50% Rule and Analysis

18 Replies

Hey everyone,

I am a new investor set to buy my first home. I have my team assembled, down payment ready, and am now looking for a deal. I'm mainly looking for 3 bed/1 bath houses around the $40-60k with little rehab needed. I will be investing in the Midwest.

My main problem is that when I run the numbers through the BP Buy-and-Hold calculator, my Cashflow number always comes up way short of what the 50% Rule would indicate. I know that the 50% Rule is just a guideline, but my numbers are pretty far off and I am well inside of the 1-2% Rule, so I feel they should be cashflowing more. 

I'm possibly being too conservative with the number(s) that I'm putting into the variable landlord expenses, but I feel as though I am being fair and cautious (I'm following Brandon's advice and setting aside about $200/month for CapEx), have a Vacancy Rate at around 5-7%, Repairs and Maintenance at 10%, and Management Fees at 10%.

My loan value is fair as well at 4.825% w/ 1 point on a 15-year note.

Perhaps that deal just hasn't come along yet, but any advice on how to run my numbers more accurately would be helpful!

Thanks,

Alex

The 15 year note is what is likely killing your cash flow. Paying down principal on a rental is a mistake. If you can not get a 30 year on low priced homes you are going to be stuck with no cash flow.

Thanks for the insight there, Thomas. I posted one of my analyses here for anyone to check out:

https://bp-v-newproduction.s3.amazonaws.com/uploads/calculators/shared_report/report_file/434f806a-c6c8-4716-9a64-35e61a2397d3/report.pdf?X-Amz-Expires=601200&X-Amz-Date=20180901T024801Z&X-Amz-Algorithm=AWS4-HMAC-SHA256&X-Amz-Credential=AKIAJ2DXENEECSJVAAQA/20180901/us-east-1/s3/aws4_request&X-Amz-SignedHeaders=host&X-Amz-Signature=b8857649cd7fde5b88e88972c3c353baa462972317053da4bbc716089aab598a

Here are the numbers for the property:

Overview

Monthly Income: $900.00

Monthly Expenses: $961.09

Monthly Cash Flow: -$61.09

Pro Forma Cap Rate: 3.54% 

NOI: $2,016.00

Total Cash Needed: $16,225.00

Cash on Cash ROI: -4.52%

Purchase Cap Rate: 3.54%

Property Information 

Purchase Price: $56,900.00 

Purchase Closing Costs: $2,000.00 

Estimated Repair Costs: $0.00 

Total Cost of Project: $58,900.00

After Repair Value $56,900.00

Down Payment: $14,225.00 

Loan Amount: $42,675.00 

Loan Points: $0.00 

Loan Fees: $0.00

Amortized Over: 30 years 

Loan Interest Rate: 5.000% 

Monthly P&I: $229.09

Expenses

Vacancy $54.00 (6%) 

Repairs $90.00 (10%)

CapEx $198.00 (22%)

Insurance $100.00 (11%) 

Management $90.00 (10%) 

P&I $229.09 (25%) 

Property Taxes $200.00 (22%) 

Total $961.09 (107%)

Financial Projections 

Total Initial Equity: $14,225.00 

Gross Rent Multiplier: 5.27 

Income-Expense Ratio (2% Rule): 1.53% 

50% Rule Cash Flow Estimates 

Total Monthly Income: $900.00 x50% for Expenses: $450.00 

Monthly Payment/Interest Payment: $229.09 

Total Monthly Cashflow using 50% Rule: $220.91

@Alex Kies , depending on how recently the big ticket items were updated/replaced (eg. roof, furnace), you could consider not allowing 22% expenses just for cap ex, but perhaps a more modest  $90.00 (10%). I'm not sure where (or if) it has become the norm to allow $198/m for cap ex, regardless of starting condition.

It's true that the lower the value of the property, the higher its repair expenses will show up, as a percentage of rent.

The other item that stuck out to me is Property Tax: $200/m? Really? 22% rent!? Is that actual?

In this case, if 1.5%+/m rent-to-value is realistic, it should cash flow. Perhaps not averaging as much as $200/m, but, I reckon it should average more than $100/m. 

Like Thomas mentioned, it also depends on the mortgage terms you can get! If you're borrowing less than $50k, your ability to get the best rates/terms could be hindered. ie. Lenders prefer to lend more, against better properties! My 2c...

There’s a few things going on here . First 57 grand for 900 in rent is a marginal deal it’s not bad not great . Second taxes are 2400 a year . That’s too high on such a cheap property . Third ,after the place is stabilized you shouldn’t need 200$ a month for cap ex unless the place is a dump. Third your paying 10% to a pm because you can’t self manage due to distance . I realize in your case that is a necessary evil but it’s eating into your potential profit by quite a bit . The insurance of 1200 a year is astronomical you are paying about double what you should pay 

Wow; taxes and insurance fixed costs are huge and will only go up...are the rents maximized or is this figure for annual lease?

Are short term leases permitted; maybe a corporate rental could yield higher rents?

Thank you @Brent Coombs , @Dennis M. , and @Elise Hazzard  for the insight!

For taxes, I am putting Property ($690) and Land ($1,770) together to get the $2,400/year in taxes (they actually add up to $2,460). I got these numbers from realtor.com because the county assessor does not list these figures online. Would I not be paying for the land tax- only the property?

And yes, after a bit of digging I did find that the insurance would be more in the $40-50 range- so that's good!

After adjusting the Insurance and monthly CapEx, I am cashflowing at about $96/month- if the taxes were not as high, it would definitely help!

Definitely hear you there @Account Closed , do you have any particular insight on how to avoid this with cheaper properties? Are you directly referring to issues with bad tenants or issues with major property expenses, or something else?

@Alex Kies Property taxes are 5% the cost of the home. NOPE. That’s a sure fire sign of rust belt dessication. Someone needs to do a PSA on CA investors looking to buy in the Midwest. There are genuine no good very bad ********s out here that will almost certainly not come back before breaking you. M
Originally posted by @Alex Kies :

Definitely hear you there @Benjamin Maciel, do you have any particular insight on how to avoid this with cheaper properties? Are you directly referring to issues with bad tenants or issues with major property expenses, or something else?

 There is a reason they are lower end properties. Low end appreciation. Low end tenants. The issue with buying these properties is expenses, including labor continue to rise--- and rents don't keep up. If you can self manage, and do all the work-- you are set. But if not--- good luck. 

Thanks @Ray Johnson , for the insight. I've got a great agent in the area as well as a reputable Property Management company. I was born and raised in this area, so I've got other objective contacts with many decades of experience to assist with Due Diligence. I've also got my loan Pre-approval process underway and have been given the above numbers (5%, 1-point) as what my interest rates will be. My minimum Cashflow would be $200/month. 

As for the low end tenants, @Account Closed , I definitely don't want to go down that road- I'd rather not deal with low quality tenants. For that, I am looking closer to the state university in the town and farther away from the quasi-warzone area where all the $20k properties are. I will also be very clear with my property manager about tenant screening (prior evictions, criminal records, etc.). 

Any words of advice for avoiding low quality tenants?

Originally posted by @Alex Kies :

Thanks @Ray Johnson , for the insight. I've got a great agent in the area as well as a reputable Property Management company. I was born and raised in this area, so I've got other objective contacts with many decades of experience to assist with Due Diligence. I've also got my loan Pre-approval process underway and have been given the above numbers (5%, 1-point) as what my interest rates will be. My minimum Cashflow would be $200/month. 

As for the low end tenants, @Benjamin Maciel, I definitely don't want to go down that road- I'd rather not deal with low quality tenants. For that, I am looking closer to the state university in the town and farther away from the quasi-warzone area where all the $20k properties are. I will also be very clear with my property manager about tenant screening (prior evictions, criminal records, etc.). 

Any words of advice for avoiding low quality tenants?

Of course. Avoid low end properties. I have bought lower end properties and been through that experience. Great ROI's--- but every month it was something. I.e gun shots, late rent's, domestic violence etc. Especially in Multi-family 2-4 unit complexes. I now believe the "buy the worst property on the best block strategy is much more lucrative, and attainable." Cash flowing $200-$500 a month if everything goes right, vs selling in 2 years and making 15-20-30kk guaranteed is much better. IMO.

Originally posted by @Alex Kies :

Right on, I will keep that in mind and keep up the search. Thanks for your insight on this, @Benjamin Maciel

No problem. What I am doing now is owner-financing as well--- For example. Buying properties and selling--- 50% ROI or better upfront with some monthly guaranteed cashflow- $100-$300 a month. Should look into it.