Are you using the 50% rule for expenses?

Question

Good morning BP Family!

Are you using the 50% rule for multi-units, 5 to 15 units, for expenses? I'm noticing that heating and hot water in places like Pennsylvania, New Jersey, New York, Chicago, Ohio, are a large part of those expenses. If you're able to pass those expenses to the tenants(wherever possible of course) aren't you seeing those expenses dramatically decrease?

Russell Brazil · Answer

Things like the 50% rule, 1% rule, 2% rule, the 70% rule are just very very basic ways to screen properties on the most superficial level.  Any property should be fully analyzed for numbers that are realistic to that particular property in that particular market.  None of my current rentals come anywhere close to needing 50% of the rents to go towards expenses, but thats because they are all A/B class rentals.  When I had C/D rentals....50% wasnt close enough to covering my expenses...I bet 75% of my rent in those went towards expenses.

Matt Crusinberry · Answer

@Ceasar Rosas, As a quick analysis, I tend to error on the side of caution and use 55-60% for expenses when valuing a properties proforma. I will use this until I have the actual numbers that will replace it (validated numbers). This is also for commercial properties only (5 units or more) as my goal is to figure out the NOI. Good luck!

Russell Brazil · Answer

If you are putting that much into renovations....ideally any repairs or capex you might have should be close to virtually zero for the first 5 to 10 years.  Basically you are front loading all those costs.

Ned Carey · Answer

@Ceasar Rosas the 50% rule was from statistics on SFHs.  There are many more variables on MFHs and only a few percent can make a big swing in actual dollars.

One of the property management organizations sells a book of typical expenses by area of the country and size of property. Sorry I don't know the name of the organization. (IREM? CPM?)

Brandon Sturgill · Answer

@Ceasar Rosas It would be wise to ignore any "Rule" that you find on BP. All respect to Brandon Turner, but he was developing huge content without foresight into how these things would be perceived by new investors. Using any of these rules to make a decision as to whether a property is a good investment is a poor idea. The focus should be on transparent evaluations of income property.

If you want to be a slumlord, you can use generalities, but that is not what this industry is about. Our service to our customers is safe, clean, and appropriately priced units. Those three criteria will land long-term tenants more than anything else. And if your units meet these criteria, they will be well maintained, lowering your operating expenses drastically.

Charles Kao · Answer

@Ceasar Rosas Does your 50% rule include debt service?  I personally only use this rule for SFHs, and duplexes.  For larger units especially those that require commercial financing I use cap rate, current and proforma cashflow and cash on cash return.  As for expenses like hot water and heat, I am not seeing a substantial increase in cost in our units because if anything we are going to more energy efficient units.  In terms of inflation, depending on what market you are in, tenants are used to seeing an annual rent raise due to rising costs such as property taxes but if you are discussing due to seasonality of the cold weather this should have been accounted for on the purchase.

Ceasar Rosas · Answer

@Russell Brazil

Yes sir. Thank you!

Ceasar Rosas · Answer

@Charles Kao @Matt Crusinberry @Ned Carey @Russell Brazil @Brandon Sturgill

Thank you all for your responses. Let me be a little more clear on why I've asked this. I follow Michael Blank and a few others who consistently say as a rule of thumb use 50%. Yes, I do look at marketing packages to try to get more accurate numbers. Mostly looking in B- and C+ neighborhoods. The property I am potentially putting an offer on now is a 6 unit, and after all is said and done average rent for each would be $1300+.  The property is fully vacant and requires a complete renovation with architectural plans in place. We're shooting for a purchase price of 255k, renovations of 225k-275k. I was thinking more of a situation like this. We may  use hard money or all cash and once stabilized refinance the hard money or pull out our cash.

Are you using the 50% rule for expenses?

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