Ft. Worth, TX · Member since 2008 · 97 posts · 16 votes
I know the "50% rule" is bandied about as gospel here in the forums, but haven't seen any actual, hard data that says that operating expenses tend to be ~50% of gross rent income. I'd like to verify this number is, in fact, accurate. (I believe that it probably is; but I owe it to myself to verify my assumptions, right?)
It would not only help me ensure that I'm using realistic numbers, I also think that it would be good data (ammunition?) to have when negotiating.
Can anyone provide links to studies that address operating expenses as a percentage of gross rent income? The little searching I've done hasn't yielded anything.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
18y
NogginBoink,
When I first started in the rental business, I read all the "guru" nonsense books. By the time I was in business a year, I had probably read 30-40 books and had seen many "gurus" talk. Most of the "gurus" never mention expenses because they are trying to upsell the "student" to a more expensive course, bootcamp, or training. Of the gurus that did mention expenses, several talked about taxes and insurance. Others talked about taxes, insurance, management and maintenance. At the one year point, I had about 10 rentals and had been very lucky. I hadn't had a single vacancy or any other irregular expense, such as evictions, court costs, damage done by tenants (in excess of the deposit), etc. I felt like a GENIUS! I thought that I had found a business that simply made money hand over fist!!!
Unfortunately, that was short lived. As my portfolio continued to grow, I had a vacancy. Then an eviction. Then damage done by a tenant. Then a drug bust. Etc, etc, etc. In other words, I began to experience the REALITY of the business, which was quite a bit different than the silly guru hype. I began to fell more like an IDIOT than a genius. Shouldn't I have known that tenants get evicted? Shouldn't I have known that there would be vacancies? Shouldn't I have known that tenants would damage my property? The answer was YES, I should have known, but instead I had chosen to be ignorant and believe the nonsense that I read in the dozens of guru nonsense books!!!
I knew that there had to be an answer out there. I started looking at all the apartment and rental housing data I could find. This data included hundreds of thousands of rental units throughout the United States. What I found out is that throughout the United States, operating expenses run 45% to 50% of the gross rents. That's where my "50% Rule" came from.
The only thing that saved me from joining the majority of other newbies that fail is that I'm extremely competitive. After I bought one of my first houses, I heard of another investor that bought a house for the unbelievable price of $20,000. I knew that if that investor could do it, so could I. My competitive fangs came out and I was on the search for properties at a HUGE DISCOUNT. So, even though I didn't understand the operating expense issues at this early point, my competitiveness saved the day.
I've been preaching the "50% Rule" every since, mainly because I was so frustrated that the gurus were either lying about the expenses or didn't understand them. That's how the "50% Rule" came to be.
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
17y
Franklin,
Can you provide detailed, complete data? Remember, the 50% rule includes vacancies and capital items. So, any loss to do vacancy, whether actual (i.e., a unit is empty) or economic (they didn't pay the rent, or your father gave them free time) needs to be added to the actual expenses, and compared to the gross scheduled rent.
Also, capital items like furnaces or roofs would need to be included, too. For example, if you own 30 houses, its probably an annual task to replace a roof, on average. If a roof lasts 30 years, and costs $3600, that's a $10 expense item, per property, per month.
Property Manager · Portsmouth, NH · Member since 2008 · 102 posts · 13 votes
17y
You can technically be making money with a $100 per month negative cash flow. The thing is, part of your cash is going to a mortgage, part of each mortgage payment is principal and part is interest. The principal part is not an expense, it's a transfer from one asset account to another.
Now obviously a $100 per month negative cash flow is still bad. But let's suppose you have $6,000 increased equity (assuming stable prices) at the end of the year. Guess what - you were profitable. (And if you don't believe it now, you will when you file your taxes.)
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
17y
True. But, in the first year of a $100K loan at 7% your "principle paydown" is exactly $1015.81, not $6000. $600K houses make really bad rentals. You have to be 25 years into that 30 year loan before you get $6000 a year in principle paydown.
Doesn't show up on your taxes, either, until you sell.
Franklin,
Can you provide detailed, complete data? Remember, the 50% rule includes vacancies and capital items. So, any loss to do vacancy, whether actual (i.e., a unit is empty) or economic (they didn't pay the rent, or your father gave them free time) needs to be added to the actual expenses, and compared to the gross scheduled rent.
Also, capital items like furnaces or roofs would need to be included, too. For example, if you own 30 houses, its probably an annual task to replace a roof, on average. If a roof lasts 30 years, and costs $3600, that's a $10 expense item, per property, per month.
Can you show us the data?
Sure, Jon. I would love to share it with you. Unfortunately, I'm at college now and cannot do this. However, when I come back home in three weeks, I'll let you know because I'm absolutely certain that the 3 year data(of 6 rental houses)I've observed has shown that operating expenses over time were close to 30% of the gross income.
Of course, my father(the owner) managed these rental houses for over thirty years and my mother is a realtor. She always bring good, quality tenants in before a vacancy so vacancy is out of the factors.
I'm going to break down the 50% rule into these factors:
Taxes: 5.5-7%
Repairs: 6%
Heating fuel: 13.5%-16%
Water:1%-1.5%
Insurance: 5%
Electricity: 1.5%
Vacancy: 3%
Property Management: 10%
This is what I've got from reading "What every investor needs to know about cash flow." Of course, these are examples from his book. I wish for someone to publish the true average of these factors so I would like to know what to subtract from the 50% rule.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
17y
Franklin, It is quite possible to go for three or even 5 years without a vacancy at any one of three properties, but over a 10 year or more period and spread over dozens of doors, you can't possibly have 100% occupancy and therefore, you must and should calculate that into your expenses. Granted you can manage yourself and do repairs yourself, decreasing costs, but you should also account for your time which must be worth something, right?
Can you get 30% OE on a property over a 3 year period? YES, Can you sustain that low of a ratio forever and over a portfolio of say 30 doors, no way. Can you average 40% in that scenario, YES, as some properties in some locations have somewhat lower expenses. Your exit startegy and purchase strategy can also be taken into consideration and can reduce OE, but this 50% rule is just a safe average to go by for evaluating cash flow on potential acquisitions.
I am not a fan of averages, but I do use this calculation as well as others for making some analysis on properties. Take it for what it is worth to you.
True, Will. For the average Landlord who is only managing 6-10 houses, operating expenses differ from the one who is operating at least 20 units.
I remember my dad talking about vacancy and he said he has never had a vacancy problem in any of his rental units in his thirty years. I thought he was lying but it seemed to me that he was telling the truth.
I also learned that our tenants are not just any other tenants. These are tenants that stayed in my father's houses for at least ten years!
Also, we have to realize that cash flow is being overly represented here in this forum. It's actually the leverage you are taking in account and using other people's money that gives you the most money in return!
Rental Property Investor · Mercer Island, WA · Member since 2008 · 22k+ posts · 14k+ votes
17y
Certainly, there are other ways to make money from real estate than cash flow. There have been periods, like between 2000 and 2006 where you could have significant negative cash flow and STILL walk away with a huge payday. I suspect we'll be back to some more normal appreciation in a few more years.
That said, this thread is about cash flow and cash flow rental investing.
I just now looked over the last few posts of this thread and see that I missed something important. The proceeding breakdown of the 50% Rule is total fiction and gibberish. It doesn't even include many of the expenses and the ones it does include are gibberish. You can NOT break down the 50% Rule by predicting the individual expenses in this fashion. For example, how much "heating fuel" does a rental really need in Southern Texas? Does it really take 16% of gross rents to heat a home in Southern Texas? Is that the same as Minot, North Dakota? Are vacancies really only 3% and are they 3% across the nation and over different time periods? Is ANY property exempt from capital expenses? Never an eviction? Legal expenses? Office supplies? Advertising? Lawsuits?
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
15y
On the one hand, the 50% rule is just pure fiction. On the other hand, the 50% rule of thumb is an excellent tool to calculate probable expenses on a rental.
Why is it pure fiction? Because the amount of rent charged on a property has absolutely no correlation to the expenses involved. For example, if I had a house that rented for $1,000 a month and wanted to lower my expenses, all I would have to do is lower the rent amount. That is totally ludicrous. Or lets say I raise it to $1,200 a month, do my expenses jump as well? Of course not.
BUT, with that being said, over the long haul, across many properties, you will find that your expenses will be between 45% and 50% of the MARKET RENT you should have collected.
Here is an error that many people make. Again, lets look at the house that rents for $1,000 a month. You have had it for a couple of years and you check your 2009 numbers. You see that you collected $11,000 in rent (had one month vacancy)and had $5,000 in expenses. So you think that you had a 45% rate of expenses (5,000/11,000). But you are not figuring it correctly. The way to figure it is that market rent for the year was $12,000. Plus, you have to add the LOST RENT of $1,000 to your expenses, making it $6,000 in expenses. Now you have exactly 50% in expenses.
To reiterate, your expenses have no correlation to your collected rent, you can't charge UNDER market rent to lower your expenses. BUT, when looking at a new investment, take the MARKET RENT, times it times 12, and figure 50% to cover every expense except for Debt Service. If you don't have 50% expenses in a given year, take that money and PUT IT IN YOUR RESERVE FUND, because that expense will come.
Real Estate Investor · Snellville, GA · Member since 2010 · 213 posts · 12 votes
15y
I have been in house rehabbing for a few years and it was always said 50% is the most it really depends on where you are. I know some places in California if you can get 65% your doing good. The problem I have had and the reason I quit doing residential is. It became too competitive. if I buy a house for 65 i want to come close to doubling my money in a few months but here people would be glad to make 25k in a few months and if you take out the carrying costs and advertising that's no money so I got out I wouldn't touch a house unless I was making 65k and up and I would never pay more than 150k for a house. The house had to be able to be sold with a 30% discount with my profit.
Developer · Santa Clarita, CA · Member since 2008 · 15k+ posts · 10k+ votes
15y
Anthony,
The 50% rule is not for or about flipping homes and does not refer to % of value. What it refers to is % of operating expenses on buy and hold properties (residential).
Real Estate Investor · Sacramento, CA · Member since 2011 · 11 posts · 0 votes
15y
Sounds like a fast talking guru to me. It his example:
Annual Rent - $21,660
Annual Operating Expenses - blank, blank, blank, blank .... ummm...hmmm...ohhh - $7,812
New York, NY · Member since 2008 · 88 posts · 8 votes
14y
Folks
Does the 50% apply to an owner-occupied 2-family house as well? Or would it be a different number? Also, is the 50% after calculating tax deductions you can take for the rental unit maintenance, renovations, etc or would it lead to a lower number?
Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes
14y
The 50 % rule, if you use it, would apply to the side you rent out. So, half of the rents for that side would go to that side's expenses. What is left over would pay for that side's half of the mortgage and any left after that would be your "profit". Then, on the side you live in, you can use your "profit" to help pay for the other half of the mortgage or not. Its up to you.
The expenses covered in the 50 percent rule cover taxes and insurance as well as maintentance, management and amortized capital improvements. I would apply it before the deduction and just consider any gain from the deduction a bonus. Hopefully you will not have so many repairs that the tax deduction is that much of a benefit!
Also, by applying the 50% rule so specifically - after deductions, before deductions - you are using an axe where you should use a scalpal.
Investor · Wichita Falls, TX · Member since 2010 · 3k+ posts · 603 votes
13y
Regardless of how you look at it, the 50% rule is an awesome litmus test to throw at a potential investment. After reading this thread I can't help but do it!
Investor · Westminster, CO · Member since 2009 · 1k+ posts · 1k+ votes
13y
Andy
Nothing "failed." so I don't get your post? I can show you one property for one year where the expense were only 25% of the market rent. But I can also show you one property where the expenses were 100% of the market rent, FOR ONE YEAR.
I have mentioned several times on here of a POST that showed the one year income and expenses for over 1.1 MILLION apartment units. That post showed the total expenses for those units to be 49.98% of MARKET RENT.
If you took every single rental in the United States, factored in Market Rent and then figured expenses, including vacancy, the number would be very close to 50%.
It is not some guru talk, it is not some invented number pulled from a cloud, it is FACT derived from decades of study of millions of rentals.
If you bought 100 rentals, all less than 10 years old, you might keep expenses under 50% and if you bought 100 rentals, all over 100 years old, your expenses would probably exceed 50%.
So just use the 50% rule as a guideline when purchasing a long term rental. The biggest FAILURE of new investors is UNDER estimating expenses.
Specialist · Memphis, TN · Member since 2012 · 1k+ posts · 1k+ votes
13y
Considering the fact that you can have a simple calc on your phone, ipad and computer and if you are working in an area where you should know what property taxes are roughly whats wrong with taking 60 seconds to work out the costs rather than "hoping" that 50% is correct.
Insurance, taxes, vacancy, maintenance and management fees can all be in a spreadsheet as percentages. Put in the purchase price, rehab costs and rent and the actual expenses will magically appear. Why guess??