50% rule question

[Matthew Dovner]

say if a multi needs to be rehabbed in order for it to be livable. Say it needs 60-80k in work. Say the asking price is 375,000.00. Do you apply the 50% rule to the 375k? Or the purchase price plus the rehab?

[Bryan Hancock]

I have generally ignored these 50% rule of thumb posts of late because they turn into holy wars with commentators that have generally never operated buildings or done any sort of detailed financial analysis. The OP's original question was whether or not the rehab costs should be included in the ratio. Over time whatever heavy cash outlay you lay out will get absorbed into this ratio and it should be included. Capex is a piece of this ratio. Debt service is not as others have already commented on.

HOWEVER, you may or may not be holding the property long enough for this to matter. If you sell the property prior to having enough time to spread this cost out your expense ratio may be higher than 50%. For older buildings it may be WAY higher than 50% as well. That is why the blunt instrument approach of the 50% rule of thumb is inaccurate, overused, and misleading to many. It is fine as a screening mechanism, but you want to speak with local property managers or other experts to find out how the building will actually operate. The economic vacancy (skips, lates, etc.) may be much higher than you expect. The locals may be prone to tearing your building apart too and thus your expenses may be much higher than you think in C or D-type neighborhoods.

Be careful with using the rule of thumb as the end-all-be-all that it is hyped up to be on the forums.