How 50% rule affectts $200 cash/unit/mo guide

Question

Hi, I'm new to multi-family rental investing; trying to get my spreadsheets in good shape.

Can someone help me understand: If the 50% rule starts out estimating 50% of gross rent goes to expenses, and folks on these forums have said it's not worth investing in a rental property if you're getting below $200/unit/mo cash flow, then...

- At what LTV rate for debt financing is the cash flow calculated? 100% finance? 75? 0%?

- I assume geography has a big impact on the $200 rule, correct? What about for the east coast - NY, CT, MA?

- Wouldn't these two rules together rule out lower rent housing? It's a rote formula; the only way to achieve >$200/unit cash flow is to invest in higher rent buildings, or calculate using a lower LTV, correct?

Thanks for any input, these forums are a wealth of help.

Scott

Ned Carey · Answer

The 50% rule is a more important rule (or guideline) than the $200 rule. Actually I would say there is no $200 rule. Many people have a number they like to get per unit but that is a more personal decision and like @Joel Owens says it varies by size of property. The 50% rule on the other hand has been show to be typical over the long run for a portfolio of rental homes. While I have tremendous respect for @Ali Boone's opinion, in this case I couldn't disagree more strongly. Most new investors have no idea how much hidden costs add up. Most would never guess that the number is anywhere near 50%. This gets a lot of people in trouble. Of course you need to do numbers on the property you are considering and of course they will vary. All the "Rules" are just rules of thumb or guidelines. They are important because of all the hidden costs in real estate. They are designed to keep newbies out of trouble. Ultimately each investor need to decide what kind of returns they expect based on their goals and their resources. Good luck - Ned

Ali Boone · Answer

I wouldn't stress about the 50% rule. I hate that rule and think it does more damage than not. Yes, returns will always be market-dependent. The NE isn't necessarily going to get you the higher returns. I'd look at some of the TX cities, midwestern states, southeastern states. If you focus on all the non-sense rules and guidelines everyone puts on here, you will just spin around in circles. You want to get yourself into a position to establish your 'personal minimums'. What number are you comfortable with getting each month? And there is a huge difference between getting $200/month cash flow from a $50k house versus a $200k house. The initial investment is a factor. Determine your purchase price first. Then choose a market and learn the going-rates there. Then set minimums. I'd say you are working backwards right now and being too reliant on what people say versus learning the digits yourself.

Jon Holdman · Answer

There have been several large datasets presented in the past that strongly support the 50% rule. Sellers and people involved in selling properties often discourage its use. You only have to look at how many MLS listings say "this will cash flow" when they're using the formula: cash flow = rent - PITI. Turnkey sellers will be slightly more honest and subtract off (at least part of) the management costs. Even then they sometimes include the monthly charge but omit the lease-up charge. Half a month once a year amounts to 4% of the gross. A full month once a year is 8% of the gross. And other expenses, like maintenance, vacancy, utilities, etc. are real. Long term expense like a new roof or furnace are real. The 50% rule is FAR better than those rent - PITI or even rent - PITI - PM phony cash flow forumlas. Lenders use the formula net rental income = rent * 75% - PITI. Not exactly the same as the 50% rule, but close. If by "more damage than good" means it keeps people from buying crummy rentals, then I'm going to keep doing damage. Way too many new investors fall for the rent - PITI phony cash flow formula and then end up hurting when they don't get the returns they expecting. Or, in many cases, counting on. Now the actual results of one property in one year can vary widely. You could be lucky and have a full year's rent and only have taxes and insurance. That's the absolute best case. Or you could have a more typical year and have a few minor repairs and a couple of weeks vacancy on top of the taxes and insurance. Or, you could need to buy a new roof. Or, like me for one my properties this year, a new sewer line. In my case that one expense was 54% of the annual gross rents. If you're serious about being in the rental property business you better be prepared for those hits because you will have them. If you have a large portfolio, say 50 properties, you will have them all the time. @Ali Boone is right that returns vary by region. Lots and lots of places in the US where rentals are not profitable. In some of those you may have a speculation play. Or not, as many people who bought during the bubble found out. Even within an area returns can vary widely from one part of town to another. If your goal is to make a profit, you need to find the profitable regions.

Ali Boone · Answer

I totally agree with you @Ned Carey. I probably should have specified more when the 50% rule is fine to use. It is a good quick-off-the-hip number to estimate expenses. But what happens is people get too caught up with it and assume the expenses of any property to be 50% and in reality they are higher, or different from that, or who knows what. So in this case, why I was so avidly against using it is because Scott was putting that "guideline" together with an "exact" cash flow number. Those two things can't be put together realistically. A guideline needs to be for one thing, calculating exact numbers another and at the end of the day, it's the exact numbers that need to be calculated. But I think you and I are totally on the same page about that, just seeing different perspectives on what is being asked. And I think us hitting both perspectives is good for it too. I agree 100% with your response to Scott.

Account Closed · Answer

Ali's last paragraph sums it up pretty good. If you're a buy and hold guy, I'd steer clear of most of the bigger coastal cities because the numbers simply don't work for rentals. The rents in places like New York and San Francisco and Los Angeles merely cannot keep up with property values, even amidst a financial crisis. Texas in general is a really good bet right now, along with many others. Take a look at some of the recent market reports to guide you to where to put your money. Listen to podcasts. Look at market trends. Follow and model what the most successful guys in the biz are doing. Oh, almost forgot- Scour BP! Welcome and good luck!

Jon Holdman · Answer

Not sure who's coming up with that $200 number. Some folks say to assume 100% financing then shoot for $100. The 50% rule doesn't appear to have much of a geographical factor. It appears to apply pretty much everywhere. Personally I prefer to look at cash on cash returns. Impossible to get 100% financing these days. So, figure out what you realistically can get, typically 80%. Take your down payment, rehab costs and any other costs to get your cash invested. Figure out your P&I payment. Subtract off 50%, then your P&I payment. Multiply by 12 to get an annual cash flow number. Divide by the cash investment to get a cash on cash return. Like that number? Buy it. The requirement to get a certain amount does matter, though. Every unit is a tenant. Showings. Leases. Rent to collect. So, even if you're making 20% cash on cash on a really cheap property it may not be worth it if you're only making $50 a month. A higher rent property that's only making 10% but making $200 a month puts more cash in your pocket for the same amount of effort w.r.t. the tenant. The 50% rule does assume you're using a PM. If you self manage you can earn the PM's cut. Around here that's 10% of collected rents plus a half to full month's rent to fill a vacancy. That can improve your returns significantly.

Will Barnard · Answer

I am going to assume that you are referring to a couple of datasets provided by a couple BP members here in the past. One was from a member who managed in a very low end, low per door rent ratio and as such, will likely have higher costs as a %. The other was taken from data that only included multi unit apartment buildings and that is where I find the 50% rule to be the most accurate, again, with adjustments needed depending on market and other conditions. When I first came to BP, I was not a fan of the 50% rule as far as single family homes are concerned and I had only used it for apartment buildings. After more yeas of experience as a landlord, I came to find out that though I did not hit 50% on my SFR's, I surely came much closer than I ever expected to. With that said, like any rule discussed here on BP, everyone must keep in mind that they are not really rules, but simple guidelines and tools for quick analysis. I strongly suggest they be used. As far as the $200 per door, that is in error. The most common rule of thumb around BP Nation is $100 per door minimum, otherwise, you are working too hard for too little money. If you hit $200 and did so after deducting ALL expenses (or used the 50% rule), then you are in great shape on that deal typically.

Marco Santarelli · Answer

@Scott Lichtman Welcome to BiggerPockets! Don't get lost in the cash-flow per door, as it's better to consider your cash-on-cash returns, and overall ROI. There is no "$200 rule" and this will vary from market to market, as do median home prices. Be sure to check out the Ultimate Beginners Guide as well as my 10 Rules of Successful Real Estate Investing. Continues success!

Ali Boone · Answer

Woot! @Ned Carey

Ned Carey · Answer

@Ali Boone yes we are both on the same page. :-)