Does the 50% Rule Apply to Newer Homes?

14 Replies

I am trying to figure out how to move out and rent my SFR primary residence (built in 2009, I have been the only owner, and it is in good condition). I've used Dealcheck.com to analyze the numbers and with the 50% rule assumption (and 8% vacancy), it is telling me that I'll be at a loss of $118 per month. I have questions:

  1. Does the 50% rule apply to newer homes? I realize this won't always be true, but as the owner I havent experienced that much in terms of repair/maintenance. 
  2. The rent rate I used in the calculation is based on the 1% rule but is $235 below what rentometer.com tells me comparables go for in my area, so is my vacancy assumption too high?

Side note: I'm using below market rent in the analysis. Actual rent rates would be competitive, but likely a bit higher. 

Thanks!

Data indicates that over the life time of a property the expenses will on average run 50%. This means that some are below, some are above to create that average.

Your actual expenses will be determined by how long you hold the property not how old the property is.

As a example you will need a new roof in about 10 - 12 years. Maybe new windows and depending on the amount of damage tenants do all sorts of other costs that would possibly not be required if the home was owner occupied.

Something to keep in mind is that newer homes will be devalued by tenants quicker than a older home that has been fully broken in by tenants. This increases expenses initially until the property is "seasoned". If you rent a newer home with the intention of short hold you will have additional costs associated with bringing the property back up to sellable condition. Tenants are harder on a property than a home owner.

The 50% rule is a guide line for guestimating expenses based on the life of a property. If you hold a new property for two years and sell your expenses may be lower than 50%, hold for 20 years your expenses could be higher.   

Sounds like you are moving regardless of the numbers? then why are you stuck in analyzing via these generic rules? rentometer Average can be low in a fast rising market. use Zillow rental and find similar features ignore age, what are current rents? the only number that matters, at first, is cash flow after Piti. I like $300 or more. most of my rentals are over $400. ok you are positive or negative cash flow without prop management or expenses. newer houses have low expenses unless the PM rips you off with fake expenses or exorbitant turnover costs. I self manage a lot of rentals. I strongly recommend new folks,learn Landlording. there you go I eliminated the 10% PM cost and most expenses due to your newer home. since you're going to move anyway the main number is are you positive cash flow good luck.

This post has been removed.

@Thomas S. My default plan is to "hold forever", unless I have a compelling reason to sell, since my goal is to replace my career income with rental income. A compelling reason could be "proceeds from sale rolled into investment with greater cashflow", etc. 

Also, thanks for the education on the 50% rule. I'm still a little mystified about whether, given the numbers provided, I stand a good chance of cashflowing. Could you clarify your opinion?

Thanks!

@Curt Smith Hi Curt, thanks for the reply. Let me answer your questions: 

  1. Sounds like you are moving regardless of the numbers?
  2. what are current rents?
  3. [What is your] cash flow after Piti?
  1. Well, if I want to get owner financing then I have to be the occupant. Thats why I'm looking to move. That said, I'm open to other options such as just selling and rolling the proceeds into a duplex, too. 
  2. Its a 4 bdrm 2 bath. I am pulling in $1625 in rents
  3. PITI comes to $989, and without PMI it would drop to about $910. If I rented for $1500 (Zillow says comps rent for $1550 to $1675 but can go up to $1795) that would net me $511 in cashflow.

I do intend to self-manage my first few units in order to learn the business and gain experience. 

Given these additional details do you think that the analysis of -$118 cashflow per month from dealcheck.com is inaccurate? Or have I not provided enough information to ask that? 

Thanks!

Much of the maintenance on a rental is caused by the tenants.  They just tend to be not as careful as when they're the one paying for any repairs.  Further, your house is now approaching the age when things, like appliances and faucets, will need to be replaced.  Things you might use for 10+ years (e.g., carpets), will age much quicker in a rental.

You cannot estimate rent as 1% of the value, which I think is what you're saying.  Rentometer is a better way.  Better still is to do a thorough rent survey in the area and determine what similar houses near  yours rent for.  You want to be very competitive.  That is, one of the best deals in the area.  Sometimes new landlords think "I'll price mine high because its really nice."  Or "I want a good tenant".  If you want to have your choice of tenants, price it to be a good deal.  If you price yours high, you'll only get a few takers and they will be the ones willing to pay a higher price because they've been rejected elsewhere.

@Jon Holdman Hi Jon. The rent estimation comes from research, rather than pegging it arbitrarily to the 1% rule. I only said it that way to make it understood. Rentometer and Zillow say comparables go for $1550 - $1795, so I think I can undercut them all at $1500 and save myself some of the headache of vacancy issues. 

And even undercutting them all at $1500 nets me $511 in cashflow after PITI&PMI. My concern is that if 50% of my rent ($750) goes to my expenses, over and above PITI, then what I've got is a money alligator.

Am I missing a key factor here? 

Thanks!

Updated 8 months ago

Correction: The homes that rent for $1550-$1795 are significantly larger than my own. Zillow actually says my rent estimate is in the $1395 range.

@Brett Rhine   See my how to buy bullet proof rentals an uploaded file off my profile, down on the right.

Jon Holdman's 12k up votes speak for themselves as does what he said, but the general formulas don't actually apply for forced landlords.  IE you having to move on for family/job issues.  When you have a forced rental, my sell/or keep decision is purely based on positive cash flow or not.  You may own in a decent appreciation area so you may choose to keep for none ideal investment reasons.   

In a sellers market its tough to sell a nice property even if it doesn't gush cash flow!  Of course if you where a pro landlord you wouldn't buy your house because of it being too expensive etc.  The question I'm guessing is will you do "ok" by keeping it?

Your use of rentometer I view is low.  Jon gave you the tip you may not have heard.  Go to zillow rental, craigslist rental.  Look at the pictures, in and out, maybe even drive those rentals.  Find the similar ones (functionally and niceness) what are they renting for.

My Bullet Proof paper will say, undercutting going price may not work as you;'d expect.   Better tenants see value being priced into a proper priced rental.  And may see below market price to be telegraphing something is wrong.  In a fast rental market you are actually (counter intuitively) better pricing the rental correctly.  This is not true in a low market I agree.

The taxes and insurance part of your PITI payment is included in the 50% rule of thumb. It truly is just a rule of thumb. Some months, even years, will be better. You'll have a tenant in place the entire year, have minimal other expenses, and mostly just have taxes, insurance, and debt service to cover. But once in a while you'll have something big. An eviction, serious tenant damage, a new appliance or AC, sewer line, etc. So, in any one year, the actual expenses may be somewhat under 50%. They can also be higher than 50% if you do have a big expense. They can even be higher than 100% if you get a big hit in one year.

Something else to be aware of is that the 50% includes property management. Around here that's typically 10% of collected rents plus half a month's rent to fill a vacancy. Half a months rent is 1/24th of your annual gross, about 4%. So total for property management is about 14%, which is roughly a third of the 50% number. If you manage yourself you can earn that slice, too.

If you do change this to a rental, be sure to change your insurance to landlord insurance, not homeowners.

Do what @Curt Smith suggests to scope out the competition.  I would go a step further and actually call the current offerings and get details - security deposits, who pays utilities, application fees, what's their process for viewing and applying, etc.  What you get for rent is a VERY key number and spending some effort to get an accurate number is time well spent.

Keep in mind too that 50% rule is just a gauge. And that the 50% rule assumes you will be paying for a property manager. If you self manage, you can knock that down to 40% and still be within the rule.

That being said, the reality is that a newer home is going to require a lot less for repairs than a house built in the 60's or 70's or even 80's.  And while you technically need to start accumulating for capex stuff like roofs and the like, the bottom line is that you will also be getting more in rent in the future too.

The reality though is that with one house, you can't play the averages. You might get hit with a 7k roof even though the house is fairly new. Or your furnace might go out tomorrow. When you have 10 or 20 houses, you can look at the averages because your portfolio will let you spread that out and the averages will be about be there.

But when dealing with one, you might find that you only spend $100 a month for the next 5 years in repairs and turnover costs (6k total). Or you might get stuck with a water heater (800), AC (2,500),  and a replacement of all the carpet (5k).

But typically, a newer hours in and of itself is going to get you a better tenant - at least thats what I've found across my portfolio (60+ houses).  And your repairs will likely (again, likely not definitely) be much less than for older homes.

Knowing what I know, I would probably put 200/mo for repairs and cap ex and 100/mo for vacancy/collections and you should be about right - at least for the next 5 to 7 years. After that, maybe adjust it a bit.  But by then, your rents should be higher so your profit will still likely be the same.

And as a rule I like to be near the bottom half of the market myself - except when I have a near new construction home (built in last 10 or 15 years). For those, I'll go a little bit closer to the high end because there are simply not that many newer homes like that ever come up for rent - at least not in the price range you're talking about there.

As for targets, my goal is to try to find a deal where the ARV is 70% or better and where the gross profit (rent minus PITI) is $400 a month or better. And these are 150k houses that I'm all in at 100k to 110k and rent for 1,400 or so.

If the expenses were really 50% of the rent, I'd be losing 300/mo or more per house per year. 60+ houses would mean I'd be losing 18k a month. I can promise you that is simply not the case. When I look at my tax returns, my average repairs, capex, vacancy, etc is probably running about 225 to 250/mo per house in total. And thats with me doing NONE of the repair work myself other than some of the make ready painting.

Again, the issue here isn't what the rule is because unless you have a portfolio that will help smooth stuff out over the averages, it isn't going to help you if you have some bad luck and the roof goes. But more than likely, you'll be netting a decent monthly profit on that house at the end of the day.

Don't forget, you also have principal paydown and appreciation in there as well as the likelihood of rental increases. So even if on paper you're breaking even today on rental income, your net worth is still going up because you're (you're tenant really) is paying down the mortgage and the value of the house is going up. And over time, those things grow as well. i.e. The further along in the mortgage you get, the more of your payment gets applied toward the principal. So principal paydown may be 100/mo today but maybe 300/mo in 10 years. Same with appreciation. 3% of 150k is 4,500.  But in 10 years, 3% of 220k is 6600. Add in the higher rent amounts and you can see how that house will produce more and more net worth every year.

@Curt Smith I just scanned your bullet proof rental file. Wow! Thats a lot of great information. I'm only just starting out and I can see where a lot of what you include here is the product of hard-won experience. I'm sure I'm going to reread this several times. 

"The question I'm guessing is will you do "ok" by keeping it?"

Yes, I will. I've been house hacking for over a year now so I'm currently living for free. The mortgage is getting paid down by my tenants and I'm stock piling cash for my next purchase. On top of that, Zillow tells me that I've got 40-45k in appreciation as well. So that gives me a few options, too. 


As far as your last your last paragraph goes, I can see the logic: "whats the catch?" is what they could be thinking if they see something priced substantially lower.

Thanks for the education, @Jon Holdman , on the 50% rule. I didnt know that it included PM, for instance. Since I will be self managing, I can at least be sure that I'll be working harder for myself than a PM will. 


Obviously I'm going to have to do more legwork with regard to properly pricing my rental. I guess the Internet can't tell me everything I need to know. 

Thanks again!

Thanks @Mike H. All of this is very encouraging. Assuming that I have to go  with conventional financing then I have maybe a year or more before I'm ready to buy, that will give me a lot of time to build up a nice cap ex buffer (especially since I'm house hacking right now and living for free). With 5-10k sitting in a savings account for just such emergencies that should help  the cashflow situation a lot. 

Thanks again!

The great thing about keeping and renting your place is that you save the fees selling incurs and you do not have to buy a loan as you would if you were buying to rent. Do a mock 1040 schedule E to see how you stand and while at it, figure out your principal paydown and get a 3% inflation number. If you like the numbers and you feel you can afford to be a landlord, then there you go.

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