Hi:
I’m new to REI. This is a great forum, so much information here. I have a couple of question for the rental property experts.
I know this has been ask alot, but what is the formula (calculation) you go by or use before buying a rental? And what is the ROI that you will accept for any property. I know a few people (in real life) who don’t seem to mind that they break even every month. That can’t be good.
TIA,
TienT
The 50% rule is what I go by when determining if a property or a multi unit will cash flow.
The 50% rule suggest that the average operating expenses across the country is 50% of the gross operating income. It would go something like this:
GOI-50%=NOI
NOI-Debt Service=Cash Flow
How about someone tell me what they think of these numbers.
Rental property SFH
Purchase price : $75,000
Down Payment : 20%
Loan at 7% for 30 yrs.
Rent: $950/month
Expense: $250/month
Cash flow : $303.13 /month
I came up with an ROI of 24% - Is this considered good for an invester?
TienT
Tien,
I think your numbers are pure fiction! There is no way that a $950 per month rental has operating expenses (including vacancy and capital expenses, which are not technically operating expenses) of only $250! Not going to happen ANYWHERE in the USA!!!
Here’s how I see your deal in the real world:
Gross rents: $950
Operating Expenses: $475
NOI: $475
Debt (including your downpayment which has a cost): $75k, 30 yr, 7%: $499
Cash flow: $24 LOSS (OUCH!!!)
Not a good deal!
Mike
I didn’t add the vacancy. How many months would you add per year for vacancy. The house is move in ready, so no rehabbing at all.
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?
Would it still be a good investment when other homes in the same neighborhood sold for $110,000 just last month?
Thanks for your insight. It’s really helpful.
Tient
I’m a newby to real estate investing and I have a question about this formula. Does the 50% average operating expense include some allowance for vacancies and possible fix-up between tenants? Or do I need to make estimates for these things separately?
Does this deal seem to make sense to you?
Purchase price: $93,500 (very little fix-up needed to be rentable - less than $1000)
Down Pymt: $18,700
Loan Pmt. at 6.375%: 466.65 per month
Taxes per month: $150
Ins. Per Month: $40
Trash per month: $50 (we would want to pay this because it is a lienable expense)
Property Management: 1/3rd of first month rent, 8% of monthly rent thereafter (for first house we’d want to use an expert - maybe get into do it ourselves later on)
Average rental in the area $995
Without taking into account vacancy rates and possible fix-up it comes out to about $200 monthly cash flow.
With a $466.65 loan payment and $995 gross rent it seems to satisfy the 50% rule but I don’t know if I am really understanding the fullness of that rule of thumb.
Any constructive input welcomed from any quarter.
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
Thanks alot Mike!
That opens my eyes to a whole new way of thinking. As far as the down payment, me and hubby had a showdown on that. He read your post and agreed with you. I thought it was a little overboard calculating it with the mortgage term. But what do I know :rolleyes.
But overall, I can see why this formula works to cover all the bases. This way you can quickly do numbers in your head when out looking at properties.
So correct me if I’m wrong, hubby explained the most simplest way to do this is just multiply the rent amount by 50 and that is the price you should pay for the property.
$950 X 50 = $47,500
But prices like that are far and few.
Great info!! Tien
So correct me if I'm wrong, hubby explained the most simplest way to do this is just multiply the rent amount by 50 and that is the price you should pay for the property.$950 X 50 = $47,500
Yes, provided there is no rehab needed. If there is a rehab you need to subtract that. For example, in your above example, if the property needed a $5,000 rehab, then the maximum purchase price would be $42,500!
But prices like that are far and few.
If it was easy, everyone would be rich!
Mike