When looking at an investment property, there are many figures needed to be considered. One of the most important things is whether the property is profitable and generate a positive cash flow. There are several methods to analyze the successful of a deal, but most of them require an in-depth analysis. However, the 50% rule is a useful tool that initial evaluate potential properties, supporting in filter to help you focus on promising properties without taking time and effort. This article will discuss about the definition of the 50% rule, how it works, and when and how to apply it.
The 50% rule is a formula used to quickly estimate the profitability of a given rental unit, which has been shown to be effective in determining whether an asset is profitable. This formula is suitable for any form of housing rental including single-family homes, townhouses and even large apartment buildings. The rule says that 50% of total rental income should be used to cover expenses.
The formula for the 50% rule is very simple, which takes the total monthly rental income and divides it in half, resulting in the amount used for the property cost. The expenses associated with owning property which include property management, vacancy loss, repair and maintenance, capital expenses, taxes and insurance, owner paid Utilities, and other miscellaneous.
However, there are some costs that are not included in this formula that have a significant impact on the cash flow, including property manager expenses, home owner association fees, and mortgage payments.
Let’s take a look at an example. Assume that you are considering a residential rental investment which can generate $2,000 in income every month. Apply the 50% rule, an amount of $1,000 will be used for expenses. The other $1,000 will be used to cover your monthly mortgage payment and the rest after that (if any) is your cash flow. If you get a positive result, you could then decide whether or not to complete a more thorough analysis of the property.
This rule is considered useful when you have no idea of how much expenses will be or there is no actual expense history. Please note that, do not use this rule in place of the actual expense history. When looking at a property, if the cost of the investment property is more or less than 50% of the rent, you need to investigate the reason. If it more than 50%, it could be the result of low rent or recent major maintenance. Conversely, if the investment property costs are too low, it could be that the maintenance was overlooked or actual investment property costs were miscalculated.
Overall, the 50% rule is a good method for the initial evaluation of a property. It saves you a lot of time and quickly realizes whether a property is worth or not. The purpose of the rule is to help the investor partially assess expenses even when there is limited information about the property.
Author: Vy Yakushenko
Esajian, P. (n.d.). The 50% Rule in Real Estate Investing: What You Need to Know. Retrieved from https://www.fortunebuilders.com/fifty-percent-rule/
Ramadan, J. (2018, June 21). 50% Rule: Yay Or Nay For Estimating Investment Property Costs? Retrieved from https://www.mashvisor.com/blog/50-rule-estimating-investment-property-cost/