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50% rule
noob here.....Can someone explain the 50% rule, 2.5% rule.....I can't seem to find a definition for it.
Thanks.
Jim
Hey Mike,
What part of Ohio do you live in? Do you know if properties exist in Columbus that can be bought using the 2% rule?
Thank you.
Jim
Originally posted by "MikeOH":So what do you do in MA then?If you can't make money in MA then I would either move to a location where you can make money or run a different business. Real estate is just one of thousands of ways to make money. It is not the be-all, end-all of the world. Someone is making money doing something in MA!!!
Good Luck,
Mike
I hear you Mike. My guess is that the majority of these apartments that are cashflowing are owners that have held 15+ years who haven't put much into the buildings.
If there are deals out there they are few and far between. At least to the inexperienced newbie like myself.
The problem is that prices blew up over the last 10 years or so and rents didn't justify purchasing at those "expected prices". I'm hoping this down turn will help create more motivated sellers and when I present a take it or leave it number based on operations they will understand the true price.
#3 Off Topic Contributor
- Investor
- Viera, FL
BostonHome,
As a former Boston resident, I know your pain. How's New Hampshire? Have you checked their market? That's not too far of a drive. Get a little rural and you'll see things improve dramatically.
Tim
Originally posted by "MikeOH":So what do you do in MA then?If you can't make money in MA then I would either move to a location where you can make money or run a different business. Real estate is just one of thousands of ways to make money. It is not the be-all, end-all of the world. Someone is making money doing something in MA!!!
Good Luck,
Mike
Mike has it right.
RE investing the way Mike does it is one business. Developers are in the RE market and they make money. The same for RE agents.
You need to run a business that will be profitable and is in demand in your market.
I know a rehab investor who buys, fixes and then sells. He turns about 100 property a year. He keeps every 3rd or 4th property and does not mortgage them. That way they have ample cash flow so he can get lines of credit when buying the short term rehab properties.
MA has been around for a long time. There were better times to buy rentals. There will be good times again. Warren Buffett only buys when he finds value. That can mean he sits on a lot of cash and is out of the market for long periods of time.
RE investing is closer to a business than anything else. More so when you actively manage rentals.
Career change is expected. Changing one's investment strategy is also required if the certain strategies will not work in a specific market at a specific point in time.
John Corey
I have found that you will almost never see a property on the MLS that meets the 2% or the 50% rule. However properties can be purchased at that price both outside of the MLS and on the MLS. The key to getting properties that meet these rules is finding people that NEED to sell. People that are desperate. When you find one of these people then many of them are more than glad to part with the property at $.50 on the dollar because to them that property is nothing but "trouble".
-Michael
quick question- just applied the 50 % rule and 2 % rule to my 1st property i got at 22, want to make sure i did my math right.
loan amount- 82,000
rent- 1150
Operating Ex.- 575 (can i lower this since i manage and repair myself, also property is renovated?)
NOI- 575
Mortgage payment- 505
cashflow- 70
Is this right? its less then a 100 which seems to be the minimum per door on here.
when using the 2% rule i am getting about 1.4%.
i beleive i could realistically sell the property for 112k- i owe 79k. Do yall think the cashflow is to poor to keep and it would be worth selling this property and going for a second one on my own. I beleive i could get a 2nd property using a family member as a private lender then refiancing after a year. However i want to know if the 1st deal can stand on its own merit, or if yall would get rid of it. Thanks!
Steven
How much did you pay for this property?
The "2% rule" is a quick and dirty check that works for rents around $500. Lower rent and that percentage must be higher. Higher rent and it can be a bit lower and still give you the $100.
I do use a lower percentage - 40%. I do that for three reasons:
1) I do self manage, and am willing to do most of that work myself for free.
2) I'm not looking for any current income from these properties.
3) I am looking for long term wealth. Long term as in 20-40 years from now. I think the long term prospects for the Denver market are good.
Realistically, you should use the 50% ratio. Then, if you do lower your expenses by self managing, you'll make more. But you're earning that income by being the PM.
From what I've read here, I think you can do better than that in Houston.
Where do you add the Tax and insurance in at?
Taxes and insurance are part of the 50% Rule - so you don't add them in. I would suggest that you read one of the sticky threads on the 50% Rule.
Thanks Mike, i was a lil confused 200k 2flat with 10k taxes, lol crazy
I am looking at a 9unit and the taxes are only 5% of gross rents, which are $4,650/mo. I verified this with assessment office.
I understand that the 50% rule of thumb is based on surveys in which individual expenses for rentals add up to 45-50% in the aggregate of which taxes are around 10% of gross rents.
Depending on whether you use 50% or 45% as your guide swings the calculation for your max loan amount by about 15%.
My question is if I know that one of these expenses, in this case property taxes, is outside the range, is it reasonable to come down from 50% in estimating long-term expenses, as in 5-10 years?
Another question I have is in today's world does buying based on prices derived from the 50% calculations allow one to buy at valuations which will allow for refinancing in the short-run?
For instance, if I buy the 9 unit for $215k using commercial loan for 75% of price and short-term private loan for other 25%, and I want to refi my downstroke to a permanent loan after I get the rents up to par in 12-18mos, assuming bank will only do 75% LTV on a refi I'm going to need the place to appraise for $300k in order to get my cash out or rate and term my downstroke and other costs. This leaves me at the mercy of a bank's appraiser who is probably going to lowball the appraisal from what I've been seeing. Then I'm stuck with unfavorable financing (even though I bought at a good price). I feel like a lot of newer investors (of which I'm one) get jammed up here and can't keep their capital in motion.
Mike -
Keep in mind that the 50% Rule is a guideline, not a fiscal certainly. So, you really shouldn't be making any purchasing decisions based on the rule.
Use the rule to help determine if a deal is a possibly good deal, and then if the deal looks promising based on the 50% rule, dig in further to the actual income/expenses associated with the property.
In some cases, 50% will be way off (low or high), so making any decisions based on the rule could hurt you in the long run.
As for your specific question about the property with the low taxes, keep in mind that a reassessment by the county could change that quickly. If for some reason, you can be certain that taxes will remain lower than typical for this property, that should factor into your detailed analysis of the deal.
Ha Ha! Love it Tim!
I must say that here in SoCal that is nearly impossibly to achieve the 2% rule because even in this market, houses are expensiveee! If I could buy a $200K property and get $4000 in rents, the house would have an ARV of almost a million! :LOL: So, apply the rules according to the areas.
But, apply the first thing you said always. :wink:
Originally posted by Tim W.:
50% of what you hear about real estate investing is crap.
Of that 50%, only 2.5% works in a down market.
The 2% rule only works if rents are about $500 a month. If rents are higher, this ratio can be lower and you can still make a profit.
That said, you need some pretty serious rents to make a profit on $200K rentals. Perhaps not $4000, but will over $2000.
This rule does apply ONLY to rentals, though. Speculation is still a valid, if risky, investment approach.
Originally posted by Tim W.:
Yes. I go somewhere else. I don't fish for trout in a bass pond. Do a radius check of about an hour and a half to two hours drive out from your location. Chances are you'll find a town that cashflows. If not, stretch a little further. I seem to recall some decent cashflow potential in Gainesville.Tim
I haven't gone by this formula because of my location, but I won't buy a property if it doesn't cash flow at least $500/month after all expenses in this market. When ridiculous appreciation was the norm, it was a different story, but the main reason it NEEDS to cashflow if you have a loan is that the banks will only take 75% of your rental income.
So, if you are getting $1K in rents, the banks only see $750 of it, so your expenses better not be more than the $750 plus a profit of at least a few hundred. May be not an official measure, but if you're leveraging, this is the magic number the banks are looking for. Making it happen where I'm at is more a LONG term investment.
I've made some mistakes and learned from them long ago, but my big failure wasn't buying at the right price, but doing the cash out refis; luckily I refused to leverage myself over 60%, so I'm not in that big of a hole.
If I had saved my money and paid off the one rental I'm now upside down in instead of borrowing to buy more (or even sold it when it skyrocketed to $500K (hope I'm not the only one that can say this :cry:), I'd have 100% income on the darn thing instead of minor negative cash flow. School of hard knocks. I've come SO far since then and want to go 100xs further yet. :D
That happens to be my first property -the one in that situation. Reading 2 books made me take the leap into REI when the value of my primary residence wasn't there; I decided to hold onto her and rent her out because I didn't want to sell for a loss in 1997. I wouldn't change it for the world though, as I've always had someone else paying for the home and its the property that got me into REI initially. :D
I really admire a lot of great advice here. Recently I bought an investment property in Central NJ zip code 08902 area. The details are as follows;
Purchase Price = $171000
Lien paid by me = $3000
Down Payment made @30% of Purchase Price = $51300
Market Price shown on Zillow on the day of closing = $ 194000
Expected Monthly Rent = $1670
Monthly PITI payment = $1247 (Mortgage+Real Estate Tax+Insurance+HOA Fee)
HOA Fee = $247 per month
Net Monthly Cash = $ 423 (positive)
Applying 2% or 50% rule scares me.
I would appreciate if any of you can take a look at my investment, look at the area where I bought property (NJ real estate is expensive) and let me know whethre I made a wise investment decision or not. If you feel the decision was wrong, how much would you have paid to acquire this property and why? Pls note, setting higher rent is not an option.
Thanks in advance.
Andy, the 50% expense concept suggests your OPERATIONAL
expenses (i.e. all expenses except debt service) will avg around half your monthly rent over a long period of time. That's higher than what you've estimated because it includes estimates for repairs, maintenance, replacements of major items, and vacancies. These are items that are less predictable, but they are real and must be considered when evaluating profitability.
Andy Andy1 - Without knowing more details about your situation, goals, and strategy, nobody could possibly tell you if you made a right or wrong decision here.
That said, from teh info given, and from a pure cash flow standpoint, your decision was a poor one in that your acquisition cost of $174k and your rent of %1670 monthly amounts to below a 1% purchase price to rent ratio which equates to negative cash flow.
The numbers you posted for cash flow are in a dream world where you never have any other expenses other than debt service, taxes, insurance and HOA. When in reality, you will have the occasional vacancy, the hopefully very occasional eviction, capital expenses, accounting fees, management, repairs/maintenance, etc. When you add all that up, it will eat more than your monthly posted cash flow over the long haul.
Now, if you bought in an area where you could likely expect great future appreciation and could sustain negative cash flow in exchange for the tax deductions and future large appreciation, then perhaps you have a decent deal for yourself under such circumstances.
Thanks for the reply Will.
I agree 2% rule for my purchase falls flat. Going by that yardstick for a rent of $1670, my purchase price should have been say $ 83.5K. For that price no properties with 2 bedrooms are available. I bought this in short sale from a bank. The bank didn't budge for 1 long year before clearing the sale.
In good days, this property was sold for $240K. Also there is a mega transit village being built nearby with a new train station that will connect North Brunswick township with NYC downtown. Hoping for a good capital appreciation.
So in a nutshell Central NJ is not a good market if you must look for a positive cash flow?
Thanks
Originally posted by Andy Andy1:
Going by that yardstick for a rent of $1670, my purchase price should have been say $ 83.5K. For that price no properties with 2 bedrooms are available.....
So in a nutshell Central NJ is not a good market if you must look for a positive cash flow?
If the first statement is true, then the second statement is probably true.
You don't necessarily need 2% to make it a decent cash-flow property, but certainly more than 1% and in my opinion, 1.5% tends to be the cutoff given today's interest rates and terms.
Originally posted by J Scott:Originally posted by Andy Andy1:
Going by that yardstick for a rent of $1670, my purchase price should have been say $ 83.5K. For that price no properties with 2 bedrooms are available.....
So in a nutshell Central NJ is not a good market if you must look for a positive cash flow?
If the first statement is true, then the second statement is probably true.
You don't necessarily need 2% to make it a decent cash-flow property, but certainly more than 1% and in my opinion, 1.5% tends to be the cutoff given today's interest rates and terms.
Given a 25% down payment and today's interest rates... .8% (8/10ths) is the break even cutoff assuming the 50% rule...
Problem for the poster is the 50% rule doesn't hold water in NJ given the taxes. His taxes are likely 25+% of his GOI alone.
This has been a rather long post but I will add that the 50% "rule" is an excellent starting point to evaluate property that you wish to hold for income. In my home town Hampton Bays NY it becomes quickly apparent that taxes and Insurance will quickly eat up any profits. Properties that sell for 600,000 rent for 3000 a month so to begin with taxes and insurance will immediately take out 1700 a month this leaves 1300 a month to take care of property management vacancy and maintenance before we can get to profit. The net result is a very low return on investment.
If I compare it to property I own in Dayt0n Ohio where I can be all in to a 3 bedroom one bath in a working class neighborhood for under 25,000 ( and in some cases 20K) The rental income is $625 monthly and the taxes and insurance average less than $125 an month this leaves 500 a month to cover property management , vacancy , and maintenance . I own 24 properties for the cost of one in Hampton Bays. If you do the math you can see where my priorities are. There are of course many other issues to consider when comparing markets such as these.
Andy Andy1 - At the $1600 monthly rent level, you do not need the 2% rule in order to get real positive cash flow. Typically, in the higher rent values, you will experience some minor lower costs and a tad of economies of scale, thus, you should be targeting as close to 1.5% as possible and if all goes well, you could even be ok at 1.3% at such a rent level (so long as you manage correctly).
While I agree that cash flow may be very difficult in your area as it is mine, there are the exceptions, so either find them, or go outside your area.
Here in So CAL, a typical 3+2 1500 sq. ft. home will sell for $300k+ and the rent for that would be around $2000, so you could not even get 1% rule here! That said, we also have areas where homes go for around $75k and you can get $1000 in rent but these areas are way outside the Main Los Angeles City limits (mostly desert communities).
We are quite pleased at 1.4% here South of Houston. Mostly buy based on purchase price and ARV. Try to end up with 25 to 30% equity after rehab and such. This normally allows to refiance and get almost all of our cash back out. We target long term value and normally refi for a 15 year note. Not really looking for any short term positive cash flow at this time, just properties that easily pay for themselves.