I’m all for a person doing all the due diligence they can. My question, however, is how will a person come up with accurate numbers to use? Taxes, insurance, and management fees are easy. However, many of the other numbers are nearly impossible to obtain (other than guessing). Vacancy allowance for example, where are you going to get that number?
It is easy enough to call a couple of professional management companies that have rental properties in the same neighborhood and ask “If I placed my property under your management today, how long would it take for you to put a qualified tenant in place?” For single family dwelling units, I don’t use a percentage rule, I use months. Turnover vacancy will be at least one month most of the time. At a minimum, allow one month vacancy allowance. It the management companies tell me they are experiencing longer vacancies for their managed properties, then I will add another month or two to the vacancy allowance.
That’s why I use the 50% rule. Over time and over a number of rentals, it’s the most accurate thing going.
The problem with the national statistic is that it is reporting the average operating overhead for properties already in service – income producing properties that have already been generating a positive cash flow.
For a property he does not yet own and for which he has no rental income and expense history, p1nn4cl3 can not just start with the 50% rule and state with certainty that his property’s operating overhead will average half of his market rent. That is fine for a beginning estimate, but unless he confirms the big numbers he has no way of knowing if these costs are even in the 50% ballpark.
We might have been able to be more certain in our responses if p1nn4cl3 had told us more about the purchase price and his proposed financing. He only said that the debt service is $600 per month. Not much help if he is making a large downpayment to get his debt service down. If his property will cost $500K and rent for $1400 per month, there is no way that his operating expenses will be under 50% of his rental income, but this property will still have a $600 monthly debt service after a $400K downpayment.
If the property cost is $125K and p1nn4cl3 uses 80% financing, his debt service (at 6%) will also be $600 per month, but even this property might have an operating overhead greater than $700 per month. If his property taxes are $3000 a year, the insurance premium is $1400 each year, the HOA fee is $175 per month, projects management costs at 10% of collected rents, and he uses a two month vacancy allowance, his operating overhead is running about 55% and there is no room to take care of all the little things like cleaning, preventive maintenance, advertising, leasing costs, excess damage, and a contribution to a replacement reserve.
The big ticket items in his operating overhead can be confirmed. Property taxes, insurance, HOA fees, and management cost are easily obtained or estimated. The smaller numbers he can estimate or make some allowance for once he knows how much budget he has to work with. My point is that just saying that his operating overhead will be no more than 50% of his rental income does not make it happen for every property.
The unplanned stuff, like tenant damage or repairs, can’t be determined with any degree of accurancy. That is one reason we want the property to generate a comfortable monthly cash flow so there is room to handle the unexpected.
If p1nn4cl3 had started with your 2% rule to qualify the property he is considering purchasing, then he could be fairly confident that his operating overhead will be no more than 50% of his rental income and further research may be unnecessary.
But since he did not give us any clue to his property selection technique, I am guessing that p1nn4cl3 just discovered this property and started qualifying the property with the 50% rule. If that is the case, then he really needs to do more homework.