The 50% Rule

10 Replies

I need some experienced investors to way in on this. How accurate is the 50% rule? I do not own any properties and I never have so I truly have no idea how much it costs to be a homeowner (including all of the expenses besides the mortgage). I completely understand that this rule of thumb isn't to be used as the deciding factor on whether or not you should invest in a property but I do want to know what other peoples experience has been and if 50% is a reliable assumption. 

Does anyone find it helpful to just put away 50% of the gross rental income you receive into a separate bank account and only touch it for upkeep and expenses? Or is it more of a mental reminder that you shouldn't spend all of your left over cash after paying the mortgage?

Thanks for any advice, opinion, or story!

- Ben

It's relatively accurate, but I would never use it for more than a rule of thumb. If the property is in a really bad area or its all bills paid or a host of other things can screw that calculation up. Its helpful for a quick analysis to see if a deal is worth it, but nothing compares to a real operating statement when it comes to evaluating a property.

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@Benjamin Eccles I'm curious about others' thoughts on this as well.

In my rentals at $1800/mo, I find it hard to imagine that annual expenses over time will average to be $10,800 ($900 per month x 12 months).

Perhaps the 50% rule becomes more relevant as monthly rent rate or property quality goes down?

The accuracy is more dependant on the type of property and has nothing, or very little, to do with the value.

A SFH will generally, over the life time of the property cost 50% of the rental income to maintain the property. The most important factor being the statement ..... over the life time of the property. A brand new home rented for one year may have expenses as low as 20% but that number has no bearing on long term expenses which is what the 50% rule applies to. At the same time a bad tenant can drive your one year expenses well beyond 100%. Again no bearing on long term expenses.

A multi will be lower, maybe only 40%, due to the fact that many of the costs are spread over multiple tenants as opposed to only one, such as vacancy, roof, taxes etc.

Expenses yesterday or today mean absolutely nothing in calculating or estimating expenses 10 or 20 years into the future. 

Let us run a little thought experiment to see if the 50% rule holds water. 2 houses, physically identical in every way, shape and form. Both built in 1980, both 3 bed, 2 bath, 2 car garage, 1200 square feet. Both stucco exterior with tile roof, both in exactly the same condition. The only difference is that one of the houses is in Los Angeles, CA and rents for $3,000/mo while the other twin house sits in Phoenix, AZ and rents for $1,000/mo. Both houses blow out their identical air conditioning units the same month and HVAC repairmen are dispatched. The repairman in Phoenix charges $300 for the visit and repair. Does the repairman in Los Angeles charge $900 for the visit and same exact repair? Run the same experiment for any other maintenance item ... go ahead ... new roof, leaky faucet, busted mirror, whatever ... does the same exact repair cost 3x as much in Los Angeles as it does in Phoenix? That's what the 50% rule would predict. Does that sound reasonable?

David, it is reasonable. There are no two pieces of real estate that are exactly alike. The home in LA would have far higher property taxes. Every property will have a defaulting tenant at some point in its life cycle. The evictions process in California is probably 50-100 times more expensive and time consuming than in Arizona.

@Benjamin Eccles

The 50 % Rule States: That 50% of gross scheduled income (GSI) goes out over time to cover expenses not including debt coverage.

The 1%, 2% and the 50% rule is meant to act as a quick analysis tool, to insure the deal is actually deal. Always, I repeat ALWAYS do a full and complete analysis on a deal and NEVER NEVER ever purchase a property just based on any of these so called Rules. You may be very sorry that you did

Make it Happen 

Steve

Originally posted by @JR T. :

David, it is reasonable. There are no two pieces of real estate that are exactly alike. The home in LA would have far higher property taxes. Every property will have a defaulting tenant at some point in its life cycle. The evictions process in California is probably 50-100 times more expensive and time consuming than in Arizona.

I have been a buy and hold investor in both Los Angeles and in Phoenix over the last 15 years. I have the data. It is not reasonable and does not match reality based upon my experience and large data set. I cannot speak as to other markets, but can speak definitively in this instance. However, if it works in some markets but not in others, then it is not a very good rule to go by IMO.

Thank you all for the input! 

I want to confirm what I believe is true - Does this "rule" encompass all expenses besides mortgage? For example, does it take into account property management fees, insurance, capex, etc?

I hate the term "rule" in this instance.  "Estimate" would be much closer to acceptable, but regardless, it's kind of a bogus number.  As others have stated, there are too many variables that could ball it up.  The example of Phoenix vs. LA is a good one, but I'll use a different example.

Property taxes in cities tend to be much higher than those outside the city.  We'll take the same two identical houses as the Phoenix vs. LA comparison, but this time, let's put house A on one side of the street inside the city limits and house B directly across the street but outside the city limits.  The percentage of rent going to expenses is going to be higher on House A than they are on House B, if all else is equal.

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