I am currently trying to get my feet wet with my first rental property, I have have looked at over 20 properties in the Denver, NC area. My budget is no more then 130k, I keep running my numbers for my profit margin, I know the 50% and the 20% rules. I currently have a house with 50k equity( owe 288) and I have a home equity line of credit of 25k (1% interest). I have another 30k invested in stocks and 8k in cash sitting in my LLC business account. My questions are as follows:
This question is for the following example of a 120k
- For people that have experience, would it be a smart move to violate the 50% rule by using a home equity loan, which would add lets say 250 dollars more to my monthly expenses giving me around 2-300 dollar profit a month, until my equity loan is paid off?
Any other advice for someone starting out would be appreciated! Thanks everyone!
I've heard the 50% rule mentioned several times on BP but I haven't looked up the source. I assume that it refers to property expenses only and not to debt service. (When looking at multi family property I expect expenses to be 40-60% of the gross income; again, any financing expenses are not considered since I'm looking for a cap rate, which doesn't include them). Can someone clarify this?
@Richard Donofrio If you take the money out of the HELOC, your payment is $250? Is that principal and interest or just I/O? And you're saying, even with this, you will have positive cash flow of 2-300? Sounds like a really good deal.
It might be a good idea to forget the 50% rule for a minute (since that's a rule of thumb) and look at the actual numbers since this is your first deal and you really want to know that you're doing the right thing. Calculate all of your expenses (Make your best guess if you can't find more exact numbers). Make sure you include: Property Taxes, Insurance, Maintenance, Management, Utilities, and Repairs. (Don't include any debt service for this; we want to see how the property performs if you bought it with all cash). Use annual numbers. Subtract a vacancy factor (5% or more if that's normal for your market) from your annual potential rental income. Subtract your annual expenses. What you have left over is your net operating income. If you divide that by the purchase price you get your cap rate as a percentage. For a typical SFR rental, that might be anywhere from 2 to 15% depending on a number of factors. Is this cap rate acceptable for your investing criteria? (This only considers cash flow and not appreciation or principal paydown)
Now subtract your debt service from your NOI. Are you still making $200-$300/month? If yes, fantastic! If no, take a closer look and make sure it's still a good deal. If you pay down the HELOC quickly and you get the $200-$300/month it might make sense for you.
I hope this helps. Good luck!
@Richard Donofrio not enough information in your post to get a picture of what you are asking. Post back with a specific property and the numbers associated with it.
Generally speaking, the 50% rule has nothing to do with a loan. The 50% rule says that 50% of your income on a property will be expenses and the other 50% rule is what you have for profit and to pay any debt you have on the property.
BTW if you use that in my market, you will never buy a property. Most are negative cash flow with just PITI since our market is so hot.
Find what works for you and do it. The biggest need is to have adequate reserves of at least 6 months.
I would ignore the "rule" (it is really only a guideline) and just calculate your straight cash flow. If it's in the positive, go for it. If it's not, ditch it.
Richard, it sounds like you're still a bit confused on how to do analysis. I'd recommend some more reading before you dive in too far.
As others have mentioned, 50% has nothing to do with debt servicing and frankly it's not something that you could violate if you wanted to... it is just what it is, a rule of thumb.
It's a useful quick analysis tool, but nothing beyond that. Older homes with deferred maintenance will go way beyond 50% given constant repair costs. Homes in NJ will go way above 50% cause 25% of their rent goes straight to property taxes. Areas that make you pay floor or hurricane insurance are probably above that estimate as well. If you pay utilities or have high water costs (like I do in Utah, 10% of rent just for water/sewer/trash) you can stress the number.
On the other hand, if you have low property taxes (about 5% in Utah) you might fall below it. If you can get a commercial insurance policy and have enough units to get the property management down a few points, you might beat 50%, etc etc etc.
For quick and dirty, it's useful... but at the end of the day you need to dive deeper.
I'm just worried with the phrasing of your post that you don't necessarily understand all these numbers.
A great investor turns crazy ideas into great plans. If you think it will work and it follows your business plan GO FOR IT! We don't follow any of the rules, and it works out great. The key is to have a plan, be able to support your plan and go from there. we love liability but have a lifestyle that can support the chance. Are you able to support the loan and the payments? Than leverage 1%!
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