Does 50% rule account for future big ticket items?

Question

Hi, I have been reading about the 50% rule and I use it for my rough analysis. My question is: Is he 50% rule enough to cover major expenses if you plan on holding the property for many years (roofing, AC, etc) or do you budget for those expenses when you see the time is near to replace.  Thanks.

Matt Devincenzo · Answer

Yes it accounts for those. The caveat is understanding that it says over the life of the asset the expenses will be about 50% of gross FMV rents. So if your roof has a 20 year life span but it is 15 years old, you can't expect 5 years of your "50%" to pay for that. So that is where you need to account for those things in your purchase price. But as long as you understand that it is a tool and is only as good as you are at using it then it can help you on your expectations for the future.

Roy N. · Answer

Taylor Green

Over time, yes.  If it happens right away, you will still take a kick to the cash flow ... or, if you have not managed to build your contingency, you may need to inject more capital into the property.

In our operating expense calculations we allow a 10% maintenance and CapEx set-aside each year ... unless we are buying a property with known higher amounts of deferred maintenance, where we sometimes use a 15 - 20% set-aside.

Taylor Green · Answer

Roy - thanks for the help. That cleared up a lot for me. By the way, nice to see a Canadian on here. (I was born in raised on Vancouver Island in BC).

Roy N. · Answer

Taylor:

If the property is in good repair and there are no imminent  large capital expenditures (new roof, HVAC, foundation, etc), then we set aside 10% of the gross revenue each year to service a) on going maintenance and b) build a reserve fund in preparation for the next large capital expenditure.

If the property has deferred maintenance when we acquire it (ie. needs a roof), then we will increase this set-aside to help fund the deferred maintenance.   Obviously if we increase the set-aside to 15-20% of gross revenue, something else has to give-up claim to that cash.  We expect this to come by way of a lower monthly/annual debt service ... which means a lower acquisition cost.

We use to keep this reserve in an interest bearing account, but grew bored with 1.75 - 2% interest, so we have taken a considerable chunk of it and purchased shares in a large multifamily property company; these shares pay a dividend slightly over 5%.  Since the particular company continues to gobble up any building of 25 units or more in our region, we figure this is the least they could do for us ;)

Taylor Green · Answer

Great responses. I really appreciate it... @Roy N. , did I understand correctly that you set aside 10% each year for deferred maintenance? If so, do you keep it in a separate interest bearing account?

Tony Cavalli · Answer

This post is a perfect example of how awesome this website is. I just learned something more about a topic or "tool" in this case I thought I already knew everything about. just awesome

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Does 50% rule account for future big ticket items?

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