Thoughts on 50% Rule

[Josh Mitchell]

While I know the 50% rule isn't always a direct measurement of things, for this purpose I am going to assume it is. So, being a newbie, it is my understanding that 50% rule simply states that 50% goes to costs of property and then 50% going to debt service (and the remaining from debt service is your cash flow).

My questions is simple, does this apply to condominium units or just SFH? Is it safe to assume that the HOA fees associated with the condo's, cover a majority of the 50% side of costs, which would more than likely be less than 50% of what the rent is being charged. If it does not necessarily apply to condo's, is there a rule to go by with these units?

While the HOA fees do diminish cash flow and can adjust year to year, it seems to me that by purchasing a condo within an existing HOA could actually save you money (no large expenses, i.e. water heater, roof, etc.)

Thoughts are much appreicated! Thanks.

[Bryan L.]

Find out exactly what's covered by the HOA fees and let us know. We'll be better able to answer your question then.

[Josh Mitchell]

HOA fees provide as follows: Water, Heat, Gas, pool, common insurance, scavenger, landscaping, elevator, tennis court, basketball court, parking, storage, laundry, clubhouse, snow removal, exterior maitenance, security door locks. (Just copied exactly how it was given) The tenant will be responsible for cable/internet and electricity.

[Patrick L.]

Originally posted by @Josh Mitchell:

While the HOA fees do diminish cash flow and can adjust year to year, it seems to me that by purchasing a condo within an existing HOA could actually save you money (no large expenses, i.e. water heater, roof, etc.)

Thoughts are much appreicated! Thanks.

They don't really "save" you money because you're still paying for anything the HOA pays for, you're just making monthly payments on it. It's fine if you can't budget for these items yourself. Do they really pay for the water heater? I wouldn't expect that, HVAC, or anything else that's just for your unit to be covered.

Originally posted by @Josh Mitchell:

Water, Heat, Gas, pool, common insurance, scavenger, landscaping, elevator, tennis court, basketball court, parking, storage, laundry, clubhouse, snow removal, exterior maitenance, security door locks

Some of the items you list will reduce your costs but many just go to pay for luxury items for the tenant. The only things that they're paying for that benefit the owner in reduced costs are the insurance and exterior maintenance. If you had a house that wasn't in a HOA you wouldn't be paying for any of the other items in your list. With the items that the HOA covers you could probably do something like 35-40% expenses (depending on property taxes) plus the HOA dues. You're still going to have management (figure 10%), vacancy (figure 8%), repairs (everything on the inside will account for the majority of repairs anyway), capital reserves (this will be lower but you still have water heater, hvac, cabinets and other high ticket items that depreciate), property taxes, and some insurance (you will need liability and contents insurance.....the COA policy will generally only include the drywall out).

[Josh Mitchell]

@Patrick L. 

For the HVAC it is a hot water/stream baseboard, and the units have wall A/C units in them (so tenant pays for usage of them with electricity). I do understand that one of those may need to be replaced at some point in time, but they are new right now. The unit was just rennovated, so cabinets/flooring/windows and other needs, won't be needed. The management fees are covered in the HOA fees though, correct? As for vacancy, I lucked out and have a renter lined up on a two year lease, and I have yet to even close on the property! Let me just throw some numbers at you and let me know what you think.

Unit cost- $86,000

Market Value- $90,000

Property Taxes- $2,000/yr

Down payment- $21,500 (25%)

Rate- 4.9% 30 yr fixed

Mortgage (P&I)- approx. $500 (rounding high for easy figure, based on GFE from bank a little bit lower)

HOA- $340/month, just updated by HOA

Insurance- $271/year or $22/month

Rent- $950/month

$500+$340+22=$862/month in total costs, so $1,000-$862= $94/month cash flow

My thinking could be nieve, but I just believe that I will never have to pay for new roof, damage to the property (outside), lawn care, pool maitenance, etc. With a good renter, who takes care of the interior, it seems to me that this is a win/win for everyone involved.

[Josh Mitchell]

I meant $950-$862 = $94/month.............. Wishful thinking with the $1,000 I guess! Ha!

[Josh Mitchell]

And if I could do math I would have put $88/month..........jeez!!

[Richard C.]

To me that deal is a dog.  Others may feel otherwise.

[Richard C.]

Adding to that a bit, the numbers are way, way too tight.  

What happens when a majority of your fellow owners decide a new sauna and hot tub would be nice, and your HOA dues go up another $50? And I am not seeing where you are assigning any value to your time, in doing the management tasks. Insurance and taxes may well go up faster than rents can be adjusted to cover them. What is the flooring? Is any of it wall-to-wall? If you get five years out of that, it is a miracle.

I could go on.  But the numbers are way too tight.

[Account Closed]

Why would even consider buying where there is an HOA?

Joe Gore

[Richard C.]

Put another way, you are getting less than 5% on your invested $21,500.  While doing work.  And taking risk.

[Patrick L.]

@Josh Mitchell

As Richard said, that's a bad deal and you will find that it's cash flow negative in the long run.

You won't have vacancy?  Just because you have someone that's going to sign a lease doesn't mean they're never going to move out or not pay rent.  What if they stop paying rent in 5 months and you spend 2 months evicting, 1 month getting it rent ready and 1 month finding a replacement tenant?  You need to figure an average of 1 vacant month per unit per year, which gives you 8%.  

Your HOA does not manage the property for you so you will either need to self manage or hire a property manager. This would cover screening tenants, showing the property, collecting rent, handling service calls, setting up repairs, getting bids, etc. There are hard costs but it's mostly time. If you value your time at $0 then that's fine, I don't. I self manage but those costs are still figured into all of my deals because if I'm going to do the work then I'm going to get paid for it....otherwise I could spend my time doing something else. So I'm leaving that number at 10%. A property management company will usually charge you 8-10% of rent collected plus a tenant placement fee of 50-100% of a month's rent.

"The unit was just renovated" is the most common thing I hear from newbies that claim they won't have repairs.  Guess what, things still break and new things still need to be replaced again.  Let's say your flooring has a useful life of 7 years in a rental and costs $3,000.  You'll need to budget to replace that in your expenses, so that'll be $35/month.  Let's say your kitchen will last 15 years as a rental and cost $5,000 so that's another $27/month.  A set of kitchen appliances cost $2,000 new and last 10 years so that's another $17/month. The same goes for everything else in the unit.  You'll have things that break that require maintenance.  You'll have to paint and make other upgrades and repairs when each tenant moves out, not all of it will be covered by (or applicable to) the security deposit.

Not every tenant is perfect, even if they seem to be when applying.  They might do damage, cause problems, move out, not pay, etc. 

Using your numbers

Gross Rent $900

HOA $340 (If it were my deal I'd stop right here, no way you're going to make money when the HOA is $38% of your gross rent)

Debt Service $500

Taxes $167

Management $90

Vacancy $72

Insurance $22

Repairs/Capital Reserves $90 (I'll use 10%)

My numbers have you losing $381/month.  

[Pat L.]

We inherited one & found the previous owner was paying a large hazard insurance premium. However, when we approached our Ins Broker with the detailed HOA Ins coverage our premiums were 50% lower.

Our attorney also discovered a transferable $4000 roof escrow that was not well advertised/explained in the paperwork.  We were subsequently able to transfer it when we sold.

But we took it back @ $34,000 (DIL of foreclosure after our borrower went broke) & sold it after 4 years of $950/mo rent for $75,000 & still hold the note.

[Lynn McGeein]

And if you haven't already decided not to run screaming, remember that HOAs can declare special assessments, so you may, indeed, be paying for new siding and roofing, storm drain issues, etc.  Make sure you check the associations reserves carefully to insure they are properly funded for these long-term issues and when they plan on needing them done.   We bought a cheap condo near work at a short sale where 3 years earlier they had slapped all owners with a $16,000 special assessment for new roof and siding as the reserves were not enough.  They did raise the condo fees and are building decent reserves over the last few years, but I've learned that officers in condo associations are not the best at budgeting or getting good deals on things like tree removal or storm drain repair and tend to waste a lot of money.  So we'll be selling this one when we retire and it will be my one and only condo purchase.  

[Josh Mitchell]

Thanks for all the input, again being a newbie, these are things that I need to know and get a better grasp on, so I appreciate it! I will look for a better scenario that will prove to provide better numbers!

[Patrick L.]

Originally posted by @Josh Mitchell:

Thanks for all the input, again being a newbie, these are things that I need to know and get a better grasp on, so I appreciate it! I will look for a better scenario that will prove to provide better numbers!

 Better to find out your deal is bad BEFORE you buy it than down the road when you're stuck with it.  No harm at this point.   That one was a clear loser.....even if you use your fantasy numbers without most expenses calculated that showed $94 in cash flow you still left out property taxes so that $167/month pushes you negative even with no repairs, reserves, vacancy or management costs.  

[Andrew Syrios]

I always try to used a fixed cost approach. In all-bills paid buildings in really bad areas with low rents and high maintenance expenses because of old, poorly cared for apartments, expenses can get well above 60% and even 70%. With houses, it really comes down to the turnover. If you have a tenant stay for five years, pretty much all you have is taxes, insurance, HOA's if there are any and a maintenance visit from time to time.

On the other hand, if the tenant leaves in 6 months and trashes the place on the way out, it's going to cost a ton. My home estimates usually come between $2500 and $4000 a year (not including vacancy and debt service). But it all comes down to management. For this reason, I use the rent/cost ratio as my primary rental valuing technique and the cap rate as second due to the major contingent factors with renting a SFH (quality of management and simple variance). Even if the property doesn't cash flow well, it doesn't mean it was badly purchased. It very well was just badly managed.

[Josh Mitchell]

@Patrick L. 

Yeah def better to find out now rather than later. I did not account for certain aspects of it, and have added them to my notes for future use. I did include the $167 taxes in the $500/month though, just didn't clarify that in the beginning! Regardless, that doesn't make the propoerty a winner!! Thanks for the help/input again.