What expenses are included in the 50%?

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What expenses are included in the 50%?

David RobertsonBusiness Member
Flipper/Rehabber · Kansas City, MO · Member since 2010 · 758 posts · 780 votes

When using the 50% rule to evaluate rental properties what expenses are included in the 50%? Are taxes and insurance included in the 50%?

Thanks for your help.

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Joshua D.Pro Member
BiggerPockets Founder · HI · Member since 2008 · 16k+ posts · 5k+ votes
15y

Nope - not going to have it anymore Paul. If the usual suspects start the usual nonsense, their posts are going to be removed without notice.

I'm not in the mood . . .

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  • Brendan J.
    Homeowner · Knoxville, TN · Member since 2011 · 207 posts · 73 votes
    15y

    David,

    Yes. Taxes and insurance are calculated into the 50% rule. Debt service (Principle + Interest) is the only thing not factored in.

    Also, this goes without saying, but any repairs that are necessary to get a tenant in the property INITIALLY are not factored in. However, future capital expenditures are.

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  • David RobertsonBusiness Member
    OP
    Flipper/Rehabber · Kansas City, MO · Member since 2010 · 758 posts · 780 votes
    15y
    Originally posted by Brendan J.:
    David,

    Yes. Taxes and insurance are calculated into the 50% rule. Debt service (Principle + Interest) is the only thing not factored in.

    Also, this goes without saying, but any repairs that are necessary to get a tenant in the property INITIALLY are not factored in. However, future capital expenditures are.

    Thanks,

    That is really all I needed to know.

    FlipperForce
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  • Brendan J.
    Homeowner · Knoxville, TN · Member since 2011 · 207 posts · 73 votes
    15y

    I should have also said that the 50% rule assumes that a property manager is taking care of the rental. If you will be collecting checks, making service calls, etc, you could safely take off 5%. Make it into a 45% rule.

    0Reply
  • Paul B.
    Real Estate Investor · Alpharetta, GA · Member since 2010 · 415 posts · 484 votes
    15y

    Countdown to "50% Rule Flame War" in 3...2...1...

    0Reply
  • Joshua D.Pro Member
    BiggerPockets Founder · HI · Member since 2008 · 16k+ posts · 5k+ votes
    15y

    Nope - not going to have it anymore Paul. If the usual suspects start the usual nonsense, their posts are going to be removed without notice.

    I'm not in the mood . . .

    Podcast Guest on Show #100
    5Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    15y

    I think the main reason BP has the fifty percent rule is that way too many sellers, Realtors, gurus, and other parties interested in ONLY selling quote things like "only 25% expenses". Bigger Pockets is interested in the success of ALL Real Estate investors, whether seller, buyer, flipper, wholesaler, long term holder, etc...

    One mistake that investors make is that they use fifty percent of the rent collected as their basis. This is incorrect. The fifty percent rule is that you use fifty percent of the "collectable market rent"! For example, if the market rent is $1,000 a month, over time, your expenses will average around $6,000 a year. If you are charging only $800 a month rent, your expenses will still average about $6,000 a year.

    The other mistake is not counting lost rent as an expense. In the example above, if you are charging the market rent of $1,000 a month but have two months vacancy, you still use the $12,000 as a basis but you also have a $2,000 expense from the vacancy.

    Using the fifty percent number greatly increases your chance for success.

    5Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    15y

    50% rule includes three categories of expenses:

    1. All traditional expenses (taxes, insurance, maintenance, property management, utilities, etc);

    2. Vacancy and rent-loss

    3. Capital expenses.

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  • Brendan J.
    Homeowner · Knoxville, TN · Member since 2011 · 207 posts · 73 votes
    15y

    Mike, great points to remember.

    J, I hope you can get that "Leak House" closed soon. I'm excited to see what you guy's do with it.

    1Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    15y

    J Scott
    I want this to be an interesting and enlightened DISCUSSION, not a debate or argument.

    I have always understood Capital Expenses to NOT be in the 50% expense category. For example, if I have a 2 bedroom, 1 bath home and remodel it to a 3 bedroom, 2 bath home, that expense goes into my "Tax Basis" for depreciation but not into the 50% category. Or if I have a house with no garage and decide to build a garage to make it more desirable, that also goes into my basis but not the 50% expense category.

    Or is my understanding of the 50% expense categories incorrect?

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    Here is the data:

    2010 Survey of Operating Income & Expenses In Rental Apartment Communities

    Parse, categorize, label, etc. as you wish.

    2Reply
  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    15y
    Originally posted by Mike M:

    I want this to be an interesting and enlightened DISCUSSION, not a debate or argument.

    Agreed!


    I have always understood Capital Expenses to NOT be in the 50% expense category. For example, if I have a 2 bedroom, 1 bath home and remodel it to a 3 bedroom, 2 bath home, that expense goes into my "Tax Basis" for depreciation but not into the 50% category.

    I think we're in agreement...

    When I said Capital Expenses, I didn't mean rehab expenses to get the property into rental/habitable/marketable condition (though from a tax perspective those definitely are capital expenses)...instead, I meant the Capital Expenses needed to keep the property in that state after you start renting it out.

    For example, replacing the roof every 20 years or so, replacing the HVAC every 20 years or so, replacing the hot water heater every 10 years or so, etc.

    A lot of people call these "expenses," but from a tax standpoint, they're classified as capital costs, which is why I call them out separately. But, you're right that I didn't distinguish these from rehab costs, which are also technical Capital Expenses (which I don't believe are part of the 50%).

    Btw, the calculations I've done in the past have indicated that these types of capital costs should add about 5% to the total cost of holding the property over the long term, so if this isn't part of the 50% rule, you'll probably want to add another 5% to your estimates.

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  • Paul B.
    Real Estate Investor · Alpharetta, GA · Member since 2010 · 415 posts · 484 votes
    15y

    My take on the 50% rule is that it's *after* you've done your renovations, etc., but it includes my replacement reserves for future capital expenses. The 50% rule, IMHO, does not include initial sunk costs.

    So, if I buy a house for $30,000, then put $10,000 into it, that's $40,000 all-in, and it has nothing to do with the 50% rule.

    However, once I rent the property for a market rent of $750 per month, I expect that, over time, my expenses -- exclusive of debt service -- will be 50% of that amount, assuming I use a property manager. That means I am going to spend, on average, over time, $375 per month.

    To the extent that my cash expenses are less than $375 per month (again, excluding debt service), it would be prudent of me to earmark the balance to some replacement reserve account, assuming that I don't just happen to have a ton of money in the bank to cover the unforeseen.

    If I were using accrual accounting for my properties, I'd accrue the different between $375 and each month's net expenses and set those funds aside for replacement reserves.

    I don't mean to speak for him, but I think when J. Scott said capital expenses, he meant a reserve replacement for capital expenses that should be accrued for the future...the roof, the HVAC, and all of those other things that eventually zap you and wipe out a year or two's worth of earnings.

    2Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    15y
    Originally posted by Bryan Hancock:
    Here is the data:

    2010 Survey of Operating Income & Expenses In Rental Apartment Communities

    Parse, categorize, label, etc. as you wish.


    Bryan, excellent website to prove the 50% guideline that BP advocates when analyzing the POTENTIAL for a deal. Although they categorize it differently, it still proves the 50% guideline.

    Gross Scheduled Rent: $10,812
    Other Income: $ 764
    TOTAL: $11,576

    Expenses: $4,308
    Vacancy/Losses/Concessions: $1,482
    TOTAL: $5,790

    $5,790/$11,576
    Within $4.00 of being EXACTLY 50%!

    Or looking at it another way, the net operating income of $5,786 divided by the Gross Scheduled Income of $11,576 comes out to 49.9%

    Again, great article!

    2Reply
  • Mike McKinzie
    Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
    15y

    Wow, I thought we might have a little more discussion on this topic. I am glad to see that there are no flames here, just good discussion.

    As expenses can differ from state to state, so may the percentage. But if you have any size of a diverse portfolio, over a period of time, you will see expenses around the 50% range, just like the link shows that Bryan posted.

    0Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    I suspect people are being cautious Mike...since the "rule" generally starts pissing contests for no good reason.

    0Reply
  • Jeff S.
    Specialist · Portland, OR · Member since 2010 · 3k+ posts · 1k+ votes
    15y

    This 50% rule is good from my experience. In 1991 I bought 2 older (close to 100 years old) duplexes and an older house that was owned by a landlord who did as little as possible. Over a 20 year period my expenses (including all repairs, roofs etc.) averaged 47%. I manage them myself and am very frugal keeping long-term tenants happy. The last 10 years expenses have creeped up a little over 50%. This tells me to start increasing rents.

    0Reply
  • Peter Seely
    Select a State · Member since 2011 · 90 posts · 3 votes
    15y

    Hi,

    I am a newbie to this site and really glad I found it. Great tips especially the 50% rule and the 2% rule. With my one rental unit I currently have I would say this 50% is pretty accurate, however, that is without taking into consideration an emergency fund for unexpected cost($100 month). To clarify a post from Mike:

    One mistake that investors make is that they use fifty percent of the rent collected as their basis. This is incorrect. The fifty percent rule is that you use fifty percent of the "collectable market rent"! For example, if the market rent is $1,000 a month, over time, your expenses will average around $6,000 a year. If you are charging only $800 a month rent, your expenses will still average about $6,000 a year.

    In regards to the above, whats the best way to find the "collectable market rent" and what do you mean by this. I apologize for my ignorence. (I take as current rental rates in your location). I am currently looking a purchasing a rental unit in Georgia?

    In addition, does this apply to condos/town houses with HOA fees?

    Thanks for your help and I think I will learn alot from this site.

    Peter

    0Reply
  • David Beard
    Investor · Cincinnati, OH · Member since 2010 · 1k+ posts · 928 votes
    15y

    This is not a reference to differences between the rent you're charging and "fair market rent".

    Expenses should be considered to be 50% of "Gross Potential Rent", which is simply your monthly rental rate * 12. "Collected rent" is less than this due to vacancies and bad debts. That's my interpretation.

    1Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    That is correct David. The difference is "economic loss:"

    -Loss to vacancy
    -Collection losses
    -Concessions

    Note that concessions reduce "vacancy" and looser screening also reduces "vacancy," but increases collection losses. Nothing in life is free.

    The trick is trying to optimize the mix of these items while maximizing rents and thus profit for the project.

    0Reply
  • Jeff S.
    Lender · Los Angeles, CA · Member since 2009 · 1k+ posts · 2k+ votes
    15y
    Originally posted by Peter Seely:
    In regards to the above, whats the best way to find the "collectable market rent" and what do you mean by this. I apologize for my ignorence. (I take as current rental rates in your location). I am currently looking a purchasing a rental unit in Georgia?

    Mike's “collectible market rent†is just the prevailing rent for your type of home in the area. That is, the amount you could rent your property for. You obtain this by doing a rent survey.

    You do a rent survey by calling property managers, searching Craigslist, local newspapers, driving the area looking at for rent signs, and however else rental properties are advertised in your area.

    I’d suggest that since you have a specific property in mind Peter, you do a detailed cash flow analysis by obtaining actual expenses and rents instead of using this rule-of-thumb. It will better define the performance of your investment.

    1Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    The rule of thumb is good for screening. Don't tell that to the worshipers though!

    1Reply
  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    15y
    Originally posted by Bryan Hancock:
    Here is the data:

    2010 Survey of Operating Income & Expenses In Rental Apartment Communities

    Parse, categorize, label, etc. as you wish.

    This report seems to indicate that the 50% rule is on average close to what has been actually reported for apartment complexes and includes capital expenditures

    0Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    Yeah...but the report is also really for larger units. Things vary by size, product type, etc. An average is a nice first pass, but is no substitute for in-depth due diligence!

    0Reply
  • Kenneth LaVoie
    Rental Property Investor · Winslow, ME · Member since 2008 · 826 posts · 281 votes
    15y

    In response to the deduction of the 5% if self managing: I like to include an 8% mgmt. fee paid to myself when factoring expenses for two reasons:
    1. I may want to offload mgmt. to someone else. If so, I need to know the cash flow is still appropriate.
    2. I want to know how much I make for my cash investment, and how much I make for my "work" (management). This makes it easier for me to decide on the value of the property I'm either looking at, or already own in the case of deciding which to sell.

    0Reply
  • Dick M.
    Electrical Contractor · both, Maine & Florida · Member since 2011 · 129 posts · 53 votes
    15y

    If I can lower it by 5% for managing it myself, can I further reduce it for doing all repairs myself?

    0Reply
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