Investor · Phoenixville, PA · Member since 2008 · 257 posts · 18 votes
When I find a promising multi-unit rental property, I usually assume that 50% of the gross rents is what I'll have after operating expenses to pay my mortgage. The listing sheets have a breakdown of the operating expenses; should I go by what they have or assume it's 50%? I don't want to overestimate the expenses too much.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Originally posted by Mark Beekman:
When I find a promising multi-unit rental property, I usually assume that 50% of the gross rents is what I'll have after operating expenses to pay my mortgage. The listing sheets have a breakdown of the operating expenses; should I go by what they have or assume it's 50%? I don't want to overestimate the expenses too much.
50% is a perfect screen test and is easy to do in your head. It is generally closer to 45% if you include management, capex set-asides, maintenance, economic vacancy, etc. Most of the broker submissions are coked up fantasy-world assumptions. Take their submission with you to the bathroom in case you run out of toilet paper.
It always baffles me to see someone with CCIM or some other high-brow designation after their name passing off some crapola underwriting example for a complex. These people should be immediately stripped of their designation IMO. I am all for them working on the behalf of their clients and trying to get top dollar for the asset, but outright bsing on the financials is borderline fraudulent in my book.
BiggerPockets Founder · HI · Member since 2008 · 16k+ posts · 5k+ votes
16y
I know that Jon already chimed in asking everyone to chill, but I wanted to stop by as well. There's nothing wrong with disagreeing about your ideas, theories, etc., but the minute you get personal and attack people and get nasty is when you cross the line. I'm just letting everyone know that I won't put up with that nonsense here.
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
16y
Bryan, I just wanted to clarify one thing based on one of your posts in this thread. You had mentioned something to the effect that the 50% rule does not account for the timing of the expenses and a big expense in the initial years is different from a big expense later on due to the time value of money.
I agree with you about the need to do a present value analysis on any major investment to account for timing issues. But based on my understanding of the 50% rule, it simply states that if your sample size is large (many properties over many years) your expenses should work out to be about half your gross rent before vacancy. It does not exclude one's ability to do a DCF analysis.
I think all of the posters here agree that one needs to do proper due diligence on any investment and do a financial analysis if the numbers are not obvious.
Interestingly, although I am a big proponent of discounted cash flow modeling, Warren Buffett does not do all that stuff. He feels that he has an instinctive understanding of the value of a stock and he would rather be approximately right than precisely wrong. I do respect that because decades of financial modeling have taught me that a DCF analysis depends on so many "guesses" that the end result is a number that looks very precise but the future is rarely going to be very similar to the model.
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
16y
Bryan, I was responding to your statement which is quoted above. It was not meant to be a question - it is just clarifying that the 50% rule is entirely compatible with a DCF analysis.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
No...it doesn't when you are underwriting a single deal based on the 50% rule analysis. If used PROPERLY the "rule" does account for capex. The problem is that people use this "rule" to underwrite SINGLE transactions and treat that model like it is the end-all-be-all "correct" answer.
It is, at best, a good screen test for projects and nothing more. A model using real-world data, experience, and intuition is what yields good results.
There is nothing wrong with "the rule." What is wrong is the way people use the rule in an improper manner when they are trying to educate new investors.
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
16y
I do not know anyone who has applied the rule improperly, but then people are not consulting me when they apply the rule. In fact, I prefer to think of the "rule" as a general guideline rather than as a rule. The way I have applied it in the past is to quickly detect BS when some broker sent me expense numbers that were a lot less than 50%.
Had it not been for BP posters such as MikeOH, Jon Holdman and others, I would not have know how to model future expenses so I am grateful to them for educating me.
Interestingly, many of the properties that I was offered - generally larger class A or class B properties with lots of amenities - had expenses that were higher than 50%, particularly the ones in Texas. So I think of 50% as the minimum long term expense and not the actual expense of a property.
Investor · Sarasota, FL · Member since 2008 · 17k+ posts · 17k+ votes
16y
Originally posted by Bryan Hancock:
The problem is that people use this "rule" to underwrite SINGLE transactions and treat that model like it is the end-all-be-all "correct" answer.
I don't know of anyone on here (including MikeOH) who would ever suggest using the 50% Rule in lieu of actual due diligence to make a go/no-go purchase decision...
As far as I know, everyone here recommends using the 50% Rule as a first-pass approximation to determine if a deal is worth pursuing further.
I think this is what many of the posters are saying here -- you and Mike are focusing on two different aspects of the due diligence; Mike is focusing on the back-of-the-envelope "sanity test" with the 50% Rule and you're focusing on the nitty-gritty of the due diligence.
Given that, you're both "right" and you both make very valid points. I've yet to read anything that either of you have written that is incompatible with one another...
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Fair enough...other than a scrap over 45% and 50% possibly.
I think everyone has said their piece. My big point in every post (I reread all of them today...consistent from the first post) was that this should be used to screen projects. Using it as anything other than that is bad practice IMO. It is also inaccurate if the rents are priced incorrectly one way or the other.
Real Estate Investor · Phoenix, AZ · Member since 2009 · 1k+ posts · 1k+ votes
16y
Bryan, regarding the incorrectly priced rents, I think the way to use the 50% rule would be to figure out what would be the normal rent for the property such that the vacancy rate would also be normal, and then apply the rule. (Otherwise we could have weird results such as zero assumed expenses for a brand new property with no tenants yet, etc.)
I would also be careful with states like Texas that have higher than normal property taxes.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
But that isn't the way it is used on here. I constantly see people take the rents given, divide by two, and tell the newbie that is all they will get. I also see people argue to the death over anything non-50% when there are obviously exceptions. I never see anyone ask about the situation of the property or qualify an answer before clicking off a quick 50% rule underwriting.
I would be happy if people would just say that their analysis is just a first cut and that it only works if rents are priced correctly. These qualifiers should be added to any "rule" post IMO...or a qualifier should be added that real world expenses could be higher or lower and that they need to do due diligence to get an accurate depiction of long-term income.
Flipper · Phoenix, AZ · Member since 2009 · 973 posts · 679 votes
16y
You guys are going in circles.
"I would be happy if people would just say that their analysis is just a first cut and that it only works if rents are priced correctly."
The rent will be correct after you buy it, so it doesn't matter what they currently are. Also, no one has said that every property every time will cost 50% of the rent.
Over a large number of units and time, they average out to be 45-50%. Some individual properties will be higher, some lower. That's where due diligence comes in. Mike's point (I think) is that people want to pretend that their expenses won't be this high (over time) for some reason or another. He doesn't want people to make that mistake.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
16y
Originally posted by Marc:
The rent will be correct after you buy it, so it doesn't matter what they currently are. Also, no one has said that every property every time will cost 50% of the rent.
First of all...I love the guy beating the dead horse...priceless :mrgreen:
Your point above is not correct IMO. The rents given by newbies when they come on are CURRENT rents for the property...which are likely mispriced when properties are distressed.
People also defend Newton's fourth law of 50% to the death despite obvious nuances for a specific deal that make this incorrect. Underwriting every deal in this manner as a final analysis is incorrect and this is as far as the majority of threads go with respect to analyzing things. I realize it is difficult to do detailed analysis without a ton of relevant facts, but people leave the thread thinking that the magic 50% number is right. This does them more harm than good in many instances IMO.
Real Estate Investor · OH · Member since 2008 · 4k+ posts · 1k+ votes
16y
The rent will be correct after you buy it, so it doesn't matter what they currently are. Also, no one has said that every property every time will cost 50% of the rent.
Over a large number of units and time, they average out to be 45-50%. Some individual properties will be higher, some lower. That's where due diligence comes in. Mike's point (I think) is that people want to pretend that their expenses won't be this high (over time) for some reason or another. He doesn't want people to make that mistake.
Exactly right!
In other words, market rents - EXACTLY RIGHT!
Exactly right! What Bryan doesn't seem to understand is that the majority of houses and small multis are owned by mom and pop landlords (many of them failed mom and pop landlords) and they don't have records of their expenses. So, what is a newbie supposed to do when there are no accurate numbers for a rental they're looking at?
If anyone doubts my claim that most mom and pop landlords don't know what their expenses are, all one has to do is read the archives in the landlording forum. You'll find literally hundreds of landlords there that have thought their expenses were RIDICULOUSLY low (often only insurance, taxes and insurance). Some of these people were even hocking their services as coaches, mentors, etc. In fact, with a little research, you'll also find that many of the national gurus preach this Rent - PITI + Cashflow B.S. I don't know whether they actually don't know anything about real estate or they're just scamming the newbies. That just shows how far this problem of misunderstanding the expenses goes and why such a high percentage of newbies fail! BTW, if you want to talk to one of these misinformed newbies in person, you'll have to go down to the local burger joint, where the failed landlords spend their time flipping burgers!
Real Estate Investor · Lebanon, PA · Member since 2009 · 41 posts · 7 votes
15y
Don't know if ya'll are still around. hope so cuz i'm sure you're the ones to ask.
Does the 45-50% include a sinking fund that is funded regularly out of rents to pay for future capital expenditures? And is there a general % for this portion of the 50%? How do you allocate rents systematically for future replacement of roofs, water heaters, furnaces. I guess just try to estimate expected date of death for each one of these and work the math, huh? Can a good home inspector help here?
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
Here is a link to a recent study Mike:
2010 Survey of Operating Income & Expenses In Rental Apartment Communities
You can establish your sinking fund from this if you wish to do so Mike.
My personal preference is to keep cash deployed in other projects and not leave it sitting idly around to replace capex when needed. We have a sizable income to draw from for this purpose and the ability to borrow on lines of credit if large amounts of cash are needed quickly so this guides our behavior on how much cash to keep in our portfolio.
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
15y
BTW...If you study the link provided you will find all of the following in print based on actual data:
1. Things vary by property type, region, etc.
2. Operating expenses are below 50% for most property types listed, but particularly for garden style product which is likely the most beneficial for the threads that come up on this board every week
3. Economic losses are purposefully broken out as a separate item from operating expenses. Vacancy, collection, and concession losses are non-trivial and are typically lumped in with the brute force 50% figure
4. It is imperative to analyze each individual property independently from a blanket 50% screen test and to be careful that 50% isn't too conservative. Small apartment complexes, SFRs, and large apartment complexes all operate differently. Stuff in the middle of Austin also operates differently from something in Killeen