50% rule

[Jim McMillen]

noob here.....Can someone explain the 50% rule, 2.5% rule.....I can't seem to find a definition for it.

Thanks.

Jim

[Timothy W.]

50% of what you hear about real estate investing is crap.
Of that 50%, only 2.5% works in a down market.

Seriously, here's what it means. If you buy right - at least 50% of your rental income will be spent on expenses. The general guideline is that you want to get rental income that is at least 2% of the purchase price. I used to believe in 1% but 2% is certainly better....and 2.5% is even better than that. With REOs the way they are, I've been applying the 4-5% rule. :mrgreen:

[J Scott]

Originally posted by @George Jan:

@Will Barnard, 

@J Scott

It would be  possible that I misunderstood J, but he said "This 50% calculation doesn't include taxes, depreciation..." and depreciation is sort of an equivalent for capex. 

Hey George,

To reiterate the definition that I posted above:

"On average, across a large number of units, a long time period and a large geographic sample, somewhere around 50% of gross income will be used for operating expenses, vacancy/rent loss and CapEx."

The 50% rule certainly does include CapEx (which as you pointed out is not a trivial expense).

My later point was that the 50% rule doesn't include depreciation.  And that's true.  

My parenthetical comment was related to the fact that depreciation is similar to CapEx, in that they both account for the wear on the capital asset (though one actually hits the statement of cash flows and the other is just on paper). So, in a way, the fact that you're accounting for CapEx in the calculation is sort of like accounting for depreciation. 

But, long story short, the calculation DOES INCLUDE CapEx and DOES NOT INCLUDE depreciation.