The 50% Rule
The 50% rule is a rule of thumb to do a very-quick first-pass analysis of a single family investment (rental) property. The rule states that — on average — the total expenses associated with operating a SFH investment will be about 50% of the gross rents. The expenses included in the 50% are things like: taxes, insurance, repairs, property management, administrative, legal, turn-over costs, eviction costs, etc. Basically all the ongoing annual expenses associated with maintaining the investment.
Here’s an example of how the 50% rule can be used:
Let’s say you find a single family property for sale for $100,000. Additionally, let’s say that based on your research of the local market, you believe you can rent the property for $1000/month. Using the 50% rule for a first-pass financial analysis, we find that all operating expenses would total about $500/month:
Expenses = Gross Rents * 50% = $1000 * .5 = $500
So, the amount you have left over at the end of the month to pay your mortgage and your profit (also known as you Net Operating Income, or NOI) is $500:
NOI = Gross Rents – Expenses = $1000 – $500 = $500
Now, let’s assume you would get 20% down, 30-year fixed interest mortgage at 6% on this property. Your monthly mortgage payment would be $480, leaving you $20/month in profit:
Profit = NOI – Mortgage = $500 – $480 = $20
So, your very preliminary analysis indicates that you can get a small positive cash flow from the property with a 20% down payment. $20 per month isn’t much to get excited about, but consider that if you can negotiate the price down (thereby lowering your monthly payment), this might be a worthwhile deal. For example, if you can negotiate the price down to $85,000, your monthly payment drops to $408/month, leaving you nearly $100/month in profit.
Also, remember that property management costs are factored into the 50% expenses, so if you plan to manage the property yourself, all fees that otherwise would have gone for property management will now go to you.
As always, don’t trust rules of thumb to make your decisions for you, but don’t hesitate to use them for “back-of-the-napkin” assessments of whether a property might be worth looking into further. The 50% rule is great for that!