How to use expense side of 50% rule

[Mike S]

Just getting started and I'm trying to figure out how to run the finances and accounting for rentals that I plan to buy.

Do you run the expense portion as a total fund or more like a line item budget? Take maintenance for example. I've calculated 10% of gross rent for maintenance. Should I make that a line item and deduct regular maintenance out of it or do you dump all the expenses into a fund and draw out of that. How about vacancies? Do I line item that and pay myself rent out of that line?

I already think that taxes and insurance need to be line itemed as those are fairly fixed and will need to be paid regularly, so why not line item the rest?

[Jon Holdman]

Because its very easy to slice the onion too thin. How much will you spend on evictions this year for this property? Probably $500 or $0. Hopefully, the $0 is much more likely. But if you were going to line item it, you would need to know a percentage. Say there's a 1% chance of needing to do an eviction each month. That means a 1% change of a $500 expense = $5 plus a 99% chance of a $0 expense. So, that line items needs to be $5.

What about a roof? They last about 20 years. Say one costs $5000. So, that's $5000/20/12 = $20.83 a mont. How about a furnace or AC or sewer or water line?

The 50% rule is just a gross number that includes all expenses, vacancy and capital. You certainly do want to look at your fixed, known expenses like taxes, insurance, property management, and HOA fees. If those add up to 45% of the gross rents, you're in trouble. The actual is going to be well over 50%.

Now, consider that property management is a big chunk of the 50%. Around here, PM's charge 10% of collected rents plus half a month to fill a vacancy. Half a month is 50% of one month. Spread over 12 months, that's just over 4% per month. So about 14% out of that 50% is a PM. If you do that job, you can earn back that 14% for yourself. Realize, though, that you're earning that through your labor. The property is not producing that itself.