The 50% Rule says that throughout the United States, operating expenses run 45% to 50% of the gross rents. The expenses in the 50% Rule include (but are not limited to) taxes, insurance, management (even if you do it yourself), maintenance (even if you do it yourself), vacancies, advertising, utilities (even if only during vacancy), entity maintenance, legal fees, evictions, damage done by tenants in excess of the security deposit, capital expenses, etc. From an accounting standpoint, vacancies and capital expenses are not operating expenses, but they are included in the 50% Rule because they are REAL expenses that do come out of your pocket.
I didn't add the vacancy. How many months would you add per year for vacancy.
I simply use the 50% Rule for expenses, I don’t add a certain number of months of vacancy per year. Predicting individual expenses for a given rental in a given year is impossible. You could get lucky and not have a single vacancy in a rental in a given year. In fact, you could go several years in a given rental without a single vacancy. On the other hand, you could be unlucky and have several months vacancy in a given rental in a given year. How’s your crystal ball? The same issue applies to evictions, damage done by tenants in excess of the security deposit, etc. It’s just not possible to know about individual expenses for a given property in a given year - that’s why I use the 50% Rule.
Also, the debt. (down payment) wasn't added either. So it would be ($15,000 divide by 360 months =$41.67. So with all rental purchases, you suggest the DP as an expense?
No, I don’t include the downpayment as an expense. I include the downpayment in the debt with the same terms as the mortgage. Here’s the reason for doing that:
The money for the downpayment came from somewhere. That money has value and has an “opportunity cost”, meaning that if you weren’t using it as a downpayment, you could make money with it doing something else. So, to account for that value of the money, I simply include it in the mortgage by calculating the mortgage at 100% of the purchase price. By doing so, I’m assuming that the opportunity cost of the downpayment is the same as the money you’re borrowing from the bank.
Does the 50% average operating expense include some allowance for vacancies and possible fix-up between tenants?
Yes.
rbednarski,
Here’s how I see your deal:
Gross rents: $995
Operating expenses: $497
NOI: $498
Debt: ($94,000 incl rehab, 30 yr, 6.375%): $586
Cash flow: $88 LOSS (OUCH!)
I would consider this a bad deal and I certainly wouldn’t do it.
I wouldn’t pay more than $63,800 for this property!
Mike