Author Topic: Breakdown of the 50% Rule  (Read 5133 times)

clarkfan1979

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Breakdown of the 50% Rule
« on: November 09, 2015, 07:35:55 PM »
I have searched on the internet for the 50% rule over the last few months, but numbers vary per category. Does anyone care to show their numbers on how they got to the 50% rule. My numbers are below

Rental 1
Purchased for 182K in 2007. Rehabbed for 10K. Current value about 300K. Originally rented for 1350/month in 2007. Now rents for 1900/month.

Taxes: 1530 (6.7%)
Insurance: 675 (3.0%)
Vacancy: 0 (0%)
Repairs:  1430 (6.4%)
Property Management: 0 (0%). Should be 12%
Long Term Repairs 1200 (5.3%)

This total is 21.4%. Even if I included 7% vacancy and 12% for property management. I installed a new furnace when I rehabbed and the roof was five years old when I purchased in 2007. Roofs in Colorado last about 25-30 years. However, wind damage could shorten the lifespan. My repairs should be closer to 1200/month, but I made a mistake the last two summers with a water problem that could have been avoided if I was more experienced. It cost me about 1800 over two summers to get fixed and should have only been 75 dollars.

Rental 2

Purchased for 95K in 2012. Rehabbed for 16K. Current value is 190K. This was my primary house. Rent was probably around 1200/month in 2012. However, I just rented out in August 2015 for 1600/month.

Taxes: 1333 (6.9%)
Insurance: 890 (4.6%)
Vacancy: 0 (0%)
Repairs:  1200 (6.3%)
Property Management: 1400 (7.3%)
Long Term Repairs 1200 (6.3%)

With property management I get 31.4%. Rental market is not as strong as rental 1. However, vacancy should still be very close to 0%. New roof in 2004. Roofs in Florida last about 20 years. Repairs was my best guess based on my previous experience with Rental 1. The house is smaller, so I lowered it a little.

I promise not to fight anyone. I was just curious about everyone's numbers. I record all of my repairs because I get the deduction for taxes. However, when it comes time to adding them up, I do round a little so they could be off by 100 per year.


Drifterrider

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Re: Breakdown of the 50% Rule
« Reply #1 on: November 10, 2015, 05:15:43 AM »
If you are talking about 50% of your revenue going to expenses (monthly cost), a lot of people believe this to be true (and it might be for them).  You might want to factor that in when determining if a potential rental is suitable for you.  My family has never found this to be true and we have never found there to be a "vacancy" rate per year.  In our market, long term tenants are the norm (if you keep your building in good repair and don't try to squeeze the tenant each year).  We have only SFR (no "plexes") and this works for us.

If you have a newer building or a newly renovated building you probably won't have this level of monthly cost (because you've already put your maintenance and repairs in place).  I have a unit that I completely renovated before leasing (new roof, windows, bathrooms, flooring, appliances).  I've put my money up front and so expect no maintenance for at least five years (more like ten really).  I did not replace the HVAC and will probably have to within ten years.

While there are some generally accepted "rules", each situation is unique to the market in which your property is located.

mr_orange

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Re: Breakdown of the 50% Rule
« Reply #2 on: November 12, 2015, 06:13:27 AM »
Reed has this covered in detail here:

http://www.johntreed.net/positive.html

there are also linked studies from IREM and NAA you can study. 

Note that not all buildings are average.  Some operate leaner, but many operate such that you'll pay MORE than 50% in operating expenses.  This is especially true in class D areas or with tenant mixes that drive high economic vacancy rates. 

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Re: Breakdown of the 50% Rule
« Reply #3 on: November 12, 2015, 12:44:34 PM »
We have three multi unit rentals. Our highest expense property is at 27%. Our PM is lower than others on this forum, we pay 5%. DH is a licensed electrician and his dad a plumber so we handle maintenance/rehab/repairs "mostly" ourselves.

Our first property was a foreclosure and we front loaded the new roof that it badly needed, so I factored it in to the purchase price.

Second property DH rehabbed while it was empty, new furnace, hot water etc. those items were also not factored in as maintenance. (ironically all other properties are wall heaters, this one unit was damaged in a fire and the previous owner went all out with gas appliances and hard wood floors for some reason.)

Because DH has decades experience maintaining buildings, we have kept repair/rehab costs very low.

Property taxes are still a bit depressed, I do expect them to rise in the next couple of years and have already mentally upped that 27% to 30%.

I still don't see us ever hitting 50%. We live in a state with mild weather which also helps.

The most we've had "so" far for annual maintenance/repairs of any of our properties was under 2k, and that included hiring a plumber for some sewage work that DH ended up finishing. - again the price you pay with older properties.

Papa bear

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Re: Breakdown of the 50% Rule
« Reply #4 on: November 12, 2015, 01:21:46 PM »
Agree that 50% is high on an actual cash out of pocket basis for my properties.  However, from an accounting perspective, you will have deferred maintenance on the property that is not accounted for on a regular basis.  25 years for roof, 20 years for furnace/AC, 10 years on appliances, etc.  that's what most people miss.  Everything needs to be replaced at some point! 


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Bobberth

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Re: Breakdown of the 50% Rule
« Reply #5 on: November 12, 2015, 01:35:40 PM »
The 50% rule is an average of a large number of rentals over a long period of time. It is possible to do much better for a period of time. Or much worse. Several categories I see missing from your list:

Utilities-most places there are some type of utility expenses. Water/Sewer/Trash is common for landlords to pay here. If you have those put onto your tenants, you would do better than average. Even if you don't pay any utilities, on average, landlords do.

CapEx-Your roof may only be 5 years old and last 25-30 years but the 50% rule assumes that you are putting 1/30th of the cost of a new roof away for eventual replacement. Water heater, furnace, air conditioner..... You may never actualize the expense of a new roof, sewer line, plumbing lines, tuck pointing etc depending on the timing of your ownership. Again, this is an average of a large number of units over a long time period. I think someone on here said something along the lines of, "Don't mistake deferred maintenance or unfunded CapEx as profits."

Evictions/legal-They will happen. Again, an average. You may be a tenant screening superstar. My one eviction they drug out as long as possible by asking for a jury trial (2.5 months). Then, as soon as it went through and I could legally get the Sheriff to serve the eviction notice; Ferguson/Michael Brown erupted in St. Louis and they weren't serving anything for 2 weeks as all manpower was dealing with that. Then it took another week to get through the backlog and then the tenants still had 10 days to get out after that. Sometimes shit really does happen.

Insurance-Umbrella or liability insurance, not just on the properties.

Business expenses-cell phone, internet, mileage, forms, printing, entity setup, legal fees, permits,  etc

Lawn service/snow removal

Other expense differences are:
Taxes-looking in my metro area, I see municipalities where property taxes range from lower than 1 months rent (<8%) to nearly 2.5 months rent (~20%). So if you're in a lower tax area, you should do better than the average.

Vacancy-I think 8% should be a minimum as that is 1 month of lost rent on a turnover. You're not off much at 7% but along with the vacancy expense of not receiving rent, usually you have added repair expenses of painting/cleaning/repairs/replacement/utilities/rent up fees/showing between tenants/first month of new tenants etc. So that tends to be an all or nothing expense. You can label those expenses differently (painting between tenants labeled as a repair or a vacancy expense). No vacancies that year? You got a nice bonus.

Repairs-One tenant tore the upper cabinets off the kitchen wall and 2 drawer fronts were missing from the bottoms so I had to replace (and I chose to upgrade) the kitchen as I couldn't match the fronts. They also took a machete to the kitchen floor (at least that is all I can imagine what happened to tear it up that bad). Those repairs/upgrades are about 60% of the year's rent. Again, it's an average.

I'm probably overlooking something but these can be added to your list. I have experienced less than 50% in expenses overall myself but I still use 50% in my projections so that I am covered by the unexpected as well as the what should be expected but usually isn't (CapEx).

clarkfan1979

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Re: Breakdown of the 50% Rule
« Reply #6 on: November 14, 2015, 03:57:52 PM »
Agree that 50% is high on an actual cash out of pocket basis for my properties.  However, from an accounting perspective, you will have deferred maintenance on the property that is not accounted for on a regular basis.  25 years for roof, 20 years for furnace/AC, 10 years on appliances, etc.  that's what most people miss.  Everything needs to be replaced at some point! 


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What percentage would be good for long-term expenses? I included 6.3%.

SwordGuy

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Re: Breakdown of the 50% Rule
« Reply #7 on: November 14, 2015, 04:19:40 PM »
Your roof may only be 5 years old and last 25-30 years but the 50% rule assumes that you are putting 1/30th of the cost of a new roof away for eventual replacement. Water heater, furnace, air conditioner..... You may never actualize the expense of a new roof, sewer line, plumbing lines, tuck pointing etc depending on the timing of your ownership.

Want to know why there are so many really cheap properties for sale in my area?

They are because the rental property owners spent all the money they received instead of setting aside 1/30th of the cost of a 30 year roof, 1/10 the cost of a water heater, etc.

Then, when stuff went wrong, they didn't have the money to fix it. 

And, of course, instead of cutting back on their expenses so they could come up with the money before there was any lasting damage, they let the damage get worse.  So they lost their good tenants and replace them with bad tenants for less rent - because that's all they could get.  Once that downward spiral went on long enough they needed to sell the property for what they could get.


clarkfan1979

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Re: Breakdown of the 50% Rule
« Reply #8 on: November 14, 2015, 05:10:06 PM »
Reed has this covered in detail here:

http://www.johntreed.net/positive.html

there are also linked studies from IREM and NAA you can study. 

Note that not all buildings are average.  Some operate leaner, but many operate such that you'll pay MORE than 50% in operating expenses.  This is especially true in class D areas or with tenant mixes that drive high economic vacancy rates.

This was a valuable read but it doesn't break down the percentages per category. I was also hoping for some numbers from some real landlords not averages in books. However, thank you for the link.

Based on my analysis it seems as though apartment complexes and single family homes are going to be a little different. An apartment landlord is going to shoot for 2% (purchase price & monthly rent) and also expect the 50% rule for expenses. However, a good single family home is more like 1% and expenses are most likely going to be less than 50%.

I can't definitely see the 50% rule for apartments, but not so much for single family homes in desirable neighborhoods with rent above the city median.  Buy a foreclosure in the good neighborhood so you get cash flow. Because you are in a good neighborhood you have less headaches with good tenants.

mr_orange

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Re: Breakdown of the 50% Rule
« Reply #9 on: November 14, 2015, 05:30:56 PM »
You have to look at the links in the link I posted.  There are very detailed reports. 

The expenses are going to vary by locale and product type as I stated above.  Make sure you set up a sinking fund for depreciation expenses or at least account for them in your overall analysis.  There are giant spreadsheets on BiggerPockets.com derived from some of my old spreadsheets that have details for all you need to account for. 

arebelspy

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Re: Breakdown of the 50% Rule
« Reply #10 on: November 15, 2015, 02:58:59 AM »
Boberth's post is awesome.

mr_orange's link is great, and you can delve into the studies linked there if you want more detail.

Also we've discussed this many times on the forums, you can do a search for more comments if you want to read more about it.

Here's a comment I made on one of the earlier threads:
50% is long term. 

You may be able to beat it short term, but probably not long term, where you will see capital repairs (like roof replacement, HVAC, appliances, etc.), maintenance as things break and tenants move out (paint, carpet), vacancy (which, even if low in your city, you will see, and moreso with a duplex, IMO) -- if you aren't seeing vacancy your rent is set too low.  Property management is another cost, even if you do it yourself, that's a side job you have as a property manager, it's not a return on your investment.

If you took that same money from the house and put it in stocks (or whatever), then got a job to manage someone else's property, that'd be the same as putting that money in the rental house and then getting a job to manage your property, so you should take out the management fees from the return.

There's TONS of discussions on biggepockets.com about the 50% rule. Here's a decent one that helps describe where the money goes in the 50% rule: http://www.biggerpockets.com/forums/52/topics/63789-5-rule-lowest-cost-efficient-producer

It cites this study here:
http://www.naahq.org/SiteCollectionDocuments/Industry%20Resources/2010%20Income%20and%20Expenses%20Survey.pdf

A search on their forums will help find lots more discussion.

Personally, my avg. 50% looks more like this:
Gross Potential Rent $1050 x 12 = 12600
8.3% Vacancy (1 mo/yr) = 1050
2% collection losses = 252
Total Revenue = 11298

Expenses :
10% Management = 1260
6% repair/maintenance (~1% on 80k purchase price) = 756
6.3% Taxes ($800/yr) = 800
6% Capital Expenditures = 756
2.4% Insurance ($300/yr) = 300
2.4% utilities = 300
6.25% marketing (housing helpers) = 787.5

Total % = 49.65 (39.65 without management).

I'm also paying an avg of 5% towards HOAs.
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clarkfan1979

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Re: Breakdown of the 50% Rule
« Reply #11 on: November 15, 2015, 09:54:57 AM »
This looks good. Thanks.

leighb

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Re: Breakdown of the 50% Rule
« Reply #12 on: November 15, 2015, 05:00:35 PM »
Here are some "real numbers." I'll be rounding to integers, but real nonetheless.

Background: 12 units two of which are doubles. In the rust-belt. Old houses, bought distressed, no financing. Mostly, class C neighborhoods, some class B, one class D. So, it's not a typical set of properties, but I would argue there is no normal. I have 2 employees and am out of state. Rents range from $400-750.

Quarter 1: 20%
Average expected rent at 100% occupancy $14100, Actual collected 15130 (late rent from 2014)
Expenses $6195  - it was a season of frustrating furnaces
Labor $4113
Tax $1731

Q2: 29%
Collected rent $11,434 (eviction and moving)
Expenses $2256
Labor $4113
Tax $1731

Q3: 18%
Bought a new house, one unit vacant
Collected: $12024
Expenses: $3410 - fixing a bathroom
Labor: $4446
Tax: $1980

Q4: So far this quarter I've put on a new roof, new gutters, fixed another roof and have two units empty, one of the empty units is the new one. It should be ready by Dec. 





Drifterrider

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Re: Breakdown of the 50% Rule
« Reply #13 on: November 16, 2015, 05:44:01 AM »
Your roof may only be 5 years old and last 25-30 years but the 50% rule assumes that you are putting 1/30th of the cost of a new roof away for eventual replacement. Water heater, furnace, air conditioner..... You may never actualize the expense of a new roof, sewer line, plumbing lines, tuck pointing etc depending on the timing of your ownership.

Want to know why there are so many really cheap properties for sale in my area?

They are because the rental property owners spent all the money they received instead of setting aside 1/30th of the cost of a 30 year roof, 1/10 the cost of a water heater, etc.

Then, when stuff went wrong, they didn't have the money to fix it. 

And, of course, instead of cutting back on their expenses so they could come up with the money before there was any lasting damage, they let the damage get worse.  So they lost their good tenants and replace them with bad tenants for less rent - because that's all they could get.  Once that downward spiral went on long enough they needed to sell the property for what they could get.

And that is why we get into rentals.  To take advantage of those who didn't plan ahead.

Our rentals are in Goldsboro.  How is the demand/supply for a median SFR in  Fayetteville?

Bearded Man

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Re: Breakdown of the 50% Rule
« Reply #14 on: November 17, 2015, 12:14:59 PM »
The 50% rule is an average of a large number of rentals over a long period of time. It is possible to do much better for a period of time. Or much worse. Several categories I see missing from your list:

Utilities-most places there are some type of utility expenses. Water/Sewer/Trash is common for landlords to pay here. If you have those put onto your tenants, you would do better than average. Even if you don't pay any utilities, on average, landlords do.

CapEx-Your roof may only be 5 years old and last 25-30 years but the 50% rule assumes that you are putting 1/30th of the cost of a new roof away for eventual replacement. Water heater, furnace, air conditioner..... You may never actualize the expense of a new roof, sewer line, plumbing lines, tuck pointing etc depending on the timing of your ownership. Again, this is an average of a large number of units over a long time period. I think someone on here said something along the lines of, "Don't mistake deferred maintenance or unfunded CapEx as profits."

Evictions/legal-They will happen. Again, an average. You may be a tenant screening superstar. My one eviction they drug out as long as possible by asking for a jury trial (2.5 months). Then, as soon as it went through and I could legally get the Sheriff to serve the eviction notice; Ferguson/Michael Brown erupted in St. Louis and they weren't serving anything for 2 weeks as all manpower was dealing with that. Then it took another week to get through the backlog and then the tenants still had 10 days to get out after that. Sometimes shit really does happen.

Insurance-Umbrella or liability insurance, not just on the properties.

Business expenses-cell phone, internet, mileage, forms, printing, entity setup, legal fees, permits,  etc

Lawn service/snow removal

Other expense differences are:
Taxes-looking in my metro area, I see municipalities where property taxes range from lower than 1 months rent (<8%) to nearly 2.5 months rent (~20%). So if you're in a lower tax area, you should do better than the average.

Vacancy-I think 8% should be a minimum as that is 1 month of lost rent on a turnover. You're not off much at 7% but along with the vacancy expense of not receiving rent, usually you have added repair expenses of painting/cleaning/repairs/replacement/utilities/rent up fees/showing between tenants/first month of new tenants etc. So that tends to be an all or nothing expense. You can label those expenses differently (painting between tenants labeled as a repair or a vacancy expense). No vacancies that year? You got a nice bonus.

Repairs-One tenant tore the upper cabinets off the kitchen wall and 2 drawer fronts were missing from the bottoms so I had to replace (and I chose to upgrade) the kitchen as I couldn't match the fronts. They also took a machete to the kitchen floor (at least that is all I can imagine what happened to tear it up that bad). Those repairs/upgrades are about 60% of the year's rent. Again, it's an average.

I'm probably overlooking something but these can be added to your list. I have experienced less than 50% in expenses overall myself but I still use 50% in my projections so that I am covered by the unexpected as well as the what should be expected but usually isn't (CapEx).

It was NoNonsenseLandlord that said that. It's a common thing people miss. They don't put away money, or calculate for those eventual repairs. I rarely spend what I budget for on annual repairs etc. but I know I have a roof, paint and flooring job coming up soon, not to mention appliances.

SwordGuy

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Re: Breakdown of the 50% Rule
« Reply #15 on: November 27, 2015, 10:34:39 AM »
Your roof may only be 5 years old and last 25-30 years but the 50% rule assumes that you are putting 1/30th of the cost of a new roof away for eventual replacement. Water heater, furnace, air conditioner..... You may never actualize the expense of a new roof, sewer line, plumbing lines, tuck pointing etc depending on the timing of your ownership.

Want to know why there are so many really cheap properties for sale in my area?

They are because the rental property owners spent all the money they received instead of setting aside 1/30th of the cost of a 30 year roof, 1/10 the cost of a water heater, etc.

Then, when stuff went wrong, they didn't have the money to fix it. 

And, of course, instead of cutting back on their expenses so they could come up with the money before there was any lasting damage, they let the damage get worse.  So they lost their good tenants and replace them with bad tenants for less rent - because that's all they could get.  Once that downward spiral went on long enough they needed to sell the property for what they could get.

And that is why we get into rentals.  To take advantage of those who didn't plan ahead.

Our rentals are in Goldsboro.  How is the demand/supply for a median SFR in  Fayetteville?

Fayetteville is a great rental market.