"50% rule"

[Aaron Junck]

As far as the "50% Rule" goes.

When you evaluate a property and you say 50% of the monthly gross rents should be figured for expenses prior to servicing any debt, does this vary much if you are going with new construction or would you still figure 50%..

Correct me if I am wrong or ignorant, however I see as far as repairs go there shouldn't be much at all for quite some time due to the fact that is new.. new appliances, furnace, AC, roof,paint..etc. I realize that you still need to budget for these expenses, bc there will come a time that you will have to repair something. I am just curious since this isnt a 15-20 yr old property that may need a new roof in 5 years or a furnace etc..

Also this 50% rule would include property management,right? which would be ballpark of 8%???

Can someone breakdown this 50% Rule for me maybe?
Thanks

[J Scott]

Originally posted by William Bannister:

With new construction I would be inclined cut that 50% number by 75% for the 1st 7 to 8 years of buildings early life.

That may be true if you only plan to hold the property for under 10 years, but if you plan to hold the property for more than 10 years, the 50% rule is still very much applicable, as the rule is an estimate of expenses/rent-loss/capex over the LONG TERM, not the short term.

Here are two things that people tend to forget about the 50% rule:

- Your expense ratio is going to seem to trek along at well below that 50% number for a long time. But, then after about 20-25 years, that first roof replacement and HVAC replacement will shoot the expense ratio up drastically. At that point, you will realize that the 50% rule was always applicable, you just hadn't hit the long term just yet.

- Secondly, people tend to believe that if they don't hold the property for a LONG time, the 50% rule won't be applicable. But, keep in mind, if you sell the property a year before you would have replaced the roof, that doesn't mean you're saving the cost of the roof replacement. That deferred maintenance/depreciation will be reflected in your equity when you go to sell -- the buyer's offer will reflect the capex and deferred maintenance costs and you'll lose money just the same.

There are lots of ways to "seemingly" cheat the 50% rule, but more times than not, it will catch up with you...