Help me understand this deal and 50%, 2% rule

[Matthew Stover]

I hope I'm doing this correctly. Thank you in advance.

3-unit apartment complex
Asking Price = $119,500 (I easily understand that this is way too high)
Total Monthly Rents = $1,235

Using the 2% rule, I would need the house to be $61,750 (61750*.02=1235 or $1235/.02 = 61750)

50% Rule says that $617.50 of Total Monthly Rent will be used for expenses.

So a $61,750 mortgage (at 100% financing, 8% interest, 20 year payback) per month is $516.50. I think I'll be able to get 100% financing if I can prove my assets, etc.

Therefore $516.50 (mortgage payment) + $617.50 (anticipated expenses) = $1,134.

$1,235 (monthly income) - 1,134 (Total Expenses per month) = $101 net income per month

I thought I'm supposed to be making over $100 per door!

Am I calcualting something wrong? Please let me know.

Thanks again!

Matthew08

[Jon Holdman]

The 50% rule (expenses = 50% of gross scheduled rent, expenses mean actual operating expenses, capital expenses, and vacancy) is discussed in several other recent posts, so I would rather not take up that subject here.

The 2% rule (rent must be 2% of the purchase price) has several assumptions. One is that it tries to get $100 per unit. It assumes SFR type financing (e.g., 30 year note, not 20 year.) For a 30 year, 6%, 100% note, it is exact for a $25,000 unit that rents for $500/month. Expense are $250/month, payment is $150/month, leaving you $100 cash flow. At 7% loan rate, it works for a $30,000 unit that rents for $600/month.

With a 7%, 30 year loan, for a $100,000 house, you only need $1525/month in rent to get the same $100 in cash flow. That's 1.53%.

If you go to cheaper units and lower rents, you need more than 2% to get the same $100. Your rents average $412. Take out 50% for expenses, and you're left with only $206/month NOI. If you want $100 for cash flow, that leaves only $106 for debt service. That will cover about $16,000. That's a rent percentage of almost 2.6%. At 8% and 20 years, you can only cover about $13,000.