Validate the 50% rule

General Real Estate Investing
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Validate the 50% rule

Will BarnardPro Member
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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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Rich Weese
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.

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

    Justin,

    Unfortunately, when Taz left it looks like he took his link down. You can still view the data, buy you will have to subscribe to his website.

    The bottom line was that he collected data from over 30,000 units spread across the country, both SFHs and apartments, and divided the data by rent range (he lists the ranges in one of the posts). The result was that in every rent range category, the operating expenses (as defined by the 50% Rule) were 45% to 50% of the gross rents.

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  • Mark N.A
    Real Estate Investor · North Carolina · Member since 2008 · 1k+ posts · 483 votes
    16y

    Personally, in some of my rentals I'm seeing that ratio improve due to wage deflation within the trades (plumbers, hvac, carpenters, etc.). These are college rentals where premier location continues to drive rents higher.

    Unfortunately, that trend becomes a wash in the properties where I have lowered rents.

    Caveat, as usual, emptor.

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

    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



    Thanks Mike. I'd like to think that I have more common sense than the average guy, but I'm always trying to learn. This property was not an investment per se, but my primary residence that I couldn't sell when I moved. So I'm slightly negative cash flow, but that's beside the point. I only advertise thru craigslist, and all my major capital expenses are covered by the warranty (I've already used it to replace the air conditioner and water heater.) I can patch, paint, and recarpet the entire place for under $500 if necessary. So I guess some other things (legal, etc) will ultimately get me real close to the 50% mark.

    I'm just now getting into investment as a business, and I find the 50% rule to be very helpful in evalating properties and weeding out unrealistic sellers.

    Question - do you use it to set aside a capital reserve fund instead of trying to calculate remaining life of individual items. In other words, if I had a property renting for $1000 and recurring expenses (taxes, insurance, utilities) were $300, should I set aside $200/month assuming that this would average out in the long run?

    -Chris

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

    Yes, you certainly should! If you don't, then you won't have the money to pay for major things when they do come up (and they will).

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  • Timothy W.
    Attorney · Raleigh, NC · Member since 2008 · 4k+ posts · 1k+ votes
    16y
    Originally posted by NC Mark:
    Unfortunately, that trend becomes a wash in the properties where I have lowered rents.


    And rising materials prices along with increased stolen copper.... It never fails. The expenses rise to meet the income - even with properties that nonlandlord Murney and Associates realtors sell.


    "Yes, you certainly should! If you don't, then you won't have the money to pay for major things when they do come up (and they will)."

    Mike is exactly right. I have been asked to come down and help with an insurance claim down in Springfield, Missouri where a tenant burned down a house and the landlord is out the $2,500 deductible until subrogation is finished. On one house, that's an easily absorbed expense. Across over 300 rental units, that adds up. Landlording is not easy. Being a landlord requires self mastery. It's too easy to look at large reserves and imagine what you "could" be doing.
    0Reply
  • Jason D
    Real Estate Investor · MO · Member since 2010 · 10 posts · 0 votes
    16y

    As Bill pointed out several times there are many variables involved. Every Investment is unique and should be evaluated based on its own merit….

    0Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    16y

    Repairs always seem to be the 'dark horse.' Some years, you have no repairs, other years, the repairs are more than the rent collected. The 50% rule is a really good rule.

    If you buy a brand new house, rent it out for five years, and then sell it, you probably never paid 50% expenses. But if you buy a 'fixer upper', you may spend more than the rent collected that first year on expenses.

    Believe it or not, on 30 rentals, in 2009, my expenses were about 70%. But those same rentals, in 2007, my expenses were about 30%.

    I like to give Mike OH a hard time with individual property examples, but he is right on when it comes to assessing the potential return on a real estate investment. If you buy an investment and the 10 year expenses stay under 50%, you have done very well, got an actually higher return then you had figured. But if the expenses did come in at 50%, then you won't go into 'sticker shock' because you planned for it.

    So just keep in mind that you figure the expenses, less the mortgage, to be 50%. $1,000 rent, you need $500 for taxes, insurance, repairs, vacancies, management, etc.... Whatever part of that $500 you don't spend each month, put aside for the future, because, I can guarantee you, VACANCIES and REPAIRS will come. And sadly, they usually come together, VERY HARD. I got that just last summer. 3 months of a $1,500 mortgage payment with no rent and $16,000 in repairs. Yes, that property is for sale now. Selling the losers!

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  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    14y

    I know this is a serious, SERIOUS bump, but this is a "sticky" post and I just want to post my 2011 percentages. I don't want to give actual numbers, personal income is just that, personal. But my 2011 total expenses came to 37% in 2011. This is on multiple properties in multiple states. It does include vacancies, repairs, personal time and all expenses.

    But Will is correct, as the property rents go higher, the percentage of expenses goes down. Property Taxes and management fees will ride higher and lower with the value of the property (I have one exception here, one of my PMS charges $50 per unit no matter what it rents for), but repairs and maintenance will be a lower percentage of the rent. For example, I have annual maintenance checks to change out HVAC filters, check smoke detectors, etc.... The cost is the same no matter if the rent is $500 a month or $2,000 a month. A hot water heater is the same cost for a $500 rental or a $2,000 a month rental. I have a rental that needs a new Microwave Oven, and that unit rents for $1,600 a month. The oven would cost the same if the unit rented for $295 a month (which I used to own units that rented for $295 a month)

    If you took ALL the rentals in the United States, and did all the numbers for 30 years, you would come to 50% expense costs. But using that "logic", you could take the sales price of all the SFR's in the United States, average it, and get the value of your house.

    I like the 50% rule and use it all the time for calculating the value of an investment. It is a CONSERVATIVE look at the cost of owning an investment property. On the units I used to own that rented for $295 a month, expenses were well north of 50%, approaching 60%. On units that I own that rent for more than $2,000 a month, expenses are in the 30-40% range.

    The other large factor is vacancies. My statistics show that vacancies on rentals less than $1,000 a month are close to 10%. But vacancies on units that rent for more than $2,000 a month are less than 5%. My most expensive rental has not been vacant since 2004. My record is 24 years with no vacancies on a SFR that rents for $1,600 a month.

    So my advice is to USE the 50% rule before purchasing a property to get a value. But keep in mind that as the rental amounts get higher, the percentage of expenses should drop.

    The other side of this is the "2% rule". If you can get 2% of the value of the house in rent, your expenses will be at the 50% mark. A house you bought for $30,000 that rents for $600 a month will be at the 50% mark. But you will be hard pressed to buy a house for $100,000 that rents for $2,000 a month (not units), so the expenses on a $2,000 a month rental should be under 50%.

    So I see a correlation between the "2% rule" and the "50% rule." If you are getting 1%, then you should see about 40% in expenses. If you are getting 0.5%, then you should be in the 35% expense range.

    There are many, MANY factors that influence the 50% rule. It is a great TOOL and should be one of the many TOOLS you use when figuring the value of an investment.

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  • Michael Lauther
    Investor · Hampton Bays, NY · Member since 2009 · 907 posts · 258 votes
    14y

    Mike M: Thanks for bumping this post, Your thinking on this comes at a time when I am evaluating future purchases. It seems like common sense to assume a higher expense percentage for maintenance on low value low rent properties for the reasons elaborated above. However It is useful to validate what we feel is correct by your sharing your actual experience.

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  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y

    Great post Mike, I agree in full. While the 50% and the 2% rule are great figures to use in initial evaluations, you must consider each investemnt and make adjustments accordingly.

    Your example of the cost of a water heater or microwave ibeing the same no matter what the gross rent is right on as is the example of having better quality tennats with lower operating costs on more expensive rentals.

    Just as in the 75% rule for my area on rehabs, I shoot to be "all in" (acquisition plus rehab costs) at 75% of the exit value (ARV), but that % rule must be adjusted based on many other factors. So one must realize that these "rules" actually "guidelines" and they all need to be adjusted from one deal to the next, one situation to the next.

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  • Brian P.
    Wholesaler · Salt Lake City, UT · Member since 2009 · 1k+ posts · 401 votes
    14y

    I finally read this thread, lots of great posts, but it still boils down to this, the two rules are not laws, just rules, but we should add of thumb, and like all rules of thumb they are guidelines, no more, no less, but guidelines not to be ignored.

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  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y

    I believe most of us are in agreement on that Brian. Ignore them at your own peril, use them as an end all, be all at your own peril as well.

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  • Nathan Emmert
    Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes
    14y
    Originally posted by Will Barnard:

    Your example of the cost of a water heater or microwave ibeing the same no matter what the gross rent is right on as is the example of having better quality tennats with lower operating costs on more expensive rentals.

    I disagree completely.

    A high end rental requires not only high end upkeep, but also more frequent refreshes.

    In a $500 apartments... it needs a stove... it can be 15 years old, stained, ugly as sin... but if it heats to a boil, you're good. Try renting a $2,000 house with the same stove. The $500 stove I put into a new rental was a HUGE selling point... cause it was nice and new... the same stove would have turned off buyers in a $2,000 rental because while it was nice and new... it was also electric, white, and no frills.

    I can replace window panes with plexiglass. I can use vinyl stickum tiles instead of ceramic. As long as they get a little bit of hot water for a shower they probably aren't complaining.

    To maintain a higher level of rent on a property you will absolutely have to expend more cash to do it... now whether that boils down to a lower percentage of GOI, the same percentage, or even a higher percentage than 50%... I have no idea. But in absolutely dollars, it most certainly will be higher.

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  • Jeff Brown
    San Diego, CA · Member since 2008 · 59 posts · 46 votes
    14y

    Hey Will -- Your point is very well taken, and in fact my experience. However, and speaking only for myself, the reason I resort to the 50% rule is to invoke a more conservative approach for my clients. I even do it with brand new 1-4 unit props. I tell them 50% is not really born out by my boots on the ground work, nor my spreadsheet, but that Murphy's alive, and knows where we all live. I follow this by ensuring them they'll have their turn in his barrel, sooner or later.

    Make sense?

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  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y

    Looks like we are on different pages here Nathan. I can say from experience that on more expensive rentals, those tenents treat the home with much more care and repairs are much fewer and further between. Also, the water heater is teh same cost no matter what. Yes the stove may need to be stainless rather than a cheap one in a cheaper rental, but I can guarantee that the stainless one in the nice rental will last much longer due to the better quality tenant.

    You also did not takle into account the point that higher quality tenants exist in higher end properties where they stay for much longer periods of time on average, saving you placement fees, vacancies, advertising, damages beyond security deposits, etc.

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  • Nathan Emmert
    Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes
    14y
    Originally posted by Will Barnard:
    Looks like we are on different pages here Nathan. I can say from experience that on more expensive rentals, those tenents treat the home with much more care and repairs are much fewer and further between. Also, the water heater is teh same cost no matter what. Yes the stove may need to be stainless rather than a cheap one in a cheaper rental, but I can guarantee that the stainless one in the nice rental will last much longer due to the better quality tenant.

    You also did not takle into account the point that higher quality tenants exist in higher end properties where they stay for much longer periods of time on average, saving you placement fees, vacancies, advertising, damages beyond security deposits, etc.

    You're right, I focused on one thing... but lets look at the total picture.

    First off, you'll have to replace the hot water heater more often in the high end home simply because that tenant will likely start complaining about the water sooner. It will cost the same to replace it... but you'll replace 3 or 4 to my 2 or 3 in the long long run. Same for things like stoves, fridges, microwaves.

    As far as quality tenants... while I want to call B.S. on lower income people being lower quality tenants, lets say for example you're right... so let me flip to risk.

    Those nightmare tenants exist in any scenario. What's your exposure in a high end rental? You know, the cement tenant... the one who pounds a whole in every wall because he got evicted after losing his 6 figure job for using drugs in the office. How much damage can he do to your $2,000 a month property? What's your potential exposure? Now look at a $500 rental. The cost to get back to a $2,000 a month rental will be WAY different than the cost to get back to $500.

    Advertising fees? You're paying 2 to 3 times as much for a placement as I am... that's generally a % of rent so that all plays out.

    Vacancies... sure, some markets support that.

    Length of tenant? I have read that multi bedroom apartments tend to have longer average lengths of residence... I haven't read on houses versus apartments. I will be very curious to see how that plays out in the next 3 years with this temp renters that are only renting cause they can't qualify for a mortgage. Most of my tenants never will, they don't aspire to own a house.

    We all have our beliefs... but honestly, the one that irks me the most is that low net worth equals low quality. I come from the lower middle class and was still taught the same morals and responsibilities of the rich. Valuing yourself and other people's properties has absolutely nothing to do with your salary.

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  • Will BarnardPro Member
    Moderator
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y
    I don't believe this for one second. Do you have any supporting evidence to show that a 40 gallon water heater will last longer in a $500 a month rental as opposed to a $2000 a month rental? I am betting not, never heard of such a thing. As for the micro/stove/oven, I also think you are wrong. The higher quality units that someone would put into the higher priced rentals, will likely last longer due to quality. Again, not true. How do you figure your Craig’s list ad and newspaper ad costs less than my very same ad in the very same place just because my unit rents for more? Makes no sense. I never referred to specific markets over another, just pointing out that in my experience and many others who have posted here on BP, the higher priced rentals have averaged longer staying tenants than the lower cost rentals. Let’s stick with apples and apples here, bringing multifamily into the picture is a different fruit all together with different economies of scale and different renter profiles. I am with you on this. I did not come from a poverty stricken family, however, we did live paycheck to paycheck and I did not have all the things that many of my friends from school had. I too was taught not only the value of the dollar, but about morals. I don't remember making any reference to low net worth equally lower quality tenant, however, if anything I said was construed that way, it was certainly not meant to be. What I did state is that in my experience and that of others who I have spoken to, both here on BP and abroad, the lower priced rentals will often average higher repair costs due to damage from tenants, higher % of evictions (just read any of MikeOH's posts from the past, that is all he had was low priced rentals), and more problems creating more costs.

    At any rate, I think we have gotten off topic here and regardless if we disagree or agree as two individual investors on some of these specific costs, I am sure we can agree that the rules mentioned in this thread are simply guidelines and are valuable tools to use, but should never be used as an end all be all. Agreed . . ?

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  • Stephen Masek
    Investor · Mission Viejo, CA · Member since 2012 · 627 posts · 204 votes
    14y

    Good question, Mr. Bernard! If I may, it seems that what you are really doing is showing that the most money / best return is made by buying low and selling higher.

    Here are the numbers for one we've had in Florida since 2005:

    Income $80,708

    Expenses: $36,953

    Profit $43,755 / $80,708 = 54%

    Planned: Insurance, Management, property taxes, HOA: 35.3%of gross

    Unplanned: Repairs, Legal, Utilities, etc.: 10.9% of gross

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  • Stephen Masek
    Investor · Mission Viejo, CA · Member since 2012 · 627 posts · 204 votes
    14y

    Regarding tenant quality. I was a poor kid - my parents were factory workers, and my father died when I was 13. However, both parents valued education. Our house was always clean. We had decent clothes.

    The business I own allows us to see many thousands of apartment and Condo. units. In the lowest rent buildings, we see much more of the grease-covered stoves (and adjacent walls and ceilings in far too many instances). Those stoves are either ruined, or would require so many new parts and cleaning effort that it is not worth doing.

    As for water heaters being replaced more often in higher-end buildings, I do not see any reason. The water heater in our house is 14 years old. I drain it at least once per year, and property managers should be doing the same on rentals. I also helped write the ASTM E2018 standard for performing Property Condition Assessments, and the lower lifespans for water heaters given by someone above are too low.

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  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    14y

    Personally I would never use the 50% rule as a hard and fast rule. There are exceptions on both sides of 50%. There are times that 50% would be an underestimate on a specific property.

    It is a great rule of thumb though that can come in handy when reviewing a number of possible investments. I use it as a way to filter potential properties that I have found and determine if I want to take more time with a property.

    When I have identified properties that might make good deals, then I do a more thorough review of the numbers based on actuals and estimates where needed. It doesn't take long as a landlord to learn about all of the various expenses that can and do come up.

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  • Michael Lauther
    Investor · Hampton Bays, NY · Member since 2009 · 907 posts · 258 votes
    14y

    The 50% rule of thumb is an excellent tool to help new investors understand that cash flow and profit from rental income needs to take into account much more than just taxes, and insurance.

    It also recognizes that whatever the financing arrangement may be that financing is analyzed separate from considerations of net operating income and comes into play after calculating the operating income.

    New investors often get into properties that are not as profitable as advertised because they did not consider expenses realistically and were sold on an inflated cash on cash return that was calculated based on a high degree of leverage.

    2Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    14y

    The main thing here is EXPERIENCE. Mike OH was the largest proponent of the 50% rule but when I asked him if he owned or had ever owned any SFR rentals that rented for more than $2,000 a month, he replied that he has never owned anything that rented for $1,000 a month. Therefore, he has NO EXPERIENCE with the higher end rental. Mike OH also talked about the caliber of sidearm he carried to collect rent. That says it all about the "quality" of his tenants.

    Obviously, anecdotal evidence can show High End folks who are Low Lifes, and lower class people who are diamonds. I have had them all over the past 40 years. But averages will prove that higher rent paying folks will cause less trouble than the lower rent folks.

    As a whole, I have had to replace appliances a lot LESS with higher end rentals and vice versa, a lot more with lower end rentals.

    BP is a place to share EXPERIENCES, and not so much theory. Having one or two high end rentals for a few years is not real experience, and neither is having one or two lower end rentals for a few years. I can show you one year of a higher end rental that expenses exceeded 100% of collectable market rent. But that same rental expenses came to 40% over 20 years.

    At one time, I had 32 units that rented for $295 a month. I have also had a dozen rentals that rent for more than $1,500 a month. So when I give my numbers, it is actual experience, not theory.

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  • Will BarnardPro Member
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    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y

    We are on the same page Mike, I agree.

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    14y

    I didn't read all of the recent replies, but I still fail to understand how people can cling to the idea that a blanket 50% rule of thumb is a catch-all. I agree that it is a nice starting point and in many cases it is conservative. In some cases it is liberal and you need to understand that nothing in life is free.

    A class property with stable rents, low economic vacancy, great locales, etc. will obviously have lower percentage expenses that D class property. What would be the use in having a grading system for property if it could be summarily discarded in favor of a blanket 50% rule of thumb accounting? Averages for all product types don't help at all for a specific project.

    Add to this that different product types have a lesser or greater time component. Some operate almost exclusively as a business (like hotels) and others are much more passive.

    My take it that we had some rather vocal advocates for the 50% rule of thumb that took it beyond its logical extreme several years ago and we're still trying to unwind the lunacy that resulted. People have different investing styles, yield requirements, tolerance for risk, time to devote to projects, etc. A more holistic and rich analysis of investing is drastically needed on BP in several threads. There's more to investing in real estate than "cash flow" or COC returns. The real world is much more complicated than that and it takes time to learn the art of investing and what is suitable for you given the resources at your disposal. These needs will also change over time as you mature and are able to gather more resources to help grow your business.

    2Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    14y

    Bryan, I opened the topic again to give my 2011 numbers, it was not to restate any debate. The very first post in this thread was about whether higher end properties would tend to expense out below 50% and lower end properties above 50%. My real world experience has proven this to be the case.

    Each rental is like a baseball player, who has a hitting percentage, a fielding percentage, an on base percentage, etc..... If all your players are doing better than 50% of the average, you should have a good team. So if all your rentals are showing an expense percentage below 50%, you should have a good portfolio of rentals.

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