Does the 50% rule hold true for lower end properties?

[Gary Dezoysa]

Hi, I know that if I compared a $30,000 house renting for $600 a month to a $120,000 house renting for $1,600 a month, the cheaper house would have proportionately less property tax and vacancy factor, maybe also insurance.

But it seems to me that hard costs such as those for repairs and maintenance would be similar, which means a higher expense ratio overall. With this in mind, does the 50% rule (50% of gross rents go to operating expenses) hold true for lower end properties?

[Michael Evans]

I don't subscribe to the 50% rule.  Our buy an hold model has our non-financing costs at 25% of our monthly lease payments.  Here is the breakdown for a typical $100K house:

Monthly lease: $1,387

Monthly property taxes: $125
Monthly property insurance: $42
Monthly property management fee: $150
Total Monthly expenses: $317

Expense to Income ratio: 22.86%

We only buy brand new construction homes or turnkey properties.  We only enter into long term lease-purchase agreements where the client puts a substantial non-refundable deposit to purchase the home over a 30-year period (7.5% of the purchase price).  Our property management fee covers renter's insurance, a home warranty plan, weekly exterior maintenance (all of our homes are zero-scaped) and annual maintenance of the property's systems (HVAC, floors, ventilation, and pest control).  Just like when you lease a car, the tenant is responsible for all maintenance of the house, but all of our new properties come with a 10-year warranty and our turnkey properties come with a 1-year warranty and are in like-new condition.

The trick to above-average ROIs is to reduce costs.  We do that by managing and shifting risk.  Here we manage maintenance risk through a thorough preventative maintenance system (I used to be the Street Maintenance Manager for the City of Lancaster, CA) and we shift risk through the lease-purchase by receiving a large non-fundable down payment and making the tenant/buyer responsible for all maintenance.

We set the purchase option price at a premium of 18% since the tenant/buyer has 30 years to execute the option. We use 100% financing on the purchase of the property and come in leveraged at 7% of total costs. Our after-tax annual net cash on the first year is $1,224 which produces a ROI of 24.8% on an initial investment of $4,935 to buy a $100K property.

God Bless You!