Does the 50% rule apply to duplexes and fourplexes

Question

Hi all,I've been doing a lot of research recently and am now starting to look at actual rentals and run some numbers. I'd like my first property to cash flow positive. I find estimates for property taxes by looking up the buildings history. I can also get a decent estimate for insurance. The part I struggle to estimate is repairs, maintenance, and capEx. Is there a good way to estimate these costs or is better to just bundle all non-mortgage costs and use the 50% rule?The properties I am looking at are mainly duplexes in a nice are (around the lakes) in Minneapolis. The prices around around $500,000 and rents around $2,000.

Mark Sullivan · Answer

$2,000 per door? Might want to clarify but I assume that is what you meant.

Jeff Schemmel · Answer

@Trevor J Dammon I am pretty specific about my expense estimates and I recommend NOT using a rule as a new investor - you should be doing the detailed research and rules are meant for someone who can absorb some risk and/or has been down the road many times and is making more deals per year and doesn't need to sweat as many details. Water/sewer/trash don't change much, taxes change the most from property to property, and CAPEX can be planned with a specific methodology. Here's how I do it:1.) I make a list of all capex items2.) I estimate the replacement cost of all items on that list for the property (I get close, but not perfect)3.) I walk through the property and make estimates of the remaining useful/productive life of that capex item on my sheet4.) I then divide the cost over the useful life...say a roof is 10k to replace and it's got 15 years left. I need to save about 660/yr or about 55/m in my capex to make sure I have enough in my reserves to replace that roof. 5.) then I take a look at my list of capex expense estimates and separate the list into urgent/non-urgent and I just prioritize accordingly. I might have 3-5 items that I actively save for and a few that I just assume are new enough that I don't need to worry about.That's the way I do it, there are probably other/better ways. I will say if you've got a ton of cash reserves it's probably not as important, but it just depends on your cash reserves, your goals, and what helps you sleep at night. This helps me sleep at night and gives me a thoughtful way to plan ahead and be aware before making a purchase.In regards to regular ongoing maintenance, that can really range a lot. In my 117yr old duplex my repairs/maintenance were about 150/m over the last year or so. As an owner-occupant, there were a couple things I did to my first duplex that perhaps others wouldn't have done and I did not include that cost here. I also consider myself a fairly handy person and if a permit is not required I will do it myself if i'm comfortable with the task.-Jeff

Tim Herman · Answer

@Trevor J Dammon you can estimate fairly closely by using a maintenance and capex budget. It starts with what you are using for vacancy factor. Where I moved the supposedly the vacancy is 1%. They have waiting lists for apartments in the construction phase. I would never underwrite at less than 5% and i usually use 8% or 1 turnover per year. 5% is your tenant staying an average o f 20 months. You next have to determine: are you going to do a major turn each time a tenant moves out or a touchup until 5 years(usually the paint will have faded by then and needs to be repainted.). Maintenance budget is cost of turnover plus the cost of repairs over a given time. I use 1 service call per year at $150. So using 5% vacancy you would have 1 turnover and 1 1/2 service calls. Say a major turnover costs $1000 and a touchup costs $500. Your cost of maintenance for major turnover is $1000+$225 service calls=$62.50 per month per unit. Touchup will be 2 minor, $1000+ 1 major $1000 + 5 service calls $650=$2650/60 months=$44.17 per month per unit.You do the same with a capex budget. Everything has a lifespan. Let's look at roofs. Lifespan 25 years. Say it costs $7500 for a new roof. $7500/300 month lifespan=$25 per month for 1 item. You now have a 15 year old roof. Your new effective lifespan is 120 months. $7500/120 months=$62.50. There is a comprehensive capex budget by @Sam Tato in the files section. Reserves are the key to surviving in this industry. If you have enough units you can probably cash flow your capex and maintenance expenditures. For me I find my most expensive capex item and make a reserve fund of 1 1/2 times. So if roof is the most expensive item then 1 1/2 times would be $11250. Take all the cash and put it in the reserve until you get to the number you set. After that you can start saving for your next down payment. If you tap into the reserve then stop saving for the dp and build back up the reserve.

Nathan Gesner · Answer

You can get some information from the listing agent, but some details aren't available until you actually inspect the property.

Trevor J Dammon · Answer

Hi @Theresa Harris, My goal is to map out and estimate all expenses as best as possible. I think finding taxes and insurance is easy to do. Any advice for estimating repairs and capEx? I realize that is highly dependent on the age and state of the house, but I would still like a way to estimate these costs before diving in. Hi @Nathan G.,I meant to say rent is around $2,000 per side. So the annual rents would be around $48,000 excluding vacancy. What specifically do you do to get detailed info a property. Currently I just look at the facts and figures on Zillow. Would the agent have all of the info about how old different systems are and whatnot?

Nathan Gesner · Answer

You aren't going to cash flow if purchase price is $500,000 and rent is $200,000. You generally want an investment to rent for around 1% of the purchase price or better. So a $500,000 property should generate $5,000 a month income.Using percentages can work for a quick analysis, but you still need to know the market and a little about investment property. For example, a 1942 home is going to require more maintenance than a 2018 home, unless the 1942 home was recently renovated. Capex on a brand new home is less than it would be on a home with a 10-year-old water heater, 40-year-old furnace, and 15-year-old roof. You can estimate 10% for maintenance, 10% for capex, 10% for vacancy and then adjust those as you get to now the market and learn more about properties.I know my market well enough that I can estimate 50% towards expenses, add the mortgage and interest, and what's left over is the cash flow. That works very well for eye-ball a property to determine if it's worth investigating further or if I should pass. If it still looks interesting, then I'll get specific numbers and evaluate it again. These general rules are filters used to analyze properties quickly so you can discard the ones you know what work. We all do it, all the time. If you're buying a home for yourself, you don't physically travel to each one and conduct a full inspection before deciding which ones to make offers on. You take a quick look at location, square footage, number of beds/baths, land, garage, pictures, and whatever factors are most important to you. If you're looking for a 3/2 Tudor, you can quickly eliminate the 2bed/1bath trailer house or the fourplex next to the strip club or the commercial mechanic shop. You look at 100 homes and eliminate 90 of them by applying your filter. Then you investigate the remaining ten more closely until you narrow down the one you really like and make an offer.

Theresa Harris · Answer

I don't use the 50% or 1% of any of those guidelines, use the actual numbers or estimates and see what the total expenses are vs the income. Percentages are misleading as they depend on the number, also the amount of cash flow you want may depend on the house. If you have a $500K property, $100 a month cash flow may not be good enough vs a $100K house. Your location also matters as in some areas you can buy a good investment where it will appreciate a lot more than other areas. You also want to look at the type of rental-you can get a cheap house where the numbers look good on paper, but the reality is you have lots of turnover and the costs are a lot higher.