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

    Bryan I have read through this tread the old posts and the most recent posts I observe that the issue is how useful and how representative is the 50% rule of thumb. I say Rule of thumb because it can not be an accurate assessment of expenses because of the varied nature of rental property. If you look at taxes in my home town you will find taxes by themselves eat up more than 50% of fair rental value.

    The attempt on much of this thread is to document the types and amounts of expenses considered in this rule and present all of us with a peek inside each others operations.

    I think it is a useful exercise for both new and experienced investors. The 50% rule is a point of reference and a starting point in a thou rough analysis of the numbers.

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

    I think there is real value in using this as a rule of thumb especially for new investors. The last thing you want as investor is to get into a property and have failed to consider all of the real costs of owning real estate.

    My only concern is for those new to investing that take the rule as gospel applying it to every deal under the sun without taking the time to review actual and expected expenses on a particular property. New investors also are less like to manage rentals well. It is easy in the beginning to get sucked up into many of the sob stories about why rent is late. Newer investors are less likely to spot the professional tenants (those that know the landlord tenant laws backwards and forwards). Not fully taking into account utilities that are not subdivided. Not considering what can be the high cost of snow removal in areas that get considerable snow. HOAs can have a huge impact.

    How rentals are managed can have a dramatic impact on this expense ratio as well. Putting a bad tenant in place can mean higher than expected repair costs, higher than expected legal costs, it can also mean a substantial amount of bad debt. States vary on how easy or hard it can be to evict bad tenants.

    I'm very happy with how I analyze deals, but I have been doing it for over 15 years.

  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    14y
    Originally posted by Bryan Hancock:
    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.
    Perhaps you should have, we were all discussing that very point, that the "rule of thumb" is usefull, but not an end-all be-all as so many factors come into play. I think most of us are on the same page these days with this rule of thumb.
  • Investor · Washington D.C. · Member since 2013 · 94 posts · 18 votes
    13y

    So I had a small disagreement over this topic with an RE investment firm who dont believe the 50% rule should apply to them. The firm refurbishes multi-family buildings (5-9 units on average), and gut renovates them in the process. Their ongoing expense rate is more like 30% because of low taxes (they normally get tax credits for 10 years) and because they dont anticipate any costly expenses due to everything being new.

    In their projections for an exit event 4 - 5 years after the refurb, they belidve they are still going to be able to sell the properties based on having 30% expenses. I wanted to ask the BP community whether this is realistic and makes sense. Thanks!

  • Real Estate Investor · Dubai, Dubai · Member since 2013 · 19 posts · 4 votes
    13y

    There is a scale for this. The more expensive and high end the property, the further you get below 50%. The less expensive and lower the rent, the higher you get above 50%.

    50% is a great rule of thumb, works for middle of the range properties. For slum lord style properties, it's closer to 70-75% (or higher). For very posh properties, it's closer to 30-35%. For less than 10 year old suburbia, go with 40%, barring getting unlucky with back to back tenants trashing your place.

    For the highest end of all (e.g. Manhattan single family) it's about 25%, and half of that is taxes.

    This is all based on my actual numbers over a lot of years.

  • CA · Member since 2013 · 19 posts · 2 votes
    13y

    People should be educated on what goes into the 50% rule (taxes, vacancy, PM) etc and guidelines provided on how to estimate them in different property/rent classes, rather than debating how well the 50% rule applies.

  • CA · Member since 2013 · 1 post · 0 votes
    12y

    I am reading all this thinking either I have been VERY lucky or there is more to the story...

    I just did the calculation and got 33%. Here are the numbers:

    Rent $1795

    Property Management $125.65

    Property Tax $407.83

    Garbage $11.33

    (I pay $34 per quarter)

    Insurance $50.50

    (I paid $606 for the year)

    I have had the same tenant in there for 3.5 years. I've only had ONE repair which was the garage door motor. So I guess I could include that and that would come to an expense of $4 a month over 3.5 years.

    I think what you guys are saying is I should take the 17% and keep it in reserves for future repairs? But wouldn't that be a little too much reserves? (lost opportunity cost perhaps?) Mark.

  • Will BarnardPro Member
    Moderator
    OP
    Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
    12y

    @Mark W. You need to fully understand the 50% rule! based on your reply, you don't. The 50% rule does not sat that each and every property will have 50% in expenses. Secondly, just because you have been lucky enough to have one tenant stay for 3.5 years and have no vacancy or repairs, that is not going to happen for you on every unit you own and for every year you own the property. Eventually, you will have vacancies, you will have evictions, you will have repairs, you will need to replace a roof, a water heater, an HVAC, electrical, windows, doors, siding, lawn, etc.

    The rule is a rule of thumb and based on an average of holding many doors over many years.

    Let's outfit this way, if I go to Vegas and place a grand down on black on the roulette table and win, am I to assume that I will win every time I do that? No, law of averages states that red will hit too and I will lose.

  • San Diego, CA · Member since 2008 · 59 posts · 46 votes
    12y

    Hey everybody — I call the 50% rule, Murphy's SpreadSheet. :) I always do the numbers to the last penny. Then I tell investors to project their holding period based upon Murphy, not their vetted numbers. It's about being OldSchool. Nobody's upset when the actual performance is better. If it's worse, something went pretty wrong.

  • Investor · Mission Viejo, CA · Member since 2012 · 627 posts · 204 votes
    12y

    The actual experience of other people is the most valuable part of this discussion, so I have read the entire thread. It is no surprise that seller tend to soft pedal repair, replacement, and vacancy costs.

  • San Diego, CA · Member since 2008 · 59 posts · 46 votes
    12y

    @Stephen — I teach other professionals to ask sellers for the pertinent info they supplied the IRS in their tax returns, on the forms they filed. It usually gets pretty quiet about then. :)

  • Property Manager · Dalton, GA · Member since 2008 · 100 posts · 21 votes
    12y

    Its a confessional moment for me here. I rejected this rule and thought it was extreme when I first started in 06-09. I believe I evened argued this rule somewhere on the forum way back then. I was at approximately 70%. 

    Does anyone with a pulse in 07-10 remember you couldn't sell a house to recoup any of your losses from rentals? Oops didn't plan for that one.

    So when I became cash flow dependent on my rentals reality hit quick and hard. It took me losing 27 houses in the downturn and reviewing my cash flows from that time frame to realize that if I had been at 50% for the aggregate of my properties I would have been able to make it. 

    Call me a believer now. You can hide your losses with flips again now but if you hit rock bottom and have nothing but cash flow to depend on its a dangerous game if your ignoring the 50% rule.

    Your mileage may vary depending on your risk tolerance and general market conditions but I'd rather not waste time building a real estate foundation on a house of cards. I'm conservative and picky now with the deals I do. Quality over quantity.

    You can either learn from those with experience here or learn from your own experience. 

  • Investor · Newark, DE · Member since 2014 · 245 posts · 198 votes
    11y

    When I first read about the 50% rule, it seemed ridiculous to me - I factor 20% for repairs, maintenance and vacancy, and a deal would be acceptable to me if rent > PITI + landlord utilities + the 20% repairs/maintenance; anything in excess I considered cash flow.

    After reading the post, I decided to calculate my expenses in this manner. Still using my 20% for repairs/maintenance/vacancy, I added the taxes, insurance, utilities, and divided by the rent. Average for my 12 rentals? 41.26%. If I pay the customary 8% management fee (or pay myself that amount), I get to 49.26%. Say what?

  • Investor · Arlington, VA · Member since 2012 · 1k+ posts · 491 votes
    11y

    Outstanding thread!  My expenses over the past 5 years after accounting for all expenses are at about 50% as well.  My experiene is a lot less "seasoned" than mose of the commentors though, but the "rule of thumb" is pretty awesome to me personnally.  Thanks to all for sharing your veiw point, I get way more out of a heated discussion than everyone simply agreeing with one another!  Happy investing!

  • Real Estate Agent · Madison, WI · Member since 2015 · 328 posts · 88 votes
    11y

    My SFH that rents for $1250/mo is also show expenses at roughly 50% over the last 2 years

  • Investor · Willow Spring, NC · Member since 2009 · 5k+ posts · 3k+ votes
    10y

    I know this is an old post. For 37,491 single-family properties in 22 states, American Homes 4 Rent is right about 50%, at 51.63% for 2015Q2 and 48.48% for 2015Q3. See also https://www.biggerpockets.com/forums/48/topics/227168-50-rule-fiction-non-fiction-lets-see-for-37-491-sfr

    This should be enough validation that the 50% rule of thumb is accurate across broad portfolios of US SFR.

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