Can anyone break down the 50% rental rule question for me in terms of the 50% the encompasses maintenance, vacancy, etc.
I am wondering how much each item takes up roughly. i know this will vary from place to place but I am just looking for a rough idea.
phatman,
I’d be happy to answer that question for you if you could answer a few questions for me first.
I have a house at 123 Main Street. It rents for $600 per month. How many evictions will I have in this property this year (if any)? Will I have any vacancies? Will the tenant slip and fall and sue me? Will the city fine me for a nuisance caused by the tenant? When the tenant moves out, will he pay his water bill? Will the house be vacant during the winter requiring me to pay the utilities for a period of time, and if so how long? Will there be a water line leak? Will there be a gas line leak? Will the price of gas get to $5 per gallon, costing me more everytime I go to my property?
Thanks in advance.
Mike
yes yes yes, and $6 a gallon. :biggrin
i did not know if there were rough numbers, that are used. if 50% can be generalized, I figured the breakdowns can be generalized. I know there are many unknowns for every prop ine very location.
just figured I would ask
phatman,
I was just trying to make a point with my previous post. In my opinion, it’s really pointless to try to quantify every expense, because so many of them are unknowable.
You can figure about 10% for management and 10% for maintenance (for lower priced rentals). Insurance runs about another 8-10% for lower priced rentals. You can look up the actual taxes on the property so that is easy. The balance is made up of all the other expenses.
Mike
So for an example of a house rents for $600/mo. Figure the expenses will be 50% of that. Insurance is $75/mo. Property tax is $60/mo. So $165/mo covers everything else? That seems like you aren’t leaving much for repairs, vaccancy, etc.
Marcus,
$75 for insurance sounds very high for a house that rents for $600. I average about $42 per month for full coverage including $500,000 in landlord liability. So, for a $600/month rental, management would be about $60 per month; insurance might be $45; maintenance might be $60; and property taxes might be $60. That leaves $75 for all the other expenses.
These are the expenses that you can predict. The other expenses are relatively unpredictable, but the $75 should cover it when averaged over a lot of units and/or a long period of time.
That gives you an idea of why people who claim the operating expenses are only 20% to 30% of gross rents are so far off. In the example above you can see that the operating expenses were already at 37.5% for only management, insurance, maintenance, and taxes! That doesn’t include advertising, vacancies, evictions, damage done by tenants, lawsuits, legal fees, entity maintenance, etc, etc, etc.
Again, I am not a proponent of trying to predict the itemized expenses because they are impossible to predict for any given rental in any given year.
Mike
Insurance probably varies some based on where you are. That and you probably get a nice discount for having so many policies. That gives bigger landlords an advantage. Thanks for the explanation. It gives a very real approach. A lot of gurus are overly optimistic.
Where did you get your 45-50% national average from? It’s always nice for me to be able to cite a source.
Thanks,
Cake
Cakeaholic,
If you want to see examples of the 45-50% average, then go to loopnet.com. Take a look at the gross income and then look at the net income. You will notice that if the gross income is $10,000 then the net income is around $5,000.
Gross income is all income received and net income is all the expenses except the mortgage. So if you are looking at a property that has a gross income of 10,000 then you can estimate that the net income is around $5,000. Then take the $5,000 and subtract the mortgage, which will leave you will an ESTIMATED profit. Always find out the real numbers, this is only an estimate.
There isn’t a place to cite a source. But if you want examples then cash flow a property, or go to loopnet.com and look at some of the properties that show the gross income and the net income.
Cakeaholic,
You can find the 45% to 50% expense statistics from any of the other national landlord associations. Depending on the source, the capital expense number may not be included in the operating expenses (technically it is not). Therefore, you will have to add in the capital expenses if you want the true picture.
Mike
Really hard to quantify what each expense will run you. Mike and many others have explained this thoroughly throughout this board so if you search you’ll find great info.
Its easy to doubt the 50% rule because on paper it seems way too much, but I’ve learned from personal experience(aka the hard way) that it is DEAD ON!!
Example
Triplex
AC in unit B stops working. No problem, home warranty covers repairs, $50. AC tech tells you “hey all 3 of your units need maintenance badly or they’re all gonna go” and shows you proof. Add maintenance agreement to prevent further wear $750.
Replacing AC for ONE unit cuz you didn’t have a home warranty, possibly $2000
Tenant complains of leaks, find upstairs bathroom flooded, call plumber, $400.
Pest control - could run you $100 per quarter, unless your tenants are fond of rats and roaches(not likely).
Painting, steam cleaning carpet, general cleaning of vacant unit, junk removal for one unit…
??? Don’t think its easy to do this yourself to save money. Vacant units tend to come at the WORST possible times, sometimes when your day job and personal life are going crazy.
Court costs in time and money to evict, lost income from non-paying tenant…
Management costs 8-10% of rental income if you decide not to do it yourself. They will RAPE you if you allow them to do maintenance. Try $100 for drilling a door back in place, try being charged TWICE for the same issue just because tenant calls again, and ridiculous charges like that. Think evil desparate car mechanic.
The list goes on, so many things can add to your expenses. If your rental income only covers the PITI by a couple hundred, you’re going to be in trbl.
I was wondering what the 50% rental rule question is. I have done 147 houses mostly partnered and wholesaled but now moving into getting some rentals as well!
In the process of renting one now.
Bill,
There is no “rule”. However, throughout the United States, operating expenses run 45% to 50% of gross rents. That’s the “rule”. Most newbies don’t understand this (or don’t believe this) and therefore fail in a short period of time.
Mike
Eventually I do want to get into rentals, and I don’t want to fail.
I’ve seen a lot properties that could rent for $100-$200 more than the PITI, but none that would double the PITI and make the 50% rule.
How in the world are you consistently finding properties that will meet the 50% rule?!? I could see finding a big time fixer at a deep discount, but then you’d have to dump a bunch of cash in it and that would seem to negate things.
Bryan
You don’t stop looking or driving neighborhoods. You attend the local REIA meetings you get out there and meet people so if they see a deal they think hmm Benjie might be interested in this. You cannot get discouraged with your market there are always houses that fall within this rule of thumb. I live in Colorado and the housing prices have barely fallen. Remember your looking for distressed yards and houses. These to me are the best deals.
Just my 2 cents.
Benjie
benjiej is exactly right.
No one who starts rentals will fully understand how important great deals really are. My standards for buying are WAY higher now then they were a few years ago. I won’t touch a property unless it is 60% or less of what it is worth.
If you want another example on top of what benjiej said. Here you go:
I scheduled about 14 properties for this Tuesday. All of them have fair to descent numbers. I’m going to look at all of them on Tuesday and then put a bid down on probably 10 of them. The bids will be VERY low, even though the asking price is already low. Then whatever fish bites will let me know what property/s I should move forward on.
So the name of the game is MAKE OFFERS. I’m with you.
gilbequick,
Of course you have to make an offer to buy a property, but I do not make a lot of offers. I’ve seen some of the gurus say something like look at 100 houses, make 10 offers and buy 1. I think that’s just silliness. I think Benjie hit the nail directly on the head. Get off the computer and out of the house! Meet a lot of people and let them know that you’re a serious buyer at the right price. Then, people will call you when there is a deal at a HUGE discount! I’m looking for great deals - not retail deals that I try to turn into great deals.
Mike
Going to REI meetings and getting your name out there is critical. But I don’t wait around at REI meetings for people to give me deals. I have no problem going out and spending the day looking at some properties that have potential. Then putting down a bunch of bids. This is what I call “Creating Deals”. You can find deals (the way already discussed), or/and you try and make deals (the additional way I discussed). Personally I can’t wait until Tuesday so I can spend the day going through a dozen properties. It’s not a waste of time for me, its an activity I enjoy. You can’t just go to REI meetings and all of a sudden know your market and become comfortable walking through properties. You need to take an active role, and by active I mean looking at properties and putting bids down on properties.
NEVER let anyone tell you that any idea that involves looking at properties and putting low offers down is silliness. You will gain a ton of knowledge each time you do this activity. In fact I can’t imagine an activity that would be more beneficial to a new investor. It will get you familiar with your market and make you comfortable looking at properties. Plus you will eventually find a fish that bits. Just make sure that you never settle for anything less then a great deal.
I see your 50% rule but honestly, I want to hear from someone in doing that in higher priced markets, not smaller cities with low priced housing. I live in a city where homes go for $200-500 a sq ft. even rentals since many duplexs and more are sold for land value alone because of all the building and tear downs to build townhomes.
I been in this for awhile and know very few people from REIA meeting that can manage to find a rental this way because the rehab dollars break you away unless your putting down about 50% of the purchase price on a unit at 60cents on the dollar… Buying at 50-60% is doable however in all markets.
Here is an example… rehabber i had an offer accepted…plan to seller finance it when done.
Asking price 275K, offered 175K, seller accepted 182K plus paying 2% of closing cost. (they sold low b/c of a divorce and I know someone who lives on block and told me the wife would take 180K to get rid of house and husband)
Rehab will run about 10K mostly cosmetic work and update 1 bathroom
House will appraise for 330K when done and even in current condition really.
Now lets see, a 195K mortgage since I roll rehab into it will cost on a 30yr I/O 1800 a month. taxes are $320 month and ins 300 month. Thats is a PITI of $2420 a month. Add $80 a month for lawn care and I am at $2500 with no other issues.
Now I am getting house at 60cents on dollar basically which is great.
But house will rent 1200-1400 month on section 8 depending on which program as we have 3 in my county or 1200-1500 month for regular rental.
SO negative cashflow is $1000 a month min. but can run $1500 a month…
So will I rent it nope. I will complete the rehab, advertise it for 280K and settle around 250-265K on an offer. To sell you need to price it on the bottom 10% in the area even rehabbed. Get a contract for at least 260K, and tell seller I will carry 20% back at 10%. Pay off my loan and walk away with about 15K and then have a seller 2nd for 45k est. Either carry note or most likely sell it to investor for 25K in this market. And still make 40K profit in 2-3months on the rehab…
See even in my market, can not make money or cashflow…so the rule can not apply everywhere even on low end buys which this is. This is a home in a starter neighborhood. Just impossible. Or I can use equity to carry home of negaitve cashflow and wait for appriecation or sell at 300K+
So Mike…what do you recommend in high markets like mine… Do you have a better strategy for me b/c I am ALL EARS…
If follow your rule with the avg rental rate on a 3/2 at $1300 a month, then I need my PITI at 650 month so that would be a 65K home tops… Not in SoFl
Andrew