50% Rule Expenses

9 Replies

So I'm estimating expenses and trying to figure out the 50% rule. I'm an experienced flipper, but moving to buy and hold. I understand the need for CAPEX reserves (5% of GOI) and property management (8% GOI), taxes, insurance, general maintenance (1% of property value). I'm planning on tenants paying utilities, HOA's, and won't buy in a flood zone.

So far, I'm up to about 34% of gross operating income.  

So, the obvious question is, what am I missing? Anything important or is my percentage low just because of my choices around HOA's, utilities, etc? Thanks in advance.

Property management is often quite a bit higher than 8%.  Its typically 10% of collected rent plus half to a full months rent to fill a vacancy.  At half a month and one vacancy per year, plus 10% of rents that works out to 14%.

But the key is that the 50% number is simply a empirical rule of thumb from some large datasets for hundreds of thousands of apartments.  Its not an addition of a bunch of slices.  Rather, it acknowledges its very difficult to predict some expenses, but you need to account for them.  Its really easy to slice this into pieces, then convince yourself the pieces are smaller.  But reality will be whatever it is.

Tenants don't typically pay HOA fees. Those are yours, if you have properties in an HOA.

You will also have legal and CPA costs, you must account for major tenant damage and lengthy, ugly evictions.  You may have utilities, too, at least when the unit is empty.

@Jon Holdman - All very useful comments.  Thank you.  I was missing vacancy rate and did not account for higher fees with tenant placement.  Thank you very much.  Problem is it's stinking hard to make the numbers work without a sizable down payment.  Getting a little discouraged...

I go by a very simple analysis. Each unit in the building has to make me $100.00 free money, in my pocket, per month or I am not interested in purchasing the property.  As an example, the last property I purchased some 5 years ago put $800 per month on  an eight family, or $8,000 by the end of the first year. After that I plan on raising rent each year to put an addition $800 the second year and 10% every year additional after that. Thats the way I do things. 

@Mike Sedlacek - Very sound. But what about the initial investment. I'm looking at single family. If I purchase a house, I need 20% down - let's just say purchase price is $100K. So, $20K investment, plus closing costs is ~ $24K investment. If my standard is $100 NOI per month, It's 12 years before I break even on the investment (not accounting for rent increases, tax deductions, appreciation). I'm having trouble justifying those numbers. The cap rate is 5%. Not much better than a money market account. Little help?

@Don Nelson If you finance traditionally, you could put considerably less down than 20%. Say 5%, that would mean you're in to the place for about $9k after closing costs. So if you can net $100/month, that would put your ROI at 13.3%. Not terrible.

@Kevin D. : I'm not aware of any loan that allows 5% down unless it's owner occupied. I will not be moving in, so that's a non-starter.

Like Jon said, HOA is usually on you. But you are not thinking of major things like HVAC, roofs, electrical, plumbing... 5% of CapEx probably isn't enough. Also, you have to look at vacancy which is probably 1 month or 8%

Good luck

Are you a first time buyer? FHA loans are at 3% down. Check with your bank on FHA loans. They also have FHA non occupied, investor loans with low down. My system doesn't work on single family homes. You do have to examine tax benefits of ownership on single family homes. Most investor that I know that purchase single family homes buy based on appreciation for the long haul, 20 years or so and depreciation on thier tax forms to figure thier ROI.

@Mike Sedlacek - Thanks again for the clarification.  I guess I was hoping for a better return.  I will get back to crunching numbers and account for potential appreciation, depreciation, and tax deductions.  I will also look at multi-family, as my primary goal right now is residual income.

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