Problem with the 50% Rule

[Peter Aziz]

Hello, BP! I hope everybody's doing well around here. 

In thinking through the 50% Rule, and modeling it out in my spreadsheets, I am finding myself very uncomfortable using it. Here is the hurdle that I'm mentally up against: 

• While certain expenses are in actuality directly tied to your gross rental income (vacancy and property management) some expenses are not (maintenance and CapEx). I'm currently looking at purchasing a multi-unit in St. Louis. In St. Louis, like most other cities, there are premium neighborhoods (A's & B's) and non-premium neighborhoods (C's and below). The premium neighborhoods obviously demand higher rental rates - however, the cost to replace a roof or snake a sink in an A neighborhood is not going to be different than the cost in a non-premium neighborhood. So, with that said let's assume that a building in an A neighborhood will fetch $2,700/mo in rent, while a building in a C neighborhood will only bring in $2,000. Most investors I've spoken to have advised to accrue 10% of gross rents for maintenance expense (and 5% for CapEx). Why on earth would I accrue $270/mo for maintenance in an A neighborhood and only $200 in a C neighborhood that could be as little as 4 or 5 blocks away?

[JD Martin]

It's the reason that every property has to be individually analyzed if you are serious to the point of purchase. As you note, a roof is a roof, although that is not necessarily true with all things. For example, you might have higher end cabinets in your "A" vs. your "C", and while they may last longer they will also be more expensive to replace. Same can hold true for counters, floors, bath fixtures, etc. 

Percentages and rules only get you to the ballpark. You still have to find your seat.