Author Topic: A Critique of the 50% Rule  (Read 5320 times)

arebelspy

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A Critique of the 50% Rule
« on: January 07, 2014, 01:05:20 PM »
Great article critiquing the 50% rule written by Frank Gallinelli, author of What Every Real Estate Investor Needs to Know About Cash Flow... And 36 Other Key Financial Measures.

http://www.realdata.com/blog/the-50-rule-vs-discounted-cash-flow-analysis/

The 50% rule is a starting point - not an ending point.  A thorough discounted cash flow analysis is needed to fully analyze an investment.

By all means, don't use this as proof to throw out the baby with the bathwater - the 50% rule has its place.  It place, however, is just not the ending point of your analysis, but the beginning.

Also this is much more relevant to commercial than residential, fwiw.
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Blindsquirrel

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Re: A Critique of the 50% Rule
« Reply #1 on: January 20, 2014, 02:09:36 PM »
  Thanks Rebelspy, I started using the 50% rule for my own planning after seeing so much about it here. I definitely tended to underestimate costs and over estimate yields. Over the years I have definitely improved my yields and gotten better tenants and better investment properties as I learn more. Our best long term tenants have made a 3 of our houses closer to 36.5 % of gross going to taxes/insurance/repairs etc for a 10 year average  but they are exceptionally low hassle investments and the tenants are true gems. Our worst investments were  70%-120%+ gross going to expenses some years. Ran calculations in Quickbooks using historical expense/income data and we ditched the  lowest performing property very early this year. (I knew it was a pain in the rear but seeing it in black and white really forced a decision I should have sold long ago) For 2013 we are right at 43% of gross going to expenses for properties we owned at the the start of the year. (but that is atypical). We bought 3 houses and fixed them up and rented them out in the 2013 and so far they are all very good performers. 2014 will probably be about the same, sell the one remaining dog and buy 3 real good investments. I tend to just add the initial repairs to a house into the purchase price for yield calculations going forward. The 50% rule is something I had never used before using this website but I think it is a great way to think even though it is using a really broad generalization. I liken it to reversion to the mean for stocks.

arebelspy

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Re: A Critique of the 50% Rule
« Reply #2 on: January 20, 2014, 07:53:28 PM »
Quote
I liken it to reversion to the mean for stocks.

Exactly Blindsquirrel!

That was a great way to put it.

Thanks for sharing your stories.  :)
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
If you want to know more about us, or how we did that, or see lots of pictures, this Business Insider profile tells our story pretty well.
We (rarely) blog at AdventuringAlong.com. Check out our Now page to see what we're up to currently.

Johnny Aloha

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Re: A Critique of the 50% Rule
« Reply #3 on: January 21, 2014, 03:05:45 PM »
That's interesting.  Have you noticed a correlation between your best performers and initial purchase price or initial projected returns? 

Some people think the high-yielding houses (bad neighborhoods, bad cities, whatever) actually underperform because there is more turnover, more damage, more theft, etc.

Blindsquirrel

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Re: A Critique of the 50% Rule
« Reply #4 on: January 21, 2014, 05:36:35 PM »
  Well my worst performer was college student rental house. We charged like sin and the phone rang off the hook with would be tenants. In general, I think the Taliban probably have better house habits than the students we had. Actually, we would have been better off to sign a long term lease with bears. College students are vermin and it is not really what we do. (our normal market is 3-5 bedroom SFRs as folks with a batch of kids tend to stay put and I am lazy and do not like to turn over houses, just how I roll. Our lowest hassles and best steady performers are all in pretty good neighborhoods, certainly not war zones, but not in a big city school district either. Our best yielding house by far at 31.5% cash ROI before repairs after tax and insurance (there have been no repairs in 2+ years with the same tenant) is rented to a convicted non violent felon that I have known for 15 years. He asked me to buy him a house to rent in a certain school district because he said nobody would rent to him with his record and we stole a foreclosure for him, total investment less than 20k cash. (he painted the entire inside very nicely and replaced all of the plumbing that the tweekers stole as he is also my plumber). He is getting a killer house 4bd/2bath about $180/mo under market rent and we have a really good tenant who pays like a clock. He is well aware of the deal he is getting and I have no need for more income from the house. At some point the house will need a new HVAC system but other than that it is in stellar shape. We do not rent any houses or deal with neighborhoods that I would not live in. My feeling is that if I would not want to live there neither would most average folks. I do know some folks who absolutely make bank in rough neighborhoods though, ie $600 a month rent on a$3000 house.

honobob

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Re: A Critique of the 50% Rule
« Reply #5 on: January 21, 2014, 05:43:09 PM »


Some people think the high-yielding houses (bad neighborhoods, bad cities, whatever) actually underperform because there is more turnover, more damage, more theft, etc.

Exactly!  Rent growth and appreciation is where your profits are!  I just rented my Waikiki one bedroom and just like last time I'm pushing one tenant because the next tenant wants in at $150 MORER rent than the last tenant that rented for $100 more than the last tenant. If the state and my sense of landlord karma didn't prevent it I could double rent.  Over 30 years of 0% occupancy so I guess Honolulu would have a 41% rule.  Management expense?  Well I placed a half hearted craigslist ad in cause the tenant was doing Vegas wedding and moving to be 1 1/2 hour closer to work so pinning an exit interview down was challenging.  Got a text that new tenant wanted to meet that same day.  I almost blew them off since I really wasn't sure when the place would be available.  I'm there anyway AND they show exactly on time look fantastic and are ready to move.  Still thought they may be flakes but old tenant is paid for 28 days into the future so tell them to send me some stuff and sure enough they sent completely and timely and are trying to tie me down to a time to get the deposit to me.  Ten minute turnover so knock off 8 of the 10% management and I'm down to the 33% rule!

Location, location, location.

Blindsquirrel

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Re: A Critique of the 50% Rule
« Reply #6 on: January 21, 2014, 06:14:48 PM »
   That is pretty cool! Love your signature and SF and HI are two of the highest appreciating , markets in the US. If I knew then what I know now would never have started in the mid west but I guess you start where you are if you do not know any better. I use 0% appreciation in my calculations and planning now. This keeps me honest for our cash on cash yield targets. I want the never ending income stream that I do not have to show up at work to get. Some of our houses are worth 2-3x what we paid for them (at least according to the tax man and comps that I looked at when trying to fight said tax assessment) but initially we had to borrow money to buy houses so we were merciless on our resolve to never pay retail for a house and only buy houses that if we needed to exit,we could turn a profit after repairs. I learned this lesson the hard way instead of reading it here unfortunately. Did not have any real problems but in retrospect was way over leveraged, now probably under leveraged.   I valued my time and energy way too low when starting out as an RE investor and now I place a high premium on them. A 10 min turn over sure beats the heck out of hauling 9 kinds of crap out of a house that tenants left for a several long days just so you can paint the place. We have had some epic bonfires at my house though. :).  Why broke people buy so much crap is beyond me. However, that is kind of the point of this site as people who want to not be broke, don't buy a lot of crap.
Incidentally, never allow a Chinese pleather coach in your places if you can.  A tenant left us one on a porch and it went up like a pan of gasoline. It was stuffed with small polystyrene beads and in less than 30 seconds it was blazing from one end to the other, top to bottom with flames 30 feet in the air with billowing jet black smoke. It was an eye opener.

Johnny Aloha

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Re: A Critique of the 50% Rule
« Reply #7 on: January 22, 2014, 02:35:42 PM »
  Our lowest hassles and best steady performers are all in pretty good neighborhoods, certainly not war zones, but not in a big city school district either.

This is what I assumed.  I've been tempted to venture into higher yielding but higher hassle neighborhoods.  Have not yet, and not sure I will.  Thanks for the info.

arebelspy

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Re: A Critique of the 50% Rule
« Reply #8 on: January 22, 2014, 03:01:06 PM »
  Our lowest hassles and best steady performers are all in pretty good neighborhoods, certainly not war zones, but not in a big city school district either.

This is what I assumed.  I've been tempted to venture into higher yielding but higher hassle neighborhoods.  Have not yet, and not sure I will.  Thanks for the info.

I am investing in those areas now (though most of my holdings are not in those areas, my newest ones are), but I'm doing so with a good team in place that has lots of experience in the area in question (years of experience and multiple dozens of rentals they personally own in the area).

I'm also tempted to venture into lower yielding, but (theoretically) lower hassle areas, ones with (cash on cash) yields of only 4-6%.

Have not yet, and not sure I will.  But it's tempting for some portfolio balance and diversity.

/I know redundant to mention to you JA, but for others on the forum. ;)
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Blindsquirrel

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Re: A Critique of the 50% Rule
« Reply #9 on: January 23, 2014, 06:55:52 PM »
    Can see the temptation on the high yield areas but not really for me. It seems like more of a pain in the rear than it is worth right now. I will probably focus more on areas outside of town closer to where I live.  Staying away from high property tax areas is pretty high on my list right now. We pay the tax man too much IMO.

GoCubsGo

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Re: A Critique of the 50% Rule
« Reply #10 on: January 24, 2014, 08:28:08 AM »
I've found over the last 10 years or so that my risk tolerance is growing a bit.  I've only focused on really SFH in solid neighborhoods (higher buy-in costs but better appreciation and tenant pool).  I'm happy with 10% Cash on Cash (never sure if that's the yield people are quoting here or Total ROI with principal payments included).  The problem is that those deals in the SFH market are drying up big time and those type of properties are tying up a lot of cash every time I buy one (20% down+ rehab costs since they are foreclosures). 

Starting today, I'm going to bid on a couple foreclosure condos I've watched for the past year or so (and sold a couple units to clients).  They are still in good areas but I definitely plan on more turnover and probably a lesser quality tenant (income and credit-wise). Most definitely lower appreciation but potential but yields are 20%.  The condo market has lagged big time and there are still a lot of solid deals.  I hope I'm not in for a rude awakening but I've have done my research so I hope it works out.

arebelspy

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Re: A Critique of the 50% Rule
« Reply #11 on: January 27, 2014, 03:55:01 PM »
Sounds like a fun challenge to me GCG.  Let us know how it develops!
We are two former teachers who accumulated a bunch of real estate, retired at 29, spent some time traveling the world full time and are now settled with two kids.
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