50% rule

41 Replies

Hey guys!! Rookie question here. Can someone give me a breakdown of the 50% rule using this example? I have already calculated it myself, I just want to be sure I am doing it correctly.

Purchase price- $75k

Rehab cost- $10- 15k.

Taxes and insurance- $300 month

Minimum potential rent- $1100-$1300

Other info:

New roof, new a/c, ARV $125k - $130k

Any insight on the 50% rule or 2% rule will be appreciated.

The 50% rule simply says that 50% of gross rents will go to vacancy, expenses and capital. This does not include the P&I payment, but does include taxes and insurance.

$1100 to $1300 is a very large range. I'd try to get a better handle on rents before anything else.

if your question is only regarding the 50% rule, then all the info you provided other than the gross rent range is irrelevant to the rule. The rule says that IF the rents are $1100, then your expenses (not counting debt service) will be $550. If the gross is $1300, then the expenses will be $650. Simple as that.

Thanks for the quick response guys. Jon the reason I say the rents can range from $1100-$1300 is because I can rent it as is for $1100 or if I put some updates into the property I can get around $1300. Will, after subtract the 50% for expenses, do I subtract P & I from the other half to get the true cash flow? Also, I only provided all other info just because I appreciate when posters include all info so I can get a better picture of the deal.

Yes, the rule does not cover debt service so the balance 50% remaining is for debt service (principle and interest) and cash flow.

And I can appreciate that you added in other info, it is always helpful, I was just pointing out for your benefit and that of others that the other info had nothing to do with the 50% rule.

Hello All,

I am curious how market dependent this rule is. For instance, I applied the rule to all the listings in a strong market in Texas. Out of 100+ listings, not one met the acceptance criteria of >$100 per unit per month positive cash flow or an ROI of more than 11%. In fact only one is 11% and all the others are less than 8%. Does this sound right or could I be doing something wrong? Thanks so much for your help and I appreciate all the great information here.

@Chris Hougland

Welcome to BP!

It is possible that properties in your immediate vicinity, at current market prices, do not provide a sufficient return to meet your needs. This is the situation in our local market. For the most part, properties are so fully priced, that obtaining a suitable return (however you would like to measure it: CoC, IRR, etc) is not possible. There are still deals, but they are far between.

While the 50% is more of a quick guide to help you size up a property for further analysis, statistically it holds over the long term {some folks use a variant of 60% for Multi-family properties where the landlord carries the utilities}, which is why it makes a good first filter.

The key is to be patient and only purchase properties at prices that work for you. Sometimes it leads you to invest in a place other than where you live.

Originally posted by @Chris Hougland :
Hello All,

I am curious how market dependent this rule is. For instance, I applied the rule to all the listings in a strong market in Texas. Out of 100+ listings, not one met the acceptance criteria of >$100 per unit per month positive cash flow or an ROI of more than 11%. In fact only one is 11% and all the others are less than 8%. Does this sound right or could I be doing something wrong? Thanks so much for your help and I appreciate all the great information here.

The 50% Rule doesn't say anything about the quality of deals. All it says is that, on average and across lots of units, long term, about 50% of gross income will be used to pay for expenses, rent loss and capital costs.

Whether you will be able to find good deals in your market is completely independent of the 50% Rule.

@Michael Baradell , as mentioned above, the 50% rule is a good guideline. You also need to look at actual figures. Texas has a wonderful fast growing economy. The rent to real estate costs are way off from many parts of the country. You will probably not make the 2% rule. That rule is simply getting 2% of your property cost back in rent per month. For example a $100K property would rent for at least $2K using the 2% rule. I have not heard of that happening in Texas, or many other markets. The 2% rule still happens in some areas but not as many. it is usually where house prices are cheap, $20K to $35K, and there is not much new building so rent tends to stay higher. The mid west is an example of this.

In Texas right now there is a fair bit of building but even then property values are climbing relatively fast so you have increases in value of really good rates. You simply will not make the same returns in Texas as other places, but property values increase. I would be even more leery of fudging on the 50% rule in Texas. Property taxes there are pretty high, probably due in part to not having state income taxes. Hope this helps.

Originally posted by @J Scott:
The 50% Rule doesn't say anything about the quality of deals. All it says is that, on average and across lots of units, long term, about 50% of gross income will be used to pay for expenses, rent loss and capital costs.

Whether you will be able to find good deals in your market is completely independent of the 50% Rule.

This is the very best, most accurate statement on the 50% rule. I certainly hope that all read it and understand it, as there seems to be so much confusion on mixing the 50% rule and that of a quality of a deal or having deals "meet the 50% rule". As I have stated before and J stated perfectly in this quote, there is no such thing as a property meeting the 50% rule, it is this rule that states that all properties will have an average of 50% expenses, nothing more, nothing less.

What I meant by meeting the 50% rule is finding a suitably profitable property when using the rule, which I intend to do.

I appreciate the responses above. Mostly what I was concerned about is an entire market at a snapshot in time not providing any suitable ROI when utilizing the 50% rule. If it can be that rare to find profitable and worthwhile properties in some markets, then at least I am more confident that I am doing my analysis correctly.

Thank you all and it really is helpful to have someplace to post to get so much good information.

@Chris Hougland

yes that's the problem, it's not easy to find properties that work as profitable long term investments. Don't be discouraged, it's much better to evaluate real properties and base your numbers on actual expenses in your market versus averages. You'll learn the numbers that work for you and be better prepared to make your offer when you find properties that meet your criteria.

I would aim for more than $100 net cash flow/month, that's break even in my experience.

I'm not sure what your buy strategy is, but are you looking at distressed, wholesale or "problem" properties? I've had more success with problem properties. They sell at a discount, I fix the problems and make them nice places to live. I've purchased a few turnkey properties, at or close to retail, and have not done as well with cash flow or return. On the positive side, they're less work and quick to rent.

@Michael Baradell I agree that's a large rent range and would evaluate based on the lower end. A common new investor mistake is overestimating rents. Yes, updates and nice finishes generate more interest and maybe higher rent, but depending on your market, many renters expect up to date finishes. We have two similar rentals in the same area, one with a stainless kitchen and the other with white appliances. They rent for about the same, but the one with stainless consistently rents more quickly.

Thanks for all of the responses guys!! It really helps to see different perspectives.

I do have an update on this deal that I figured I would share. This particular deal started out as a fix and flip, however my backup plan was to fix and hold. I ended up listing the property and this was the outcome.

On the market for 33 days. In that time I had 14 showings and countless Internet and phone leads. Just yesterday I received two offers. The first was about 9k off asking price including closing costs. The other however, was for full asking price with no contingencies or seller assist.

Here's the breakdown of the entire process:

Purchase price- $85k plus seller paid $3k for closing

Initial plan- $15- $18k rehab costs, 4 week time frame

What really happened (haha)- total rehab and carrying cost up to this point

$28k!! Time frame- 9 weeks.

Selling price $143,900

All in for about $115k

When all the dust clears there will be a profit of around $24k before taxes. Of course there are still inspection so hopefully all goes well.

Overall, I would call it a success for my first flip. I have learned a ton, paid way too much to my contractor and mismanaged the project terribly, but it looks like I will survive!! BP has played a huge role in this process and I'm very thankful for that. On to the next!!

Yep, that a good one!

Well, now that I understand that expenses will be half my gross rents, it just makes sense then, to reduce my expenses just reduce the rents! :)

Originally posted by @Michael Baradell :

Here's the breakdown of the entire process:

Purchase price- $85k plus seller paid $3k for closing

Initial plan- $15- $18k rehab costs, 4 week time frame

What really happened (haha)- total rehab and carrying cost up to this point

$28k!! Time frame- 9 weeks.

Selling price $143,900

All in for about $115k

When all the dust clears there will be a profit of around $24k before taxes. Of course there are still inspection so hopefully all goes well.

First, congratulations!!!

Second, are you sure you included all your expenses when you determined your final profit number? If you paid $85K and spent $28K on rehab, that's $113K not including your fixed costs.

If you're selling for $143,900, that's a $30,900 profit minus fixed costs. Are you sure you only have $6400 in fixed costs? It's quite possible if you're selling FSBO (no commissions involved) and if you're not paying any concessions or closing costs of the buyer, but these are less common circumstances.

Typically, closing costs (on the buy and sell side), holding costs (taxes, insurance, utilities, etc) and selling costs (concessions, commissions, home warranty, etc), tends to be closer to 10% of the selling price, if you're doing an all-cash deal (i.e., you have no loan costs).

Regardless, sounds like a successful deal...congrats again!!!

@J Scott I have accounted for all spending. The $115k amount is what I anticipate spending by the time closing comes around. Taxes and insurance are included in that amount as they were paid in full at closing, not escrowed. The financing I have is an interest only loan, so we have only paid three interest payments totally around $1350. The electricity bill has not exceeded $85. I have it listed my self, so I am only paying 3% to the buyers agent. I should have specified that ALL costs were included in the $28k ( minus 3% commission ).Because of the type of financing, I was able to pay ( and keep track ) of everything through the one construction account. I wrote checks for everything, no cash. There are no other concessions or closing costs that I will be responsible for at closing.

@Kevin Pfeiffer Thanks!! BiggerPockets has not only provided a ton of knowledge but also has given me the confidence to trust my instincts. I am finding that a lot of potential investors I speak with never get started because they never get the full support or backing from their friends and family. For me, one of the most difficult hurdles to overcome was the negativity that came from friends and family about how risky it will be. I was afraid of the " I told you so" conversation that would take place if the deal went badly. The way I found to overcome that fear was by simply trusting the numbers and my research and just going for it. I am set to close on my first flip in about two weeks and I have just picked up another that is set to close ( initial purchase ) in about two weeks as well.