50% Rule Expenses: How long / how much?

Question

FYI. I am new here and don't have any experience with Buy and Hold investing.

I have a question regarding the 50% rule. I understand that this is a general rule of thumb when determining a properties feasibility but the 50% that gets carved off ultimately does get exercised during tenant occupation, correct? My question, and I know the answer is subjective, but how long do you accumulate that 50% and what would someone consider the upper threshold to stop putting that portion away and start counting it as profit? I understand an AC or a roof has a life span and they will eventually need to be replaced but lets assume after 15 years of holding the property, nothing broke or wore out.

What are peoples experiences with this?

Dmitri L. · Answer

@J  Scott

That's a great summary, thanks!

Another thing worth considering is - if you have only one or two properties, some people might be tempted to "roll the dice" and not set funds aside for the low-frequency high-cost repairs. Obviously a bad idea, but statistically some people will get away with it, then come on the forums and say exactly what you mention, perpetuating the cycle.

However as you start acquiring more properties, which I'm assuming is most people's goal on here - to have a substantial amount of passive income - the more individual properties you have, the more chance of at least one big ticket item each year. So over time your "expense" curve will get alot smoother and stay around that 50% number overall.

With one house you might be at 40%, 40%, 40%, 125%, 40% each year...

WIth 20 houses, you'd be more likely around 49%, 51%, 48%, 52%....

One last point - that bad year above at 125%, you're effectively out 16 months of gross rents. Assuming that same hypothetical house with 1000/mo gross with 200/mo cash flow, that "bad year" just wiped out 4 years' worth of assumed "profits". I say "assumed" due to the fact that this money should have been in a reserve fund instead :)

-D

J Scott · Answer

This is where people tend to misinterpret the 50% rule.  For 15 years, they look at their property and say, "Wow, I've been spending next to nothing on maintenance and repairs...clearly the 50% is too conservative...I'm at closer to 40%!"

Then one day they realize that the roof needs to be replaced ($6000), the HVAC needs to be replaced ($5000), the hot water heater needs to be replaced ($800), the siding needs repairs ($1000), etc.  Before you know it, you've spent $15-20K on repairs over a year or two.

If you amortize that $15-20K over the 15 years you held the property, that's equivalent to about $100/month.  If you were getting $1000/month in rent, you then realize that your 40% expenses all that time was really 50% expenses (the extra $100/month is the other 10%)!

Unfortunately, too many landlords will look at that $15-20K as an anomoly (since it too so long to happen and happened all about the same time), instead of looking at it as part of the 50% that just took a while to "catch up."

That's why, when someone comes on here and says that they're no where near the 50%, the two questions I'll ask are:  1.  Do you do your own property management (if so, that WILL save about 10%); and 2.  How long have you owned the property (invariably, it will be much less than 15-20 years).

Walt Payne · Answer

It is an estimated average cost over time. Some might cost less, some more. Look at the cost of the things it should be reserved for. If you have enough to cover HVAC, roof, one of each appliance, a major pluming repair with leaks, and an eviction with major damage all happening in one year then you should be good for now. Since we do our own rehabs and repairs I keep less than others might, due to our lower costs of repairs. If that changes I will need to increase it.

I keep two separate accounts. One is for minor stuff, one major. I put 10% from each rent in the major repair fund and don't touch it no matter what, until it is at $10,000 per property. If any of that gets used I will immediately replenish it from 10% of each rent check.  A small part of that is in savings, then in increments in less liquid but solid short term investments such as CDs. Not a high return but better than savings.

J Scott · Answer

Every real estate strategy has its different pros, cons and unique aspects.  For buy-and-hold, one of the cons is that it is (generally) pretty capital intensive.  This is because you need capital for long periods of time, making it tougher to find lenders or equity partners.

A lot of buy-and-hold investors will also have a more active strategy (real estate or something else) that allows them to generate additional income to speed up their ability to build a rental portfolio.  For example, many landlords will flip houses to build their capital, some will start side businesses, some with wholesale, etc.

Walt Payne · Answer

It is how I organize the expense funds. Because I am reinvesting all profit right now I am temporarily "cheating" by keeping the float lower in those funds than would theoretically be needed. I will write a small book here to explain. Disclaimer ... Note that there are several things different from how most people do things. Some of those things make "cheating" possible while not adding much risk. We have minimal leverage, do our own repairs, and do not withdraw any money from profits at this time. This model works well for us because although not using leverage, we can compound our investment this way and expand almost as fast with no debt. In an emergency we have credit to fall back on, in addition to almost all of our property income.

I keep separate accounts, since they are big enough to be free. Insurance and taxes in one. Minor maintenance. Long term maintenance/capex fund. I do not keep a vacancy fund because I have minimal leverage, again because I am putting income back in so I can afford that, though most people's investment model would not support this. Separate funds is not necessary, but makes it easier for me to keep it straight how much I should have available.

We do fix and hold. Virtually everything new or near new. So part of my assumption is that repairs will be reduced short term. Plus we do our own work so for now the costs are greatly reduced.

What I do, assuming less repair costs for now, is maintain a smaller repair fund, and sort of borrow that money for expansion.  Because it is being funneled back into expansion, I can replenish or increase those funds quickly if needed ($5k per month after insurance and taxes). When I am near retirement, and ready to live off of some of the income, I will temporarily put everything into increasing those funds to create a quite conservative cushion.

Walt Payne · Answer

True. Not a matter of "if" but "how bad" you will get hit, over time. Which is one of many reasons buy and hold is not really passive income.

Justin B. · Answer

@Walt Payne Would this be outside of the 50% stash? Or just how you organize that 50%?

Kathleen Leary · Answer

If  you hold a property 15 years, you WILL need to spend major bucks to fix something. Plan from the start to have money to cover it or you will be in over your head before you know it.

50% Rule Expenses: How long / how much?

Most Popular Reply