Does 50% rule work in Texas / Houston?

Question

Hi Everyone.  I'm looking at a 4-plex in Houston area.    When I run the numbers I seem to get expenses (including vacancy) that is usually 55-60% of gross rents.  I think this is partly due to property taxes that are higher in Texas due to lack of an income tax.  Anyone else seeing similar numbers for expenses?

Should I use a higher expense ratio for Houston  or am I being too aggressive with the estimated expenses?

Here are some numbers as an example for a $300k 4-plex.   Please look over and let me know what you think.  Do these number

Monthly Gross Rents $ 4200

Monthly Expenses

Vacancy       $ 336 (8%);  (including here since 50% rule includes vacancy as part of expense)

Prop Mgmt   $420 (10% of gross rents)

Insurance     $208 ($2500 yearly; quoted by insurance agent)

Prop Taxes   $680 (2.9%/year of assessed value; actuals; eats up 15% of gross rents)

HOA fees      $330

Maint Reserves:   $420 (10% of gross rents)

Maint/Repairs       $84 (5% of gross rents)

Total Expenses : $2478 (59% of gross rents)

NOI:   $1722

Mortgage: $1215 (25% down @ 5% interest)

Approx Cash Flow: $507/month (about $125/unit)

Cash-on-Cash: 7.2% (Assumes 25% down + 3% closing costs as initial cash requirement)

Thanks,Jacob

Cameron Tope · Answer

Hey Jacob,

I have definitely turned down many rentals due to the property taxes eating up significant portion of cash flow. However, what's your goal? Some people are content with 7.2% COC because the bank is paying 0.25%.

JR T. · Answer

Your insurance is too high. Try @Jason Bott on here he got me insured for ~$25/door/month.

With an HOA do you really need a property manager?

I believe your vacancy will be higher than 8 but only time will tell.

JR T. · Answer

Incidentally I just got my renewal and with more units it is now $23/door/month. Couldn't be more pleased with @Jason Bott

Cameron Tope · Answer

For quick screening I don't include expenses.

Is the roof new or old? How's the AC? These are the big ticket items that will significantly impact cash flow.

Mark B. · Answer

Can you find a place without HOA fees? That seems to be cutting into a big part of your budget.

The rest of your numbers look very similar to what I'm using when I look to find my first deal

Bram Spiero · Answer

@Jacob M.

Like @Cameron Tope said, knowing what your criteria are is essential for determining if something is a deal for you.

COC is a rather shallow metric, especially when comparing with other investment types as it doesn't take into account the advantages of leveraging, on paper losses and other tax advantages that you get with RE.

Jacob M. · Answer

Thanks JR.  I'll check with @Jason Bott on the insurance.  $25/door would be very nice!   HOA does not help with leasing.  The fee pays for common area maintenance - parking lot, pool, tennis courts and  management company fees.  A lot of money for the benefits.    I agree that 8% is probably low in Houston, especially as we look to the next year.

Jacob M. · Answer

Thanks Mark.  Good to hear that most of your numbers are similar.

Most 4-plexes and condo/town homes in Houston under 4 units have higher HOA fees single family.  This typical covers exterior maintenance and some fees (parking lots, sewer, etc).  Sometime it also covers roofs, but not on this property.

I was more concerned by property taxes in Texas.  Even a 1% difference in tax rate translates to about  7% of gross rents in this example (1% of purchase price = $300; $300 = 7% of gross rents).

Jacob M. · Answer

Thanks guys for the feedback.

My goal is about 10% COC but don't know how often those deals come along in Houston area.   Cash flow is important especially on first few properties.

I'm a fairly patient person so I generally don't mind waiting unless it is very difficult to find properties using 10% COC (with 25% down) criteria.   I would like to have some extra margin of safety since Houston rents are likely to go down over the next 1-2 years.

Cameron - Since you are from Houston area, are my expense estimates reasonable?  This property is a few mile south of the Energy Corridor.   For quick screening, do you use a number higher than 50% when evaluating Houston area properties?

Just trying to get a sense of typical expenses and want to make sure that i'm not way off in my estimates.

Does 50% rule work in Texas / Houston?

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