Magic Formula!?!?

Hello all, I’ve been reading these forums for a few weeks now, going back through the history and looking at the tremendous wealth of knowledge in these pages. I’ve learned a lot and hope to learn more. Which is the objective of this post.

I’ve seen on many posts, most frequently by “PropertyManager” Mike, that indicate %45 to %50 of your gross rents will be absorbed by costs OTHER than your mortgage payment.

Does this %50 rule include full PITI or just P&I? What percentage of this %50 figure is allowance for vancancies?

Any further breakdown of the percent of costs represented by this %50 would be very helpfull. I understand the catagories of expenses, but the breakdown by numbers would be very nice. Does anyone know the actual source of this %50 figure? Perhaps I could find a more elaborate breakdown of the %50 from the source.

What are some other cashflow formulas? I’m sure there’s a dozen ways to determing cashflow probability for a property.

Could some of the more experienced landlords reply here with their own personal process for evaluating properties?

I’m obviously new to the arena, and am trying to develope a firm business plan, complete with guidelines such as these. Any help would be much appreciated.

Thanks everyone.

So your familiar with Mike’s mating call/ battle cry.

Per the “magic formula” 45- 50% of the gross rents are operating expenses. This does not include any debt service because debt service is a little different for everyone. Property taxes and insurance are operating expenses though. That percentage does include vacancies however, there is not a set amount, that’s something that will be determined by your market and advertising. It’s a rule of thumb, not a law of physics.

The break down of the 50% will not be the same for every market and every property. But the more of one thing will give you less of another, with the sum near 50%. Better maintenance might result in less vacancies, therefore it all works out to about 50%. More amenities (pool, tennis courts, whatever) might result in higher rents and so on.

there are no magic formulas.

The “50% rule” is just a rule of thumb or starting point based upon the average of what people experience across the country for all size rental units. Actually cost can be much higher or lower depending on the exact situation.

However, this figure does not include debt services (i.e. P&I). This figure included, insurance, taxes, property management, repairs, adevertising, utilities (if you pay them), lawn care (if provided), etc, etc.

I prefer to use a bottom-up analysis for a particular property however, this works well for me as I have been renting properties for quite a while and I know what to expect in terms of cost. This is not a useful technique for rather inexperienced folks as one is very likely to underestimate your expenses.

Things I consider in evaluation of a property

  1. age of property and likehood of need for capital repairs (roof, etc)

  2. neighborhood and general expectations of likely tenants. If your units are at or near the bottom on the rental food chain, you may be able to get away with being more rough around the edges

  3. utilities and services that you will have to pay for (or be expected to pay for based upon local market). Example, in one area I have properties I do not pay for/offer snow removal; in another area I do. Other things in this ctagory are lawn care, sewer/water, electrical in common areas, etc.

  4. property management cost and how they handle repairs; some prp. mgmr will use their own people and charge you a flat hourly rate or use local handyman. Other places will call out licensed contractor for every repair. That can make a sunstantial difference in what your repair expenses look like.

  5. how strong local rental market is and likehood of vacancies; also consider the competition. if there is a lot of new rental property construction nearby and your porerty is older, you might face pricing pressure in order to attract tenants.

good luck

Thanks for the feedback guys.

Anyone else willing to describe their process?

50% is common but still too high in a lot of cases.