertising and you are alluding to some 'better way of doing things' but don't say what that is. The rental business has been around for hundreds of years and there is nothing 'NEW' or secret about it. So, again, I challenge you to post the details if you have a "NEW" way. I'm betting it will be something we've all heard before!
Mike
Good question, James, since the discussion is turning a little ugly. It may not do much good to continue to debate expenses and business models because the positions are pretty clear.
Those of you who are reading this, and contemplating becoming landlords need to consider these points of view when you do your math. At one exterme, if you assume taxes and insurance are the only expenses you will have you are due for a nasty surprise. Rest assured there are other expenses, and if your deal only works with a low amount allocated for expenses, and you don't have reserves to cover the others when they come up, you're going to be in trouble when something happens.
Those have been around a while know I sometimes compare investing to gambling. I would say landlording expenses can be compared to gambling because you are dealing with probabilities. Some of the expenses are fixed, so you can neatly account for those. Others can only be dealt with probabilistically. There is some chance a tenant will wreck the place, no matter how good a job of screening you do. There is some chance you will have an extended vacancy, no matter how nice your place looks or how well you market it.
If you play a game, like blackjack with good rules that has a 0.5% house edge, you know what your losses will be over the long term. The long term being tens of thousands of hands. If you're someone who likes to visit Vegas, and does so frequently, and spends many hours at the tables, you can calculate your losses ahead of time. Number of hands x bet x house edge.
Over any short time, though, your results will be dramatically differnet. You can easily win or lose five hands in a row. You can easily win or lose 15 hands out of 20.
If you own one rental for a few years, its unlikely your expenses will be any specific percentage, whether thats 20% or 50%. You may be lucky, fill the place immediately with a great tenant. You may be unlucky and have the place totally wrecked. If you thought the place would be wrecked and cost you major bucks you would never buy it. Similarly, don't buy it if the only way it works for you is if things work out just perfectly. While both outcomes are possible, neither is likely.
As James and Mike mention, and I've said several times, I do assume 40% for evaluating properties. Mike is correct that I use this lower value because I am willing to donate my labor to my business. I do that because there are local drivers (population, jobs, new businesses) that I believe will improve the rental property economics here over the years to come. But I realize I am taking a risk. I also have enough reserves set aside for this business to ensure I am not forced into foreclosure if I cannot fill my property or if I have a significant expense. So, in the cash flow/appreciation spectrum, I'm way over toward the cash flow end, but also factoring in a bit of appreciation potential.
Readers, you're going to have to evaluate what you read through your own critical thinking and make you own call where you stand.
Hmmm, its not at all clear to me what your strategy is. My guess is that you're renting your properties by the room to recovering alcoholics or drug users. If you want to explain your strategy, preferably in a new thread, we could discuss it.
Jon -
Thanks for bringing things back to planet earth here. These 2 have no shot of agreeing with one another, so lets move on guys . . .
The key here is that this "50% Rule" is only a guideline, and will not work in many markets. However, if you did follow it, you'd be sure to be looking at a good deal. There is no one way to invest, and no one rule that you must follow --
Lets get back to the discussion without trying to kill one another.
Thanks, Josh
Josh Wrote:
JOn, I agree with most of your post as well as there are many factors which can reduce or increase, for that matter, rental property expense ratios. If you own 5 doors or 100 doors, it all depends on how you operate your busienss and where you are investing. End of story!
MikeOh Wrote:
You need to re-read the thread as I explained as plin as day, why there is not national data on residential property operating expenses nor is there a national average. Even if there was, a National average does little good to an individual investor.
Josh and Jon, I agree 100% that there is 0% chance of MikeOh coming to any agreement here. He is hell bent on his opinion which is his right, but I can not see why anyone needs to use his 50% rule or any other rule in order to be successful. This will be my last post in any response to Mike or any of his attacks or whatever he wants to call them. I will however, continue to give my knowledge and experience to anyone who wishes to have it.
Best of luck to everyone in all endevours.
Again guys . . . lets move forward.
Any further posts that continue the argument that has been going on will be removed.
Lets continue to discuss this topic without the direct attacks.
Thank you.