Validate the 50% rule

Validate the 50% rule

Will BarnardPro Member
Moderator
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes

It has been agressively stated here on BP that operating expenses average 50% of gross rents. I have posted many times that while that may be true with some properties, it is not accurate or appropriate to use this percentage on all properties (speaking of residential 1-4 units only).

I have stated that when you have gross rents of $400-$700 monthly, it will most likely average out to be in the ballpark of 50%, but as rents increase to amounts above $1000 per month, the ratio or percentage decreases due to a variety of factors (which will not be explained here).

The purpose of this post is to get some viable data from many individuals who have rental units with monthly rental rates in excess of $1,000 (per door) and have at least 3 years of financials. So, if you have property which fits this criteria, Please respond here with the following: (Take all the years you have owned the property(ies) and combine all the amounts listed below, then divide by the number of years to get an accurate annual average):

Gross rents
Actual annual operating expense figures (fixed expenses - taxes, insurance, PM, utilities, etc.)
operating expense reserves (items which do not occur regularly such as repairs, maintenance, vacancy, damage, advertising, legal, etc.) Please include what you have personally experienced with your properties only!
Then list your capital expense reserves (although this is not actually an operating expense, accounting wise, for avoidance of arguments sake, let's include it)
Finally, we can now arrive at your NOI, so post that as well.

Note: If you have multiple properties, combine all the figures as one and note how many properties (actual doors) the figures represent. Once we have had at least 100 doors represented by many posters, I will compile the numbers and see what operating expense ratio was averaged. If we get a rapid number of posts which quickly total more than 100 doors, we can move the figure up to 200 or more before I compile the numbers. The more data entered, the more accurate the average should be. Let's have some fun with this! :lol:

I will post updates here on the figures as we get enough to compile.

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Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
17y

Merry Christmas to all!! I'm in Cancun and this is not what I wanted to be doing this morning, but I disagee with using this 50% as a catch all %.
Here are 2 things I've found in owning oVER than 1000 residences for rent.
1. There is a distinct difference between low price and higher priced rentals. As rent goes up , % goes down,,period
2. If you own in TX and rent for $1000 per month, JUST your taxes may be 25% per month of your rent, while other states might be 4% per month. (MS)
There are other items that cause a big difference, i.e. age of property, and condition of property. If you stick with newer properties, the % will be less than 50%, imo.
The 50% is ok as a general thing, especially for newbies as a starting point, but there are so many other conditions that will affect the %.

p.s. I currently have 11 properties at $975 or higher. All are less than 5 years old and my % is CONSIDERABLY less than the 50%, fwiw.

See this reply in the discussion

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  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Yes, the 50% Rule is valid in all markets. The 50% Rule does NOTHING to provide the optimum investment or any other type of investment. The 50% Rule simply says that operating expenses (plus cap. expenses and vacancies) equals 45% to 50% of gross rents. That's it.

    None of this has ANYTHING to do with the 50% Rule. Over time and/or a large number of rentals, your expenses will be 45% to 50%. You can pretend they are anything you like - that doesn't change anything.

    Do you have any useful data to post?

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Mike, just opinion. Do you have data to copy and plaster on the internet to prove that, say in Branson, Missouri? I didn't think so.

    If any rule of thumb fits your needs and it works for you, use it! To say everyone should use it is an opinion, to go further and insist on its use is really unreasonable. Good luck, Bill

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Bill,

    Yes, there is a LOT of data that shows the 50% Rule is accurate throughout the United States. Furthermore, I am not suggesting that everyone should use it. To tell you the truth, I could care less. People can delude themselves into thinking that the expenses are whatever they like. Newbies FREQUENTLY do that. MANY have been on here making ridiculous claims over the years about how low their expenses are. In EVERY CASE, when they posted the numbers - their expenses were indeed in the 45% to 50% range. In Taz's study, which spanned the USA AND different rent levels, EVERY SINGLE CATEGORY OF RENTALS IN EVERY LOCATION had expenses in the 45% to 50% range. EVERY SINGLE ONE!

    You are arguing about this, but DO YOU HAVE ANY DATA TO POST or are you just posting an opinion based on nothing?

    That's why the 50% Rule is valuable - because most newbies have absolutely no idea what the reality is. The 50% Rule gives them the accurate info. Whether they choose to use it is up to them. The vast majority of newbies fail because they are ignorant - there is NOTHING I can do to change that.

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y
    Originally posted by MikeOH:
    Bill,
    In Taz's study, which spanned the USA AND different rent levels, EVERY SINGLE CATEGORY OF RENTALS IN EVERY LOCATION had expenses in the 45% to 50% range. EVERY SINGLE ONE!

    WOW! Seems the sample size (units included in the study) would be alot more than 30,000! I wouldn't begin to "argue" with that kind of statement! :roll:

    Anyway, I'm not arguing, it's just a different point of view, an opinion! My opinion also includes newbies learning how to evaluate a property as well, not to make buying or investment decissions on generalizations or rules of thumb. But Mike, you make a good point Mike, not everyone can learn the business, that's why so many guru books are sold I'm sure.

    Any other perspectives on the 50% rule? Bill

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Bill,

    Do you own ANY rentals, or are you just arguing to be arguing? Do you have even the first bit of data to prove your point or are you just making this up as you go? What do you base your opinion on, other than data for HUD housing which you said you were "just guessing it's about 12,000 pages a year. Who could understand them?" So, if you can't understand this data, which appears to be the only data you have, what exactly are you basing your opinion on? Anything at all?

  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    16y

    I do not intend on joining in on the argument here and who is right and who is wrong. In fact, everybody coulod be right and everybody could be wrong.

    As to the study performed by TAZ, Mike OH was tossed out some specific claims as to the study which are inaccurate. First, not all 50 sates were included in teh study, in fact many, many states were NOT included. Secondly, many of the units (doors) were from apartments and not single family residences which is also where Mike OH gets all of his own stats from and makes his quotes from.

    Thirdly, not "every single one" of them were in the 45%-50% range. When I looked over the numbers, there were many in the high 30's% (37%-39%), many more in the low 40's and a very sizable amount of them in the 43%-48% range. There were very few above 50% so that specific study (and there was no data presented as to where the data came from or how it was independently verified) would show that 50% would be a very aggressive OE ratio and not an "average" one.

    All that said, I "PERSONALLY" belive (my opinion, not fact - as is most other statements made in this thread) that using a 50% rule to quickly caluclate expenses and thus, the NOI, is useful. I do not believe, however, that it is an end all be all, but again, that is just my opinion.

    Mike OH and anyone else is certainly welcome to use this or any other rule they deem necessary, but each individual investor should consider the market conditions in which they invest, they specific goals and strategies, etc. to evaluate each deal they look at.

    Mike has made a very strong and firm point that if you run a "landlording business" (and not just own a few rental doors), that you are better off assumming EVERY door will have 50% OE over the lifetime of ownership. I don't see any fault in that and it seems to work for Mike's business. I know for a fact it will not work here in southern CA simply because if you assume 50% OE and go after $100 per door in minimum cash flow, you would never get a deal because nobody (not even the banks) sell properties for prices at 40% of market value. This is not to say that the 50% rule does not work, simply to say that using it here in CA (with the exception of some outskirt areas of the city) would price you out of the possibility of getting a deal.

    I also think, although it may not be admitted by some, that there are some exceptions to any rule and an investor buying only hgiher end properties in nice neighborhoods with professional working tenants could have the OE expenses much lower over the lifetime ownership simply because they deal with less or no tenant damge, high turn-over ratios, higher management fees, etc.

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    As to the study performed by TAZ, Mike OH was tossed out some specific claims as to the study which are inaccurate. First, not all 50 sates were included in teh study, in fact many, many states were NOT included.

    I didn't say that every state, city, town, parish, or street was included in Taz's study, yet his study did cover the entire range of rentals all across the country.



    Yes, many were from apartments and many were from SFH's. The key point is that EVERY single category that he posted had expenses between 45% and 50% - EVERY SINGLE ONE!



    I was clearly not referring to every single door in the study, I was referring to EVERY SINGLE CATEGORY of rentals that Taz listed i.e. lower rent, higher rent, apartment, SFH, geographic location etc. EVERY SINGLE CATEGORY Taz posted was in the 45% to 50% range. As I clearly said, the 50% Rule is for a large number or rentals and/or a long period of time. It is not about one unit and/or a short period of time.



    I agree that the 50% Rule is accurate and that following that may indeed proclude you from doing a deal. Whether or not you can do a profitable deal has absolutely nothing to do with the 50% Rule. The rule simply states that operating expenses will be 45% to 50% of the gross rents. As of this date, we have yet to have a single person post any data to show that this is incorrect and every single one that has posted has shown that it is correct.



    And yet that was not what Taz's study demonstrated, even though he specifically looked at different rental ranges. His study confirmed the 50% Rule for all rental ranges.
  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Hi, Thanks Will, you explained it very well. It really seems hard to provide an opinion sometime without it seeming like an argument, I thought I said if it works for you, use it....anyway, I have not looked up the study mentioned because after reading about it, I really don't need to know it's not accurate, as explained further up the thread. I had 27 at one time Mike, got rid of them and seller financed them. Post data, how silly, where did you get your MBA Mike? I went to McNeese, LSU and Northwestern University. What you learn is how to recognize BS when you see it.

  • Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
    16y

    Enough, folks. There's no need to get personal.

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    I wasn't offended Jon, I have skin that is certified to be 1 inch thick.

    Bill, to answer your question, no - I don't have a MBA. I own a rental business and I'm not sure that a MBA would impress my boss (but I'll ask when I see him in the mirror). I do have an engineering degree and I do have the facts on my side as it pertains to this issue. However, if you have any data or other information that demonstrates that the 50% Rule is inaccurate, I would definitely like to see it.

  • Residential Real Estate Agent · Mt. Pleasant, SC · Member since 2010 · 257 posts · 130 votes
    16y

    I just came across this thread for the first time, and had a thought that's a little difficult to explain. Maybe I'm stating the obvious, but instead of trying to prove or disprove the 50% rule, I'm trying to rationalize why it would work so well.

    It seems that natural market forces will drive the expense ratio of a property to some sort of "equilibrium" that would be the same regardless of the region or type of property. As investors, we value properties based on their income, however from an economic standpoint, the rents in a region are based on what income it takes to support the costs of operating the building. Assuming that reasonable investors are looking for similar returns on investment properties, the expected return sets the expense ratio. So, if most investors were willing to accept a 1% return, market forces would drive the rents lower, and it could be the 60% rule. Or if investors or apartment owners would only accept a 25+% return, rents would be higher and it could be the 40% rule.

    I have some data to contribute (a big sample of 1). 1 br/1 ba/600 sf condo outside DC. Rents for $1200/mo.

    Expenses:
    Taxes - $200
    Condo Fee - $218 (inc. insurance)
    Vacancy - $60 (@ 5%)
    HMS Warranty - $35
    Total = $513/month

    The warranty covers all appliances (I use it about once a year at $100/deductible), and I can turn the place over for a new tenant for about $250. Adding that in, I get $542/month or about 45%.

    My point is that if the taxes or condo fee were lower, than the rent would be lower by natural market forces. And if they were higher and the local market couldn't support higher rent, than people wouldn't own them as investments anyway.

    Just 2 cents from a beginning investor.

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Chris,

    For a new investor, you've got something that many investors never get - COMMON SENSE. In a general way, what you said is correct. Even though the specific individual expenses are quite different in various areas of the country, it's amazing how the total expenses add up to 45% to 50% of the gross rents all across the country. For example, here in Ohio in some of our lower income rentals, we might have a higher rate of evictions than in the land of socialism (Kaleefornyah). However, with all their tenant friendly laws, an eviction in the land of socialism might take much longer and costs MUCH more. Property taxes in one area might be much greater than another area, but the second area might have a much lower vacancy rate. The bottom line is every significant study (including the large apartment associations who have data from hundreds of thousands of rentals) shows that the expenses (incl. vacancies and cap expenses) consistently run 45% to 50% of the gross rents.

    You might want to read the sticky threads on operating expenses (this one and the one in the landlording forum) very carefully. You missed some expenses and it's important to understand this issue before you buy any more rentals.

    Good Luck,

    Mike

  • Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    If there is any city where the 2% and 50% rules are alive and well and in action, it is Springfield, Missouri. I was taught investing by landlords there who own hundreds of rental units in Springfield.

    What these real owners tell me supports exactly what Mike says.

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y
    Originally posted by Tim Wieneke:
    If there is any city where the 2% and 50% rules are alive and well and in action, it is Springfield, Missouri. I was taught investing by landlords there who own hundreds of rental units in Springfield.

    What these real owners tell me supports exactly what Mike says.


    Hi Tim, didn't say it did not apply to any units, or that no one used it. You were not in my class. If you had been you would have been taught appraisal techniques and going by the numbers. I know Carol Jones uses it, initially Tim, but she crunches numbers like I do. Initally, a loan officer will calculate the same thing, but won't loan on that analysis. As I said above, I don't have a problem with it, just won't buy on that analysis alone.

    I recognize all the little diggs guys, like "real owners" ans "if I can't understand reports", I'm thick skinned as well, that's OK.

    What I realized here is that after going to some profiles, some not being public, that we have some authors of books and others that perhaps teach methods discussed on the site. Clearly, if any materials used in such material were found to be invalid or even questioned, that represents a problem for such teachings. Now I understand the insistance on some points of view. All I ever said or meant to imply was that data can be manipulated and it is not always 100%, in every deal in every place. Most properties in Springfield fall into that category I'm sure, Will pointed out the variables very well. I have a tri-plex, owned for about 15 years and it was well above 60% when I acquired it, it's now about 35 to 40. My other properties have been sold off, I'd rather have a note than deal with tenants now! Good luck, Bill

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y
    Originally posted by Tim Wieneke:
    If there is any city where the 2% and 50% rules are alive and well and in action, it is Springfield, Missouri. I was taught investing by landlords there who own hundreds of rental units in Springfield.

    What these real owners tell me supports exactly what Mike says.

    Well just had a longer reply but it was lost in trying to post it.

    Hi Tim, Carol uses this formula but she crunches the numbers as I do. If you have been here I'm sure you know who I'm speaking of. If you had been in my class you would have first been taught appraisal techniques and a little accounting, too much trouble for most I know. What I did learn the past day is that there are some on this site who sell books and teach methods of investing. Perhaps such information is included in those materials. So, I now understand why any other opinion is so actively defended against since if any such method were seen as not being valid, it would present a problem for the instructional materials sold or other instruction. I get it now. It's OK. I never said it did not work, I just pointed out the need to crunch actual numbers. I don't buy based on rules of thumb and to be prudent, others should do their due diligence as well. We have thousands of rentals in Springfield, I'm sure many of them meet the rule as well. I have a tri-plex left that did not when I bought it (about 65%) and now, after 15 years, it's about 35 to 40. Lot's of maintenance expenses at first, now it's all fixed and is a great little 3700 sq ft property. All my properties were sold off, I prefer a note as to dealing with tenants! Some day you can do that too. Good luck, Bill
  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    You don't seem to be getting it. The 50% Rule doesn't say ANYTHING about what a given property will do in a given year. Is it possible for a given property in a given year to have expenses of 35% to 40% of gross rents? ABSOLUTELY! Is it possible for a given property in a given year to be 90% - YES! The 50% Rule says what rentals will run over a large number of units and/or a long period of time - in other words it tells you what you will average over time, which is the information you need to know to successfully stay in business. Failing to understand this issue is the NUMBER ONE reason that newbies fail.

  • Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    "You were not in my class. If you had been you would have been taught appraisal techniques and going by the numbers."

    Appraisal? The 50% rule is about OPERATIONS.

    I did take an appraisal class in Chicago and learned that the market appraisal technique was useless for calculating whether or not a property was a decent rental. Market appraisals only tell you what some other idiot is paying for property. The only one that came close enough to be dangerous was the income valuation approach. The problem with the income valuation approach is too many realtors/flippers were applying a 1.2% version of the 2% rule. If you apply 1.2% on the purchase, I've yet to see anyone hit 50% on operations without an obscenely large downpayment. To get to a price to match what realtors/flippers were preaching they HAD to do something to "invalidate" the 50% rule.

    "What I realized here is that after going to some profiles, some not being public, that we have some authors of books and others that perhaps teach methods discussed on the site. "

    Everybody here knows about Mike's book. What everyone doesn't know is the eviction process in Springfield, Missouri requires you to file for an execution where the sheriff will forceably moved barricaded tenants. You're advice to RobJ to break down the door on a tenant will get you arrested or justifiably shot by the tenant in a pro gun state like Missouri. I hope your real estate coaching include field dressing bullet wounds.

    Missouri is the "Show Me" state Bill. Show us some numbers to validate your points.

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Tim, I also said accounting, and you propably did not get into narrative appraisals and analysis, dig deeper. You have to go deeper than Marshall Swift for the analysis of reantal properties. Cosy, market and income is only part of it. Are the subject expenses in line with comps if such are known? Where they are known Tim, is at the bank or at other lenders! Loan files are full of expenses for similar properties!

    Which is a good point to bring up with the analysis of your 50% rule. When you do a pro-forma statement (an accounting statement which illustrates expected future expenses) in your loan request, those figures can be considered with the other recent files if necessary. In the INITIAL assessment of a loan, the loan officer will generally use 2% and 50% just to see if it is worth going forward with the loan! But they don't use it for loan analysis, they use the pro-foram statement. I think what I said all along is that you have to crunch the numbers and not buy based on any rule of thumb alone, and that's what I was saying. I also said if it works for you then use it, or something like that.

    In Springfield, a judge told me, while having coffee, that sometimes you have to take care of things on your own toughness. He wasn't saying pound they guy in the ground, but I can force a door open any day of the week if there is an emergency, like water running down to the unit below. And you know that, or at least I think you schould, maybe not.

    I'm certainly not going to take time to hunt down the things you have said and pick at it as you are doing. You may do so if you like, but I'm done with this game. I had no idea about Mike's book until I went to his profile.

    If you will read what I said above with an open mind you'll see that I was not saying that your ratio would not work, never said that! When people use terms like "in every case" "always" "every unit", that's simply wrong if you are speaking english! "Every" "always" means without any exception whatsoever, there are always exceptions. I was speaking also to the variance as a statistical measurement, and from that the data could not be as relevant as it was being proposed.

    Tim, I have seen in other threads where someone tells someone to post the data or the numbers, think about that, how silly that is, to post something that justifies their position. If you don't trust what someone is saying, simply don't address them, or use what they are saying, pretty simple.

    Let's just get over it now. If you like, you win. means nothing to me, I'm not selling anything! Good luck, Bill

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    That's the difference between talking about a subject and actually being in business and KNOWING about a subject. I could see that kicking down a tenant's door could result in the landlord having a very bad day. Not only could they be legally shot by the tenant, but then to add insult to injury, the sheriff would arrest the landlord for Breaking and Entering! LOL!

  • Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    16y
    Originally posted by Financexaminer:
    In Springfield, a judge told me, while having coffee, that sometimes you have to take care of things on your own toughness. He wasn't saying pound they guy in the ground, but I can force a door open any day of the week if there is an emergency, like water running down to the unit below. And you know that, or at least I think you schould, maybe not.


    I know you don't have to go into a unit to shut water off to it.

    We got the proper procedure on eviction and the proper entry into units from John Q. Hammon's personal attorney. He was our attorney before John hired him on full time. You can argue it with him all you like.

    I just don't buy what you're selling - which is "Real Estate Coaching" based on what you've tried to say about Springfield, Missouri. My family owns over 300 rental units there, and we've been there for 20 years. I know the 50% rule is just the reality there.

  • Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
    16y

    Bill,

    I didn't know that you were offering real estate coaching. If that is true, you really should be careful with the advice you're offering. Suggesting that someone break a door down is VERY POOR ADVICE and is blatantly illegal for the landlord that does it. If there is a water leak, the landlord could shut the water off at the street or call the water company and have them shut it off. Advice such as breaking down their door could get your student arrested or even killed, and you would be liable for giving that advice.

    Please be careful with your posts.

    Mike

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Hi, Tim! So you know John's attorney, well my daddy is personal friends with Johnny, all the way back to college! :roll:

    Maybe if you're good I'll introduce you to your old attorney's boss and we can all go to dinner sometime.

    Tim, even in Missouri, if there is an emergency, you can enter. Knock, knock, no answer, water running out of the unit, water was shut off, water was still running out, enter the unit! Very simple. And yes, being an Army type, I'm not really worried about that, been there and done that too Tim. You didn't ask your attorney the right question Tim!

    I have probably been teaching real estate longer than you have been in the business on your own Tim. My first class was in 84. Your snide remark about my coaching seems to be your best shot. Well, 20 years, yes, I remember when you guys basically showed up. Nice family! Why did you leave town Tim, you were here as a kid weren't you?

    And I wouldn't beat myself up everyday with 300 units in this town (or any other for that matter) even if I were stupid.

    Tim, look at it this way, I'm bullet proof! You, or anyone you know can't hurt me. Life is not limited to this site or the internet. You know what they say about people who throw stones and live in glass houses. My family has been in these here parts for a hundred years, I was born here, so was my dad. Talk about history...and knwoing the people and the market...LOL

    I don't sell books, tapes, methods, programs, or any of the other crap pushed on newbies. I retired at 52! I've been bumming on MY bucks (not family money) ever since. I hope you do better than that Tim, but you won't, I assure you, if you spend your time like this! But then, you could always come back home. Work on another deal, go sell something or rent something! Tim, pups don't teach old dogs new tricks! Good luck. Bill

  • Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    16y

    Josh or Jon, Sorry it got so far off the validation subject. Sorry Will. Bill

  • Joshua D.Pro Member
    BiggerPockets Founder · HI · Member since 2008 · 16k+ posts · 5k+ votes
    16y

    If everyone is so sorry about getting off point and arguing like children, perhaps we could stop doing it?

    Enough already, please. I have no intention on closing this thread, but if you continue to get personal with one another, I will have to start deleting posts.

    Thank you,
    Daddy Josh

  • Residential Real Estate Agent · Chandler, AZ · Member since 2009 · 1k+ posts · 928 votes
    16y

    I would like to see Taz's data. I clicked on his link, but it did not work. Does anyone have it?

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