Author Topic: Struggling with the 50% rule  (Read 3923 times)

Left Bank

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Struggling with the 50% rule
« on: December 27, 2013, 08:38:55 AM »
I already own two, 3-family properties in Boston that I bought a couple of years ago after doing my own analysis.  I researched the 50% rule recently and some video was suggesting that properties should be about $100/unit positive cash flow.  So I put my investment to the 50% rule test and found that on both properties I am about $25/unit in the black.
So two points for discussion:
 
1) If the 50% rule is right and ideally you want a property that is making $100/unit, that seems like a ridiculous amount of work/risk/headache/BS to put up with for $100/mth/unit, no?  Why would anyone do this?

2) Then with my numbers, I have trouble believing that I will spend on average, even over the long haul, 27K/yr/property.  Hell, I could build a new place every 15-20yrs with that kind of cash allocation!

I know markets are different and it is only a rule of thumb but still, really?

arebelspy

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Re: Struggling with the 50% rule
« Reply #1 on: December 27, 2013, 08:59:11 AM »
Regarding #1, the 100 per door depends drastically (like almost everything in real estate) on your local real estate market.  Some places you'd better be getting over 1000 per door.  In others, 100/door is fine.  It also depends on the type of product (multifarious commercial versus SFR sized) and cost of the investment.  $100/door on a fourplex that cost you 30k is very different than 100/door on an SFR that cost you 1.2 million or a $100/door on a 196-unit apartment building that cost 15k per unit, and all of those are very different based on their location.  I'm certainly not happy with 100 per door in the markets and product types I invest in, but there are investments I've considered where that would be fine.  Many would be ecstatic with that return in a cash flow negative place where they're counting on appreciation.

Regarding #2, I'd suggest you start with some basic reading on the 50% "rule" - where it does and doesn't apply, where it comes from, how to use it, etc.

Start by searching on BiggerPockets.com and Google (there are a few threads here that discuss as well).  Read up on the original studies done by the various professional real estate associations around national average expenses, and what property types they were done on.

Especially focus on how the 50% breaks down - it's not a number pulled out of thin air, but look at the components of it and how much of that 50% comes from each one.

It'll give you a much better grasp of this "rule" and when to apply it and how to use it, rather than blindly using it (a big mistake), or blindly dismissing it (a potentially bigger mistake, IMO).

Hope that helps!
« Last Edit: December 27, 2013, 09:01:44 AM by arebelspy »
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Left Bank

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Re: Struggling with the 50% rule
« Reply #2 on: December 27, 2013, 09:35:26 AM »
"Especially focus on how the 50% breaks down - it's not a number pulled out of thin air, but look at the components of it and how much of that 50% comes from each one."

Thanks, Arebelspy,
This is probably quite important to help modify the rule to each case/market - I will look into that. 

arebelspy

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Re: Struggling with the 50% rule
« Reply #3 on: December 27, 2013, 12:50:25 PM »
Indeed.  :)

Taxes, insurance, property management, vacancy, etc. etc. all can vary quite a bit.
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 three kids.
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Another Reader

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Re: Struggling with the 50% rule
« Reply #4 on: December 27, 2013, 01:35:34 PM »
The 50 percent rule also includes capital improvements, averaged out over time.  A $5,000 heat pump might last 10 years, so on average that's $500 per year.  Roofs, hot water heaters, etc. are treated the same way.  New houses have an initial round of capital improvements for window coverings, appliances, and landscaping, but the capital improvements tend to be less over the first 10 years or so.  I bought several new houses between 1999 and 2002 and I have started the hot water heater replacement cycle.  Maintenance costs in general are creeping up.  The first A/C unit is probably due in 2014 or 2015, been lucky there so far.  Overall, the operating expenses have run significantly less than 50 percent on the newly built houses.

The 50 percent also includes vacancy loss and management.  If you manage your properties yourself, you are taking on a job and paying yourself the savings in management fees. 

As Arebelspy says, do the research.  Come up with what you think your expenses over time will be, factoring in vacancy, capital improvements and professional management.  With your high taxes, and the cost of boilers and the like, I would be surprised if you end up with much less than 50 percent.


Johnny Aloha

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Re: Struggling with the 50% rule
« Reply #5 on: December 27, 2013, 02:50:31 PM »
It's important to understand where the 50% rule comes from and determine if (or how much) it applies to you.

One of my properties would also be cash flow negative according to the 50% rule.  But I think expenses will be lower than 50% (although maybe not much) for the following reasons:

- extremely high demand area (very low or no vacancy)
- low property taxes and insurance relative to rents and value
- no mechanical systems (no A/C, no heat, etc)
- I self manage (yes it is a job!)
- can do most repairs myself

I also bought the property after learning about the 50% rule, but am planning to keep the property even though there are better cash flow markets if I invest long distance.
« Last Edit: December 27, 2013, 03:01:42 PM by Johnny Aloha »

GrayGhost

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Re: Struggling with the 50% rule
« Reply #6 on: December 29, 2013, 10:51:52 PM »
Something that I'm not sure has been mentioned is that in general, the 50% rule is pretty conservative. That means that even if your property doesn't quite meet the 50% rule, you'll probably still make money.

I certainly don't advocate using hopeful math when analyzing business deals, but it's also a problem if you cling to a rule of thumb when it's just that--a rule of thumb. The 50% rule is not hard, you can bend it and wiggle it depending on market conditions.