Should I assume 50% for rental expenses when analyzing a deal?

Question

Many REI calculators use 50% for expenses for Rental Property analysis. Should I stick with that when analyzing deals or try to be more accurate by breaking it all down? In other words, is the effort involved worth the added accuracy? Or is 50% a pretty good estimate? It feels high, but then again I am new at this and have nothing on which to base that. Same for closing costs - I tend to see 3% used a lot.

Thomas S. · Answer

It is also extremely important to understand that expenses are not only about yesterday and today. The 50% guide line is a number projected forward for the life of the property. The biggest mistake investors make is in assuming a new build or fully renovated property has lower expenses. That would only be the case if they did not intend to hold long term.

Andrew Johnson · Answer

Tim Schroeder I’m with others that are saying that it’s an easy starting point. I’ll also posit that it’s pretty close, especially if you’re using external property management. To be even MORE overly general, it’s probably low if you’re looking at a home build in 1910 renting for $550 per month and high if you’re looking at a home built in 2015 renting for $2,000 per month. Watching (new) people post on here I think the most common error is to underestimate expenses: they assuming vacancy will be 5%, cap-ex will be 5% on an 80 year old home, etc. So they basically take 7%-10% categories will magically turn into 5% for them. Maybe it will for a year, possibly two years, but never over the long-term. You “favorably adjust” with 3-5 categories and you have a materially different analysis of expenses. What is best is to look at actuals: actual property taxes, get an insurance quote estimate, see what owners actually pay for utilities, assume 8% for vacancy (1/12 months), etc.

Tim Schroeder · Answer

Thanks, that sounds good. Use it when scanning for deals, then plug in real numbers.

Ali Boone · Answer

Absolutely, no questions asked, for sure-- break it down and be more accurate. Never ever trust an estimate. You can use the 50% estimate to scroll through properties faster while you shop, but as soon as you narrow down your selection, go with the actual numbers. It absolutely pains me that so many people have made the 50% rule so popular (and the 1% and 2% rules) and consequently suggested they can be trusted by themselves. So not true! Hope that helps :)

Henry J. · Answer

Tim Schroeder IMO, it depends on what you are trying to do. The 50% rule is good for quick estimate for what I Invest, but I will only buy after I run my numbers on my spreadsheet. If you already done enough analysis and have a good grasp of the expenses, and it’s close to 50%, then apply the 50% rule to do your quick estimate. If you haven’t done that many analysis yet, it’s always a good practice to go through full analysis anyway. Good luck. Henry

Tim Schroeder · Answer

@Andrew Johnson yeah I can see the truth in what you're saying. But of course, an AirBNB in the right place will net a MUCH higher gross income, which can offset all those extra costs and then some. There are people with multiple properties and a good cleaner/handyman/agent support team making a killing at this.

Diogo Marques · Answer

No. Assume nothing. It starts with what the last guy did. Send the property to the property manager and ask what they think. Pick up from there

Andrew Johnson · Answer

@Tim Schroeder STRs will be higher than 50%. If you want someone to manage it for you, it's not going to happen for 10% of gross rents. You will not be able to pass off any of the utility costs to the tenants. That means water, gas, electric, etc. will all be 100% on you. Pesky landscaping twice a month as well. And guess where the towels and sheets are going to be laundered by the cleaners? Your house. Guess who doesn't care about taking a 45 minute shower? Your STR guest. In many cases, it's a group of people that are STRing a house because they don't want to pay for a hotel room. So it's mom, dad, grandma, grandpa, and two kids in that house. Sure, it's for a shorter amount of time but that time will be like "city miles" on your car instead of "highway miles". There's also a chance you'll have to bump up your insurance premium if STR tenants are covered in your policy (they are in some).Not to mention that you're probably looking at paying $150+ per month for cable/satellite TV and high speed internet.I will say this, you're probably not wrong about kitchen appliances lasting longer. If you keep people under 7 days there's a much higher propensity to go out to eat, bring food back with them, etc. The stove will likely look new for a while!

Tim Schroeder · Answer

@Thomas S. @Ariel Vincent True... cleaning, management, utilities, disposables will all add to cost, but that is accounted for elsewhere in the cash flow analysis. When looking at pure maintenance, I was thinking wear on appliances fixtures, damage to interior, etc might be less with transient guests who mostly just sleep there and go out during the days.

Ariel Smith · Answer

@Tim Schroeder In my experience, wear and tear is much higher in an Airbnb. Also you have to factor in included utilities (and a higher cost for them since guests will run A/C & heat the entire time they are there since they are not paying for it) as well as replacing furnishings, bedding, towels, soap, etc.