50% Rule clarification?

[Dave Versch]

Can someone give me a definitive answer on the 50% rule? I understand the concept, that your expenses should only equal 50% of your gross rent in order to get positive cashflow. But which expenses are included in the 50%? PITI for sure, but how about maintenance, vacancy allowance, property management, and capital improvement? And if the answer is that I should include all of those in the 50%, then why should it be a 50% rule? Why not an 80% rule if we've already accounted for all possible expenses? (I'm assuming the tenant pays all utilities.) I'd be perfectly happy with $200 net profit on $1,000 gross income every single time. Is the other 50% being budgeted just for unknowns and net profit, or am I missing something?

[Dave Toelkes]

Originally posted by Dave V.:

Can someone give me a definitive answer on the 50% rule? I understand the concept, that your expenses should only equal 50% of your gross rent in order to get positive cashflow. But which expenses are included in the 50%?

Just to clarify. The 50% rule is an estimate of the probable overhead costs for your rental property. It is also an estimate of the most you can allocate to your debt service and your cash flow.

If 50% of the rent won't cover your debt service (principal and interest) and still give you an acceptable cash flow, then you don't even want to consider buying the property.

If the property passes this first 50% test, then you need to determine whether the other 50% of your rent is sufficient to pay all your costs of ownership and rental operation -- or, in other words, your overhead.

Start by pretending you own the property free and clear. Now, everything you spend to own and operate your rental property is included in your overhead. The overhead cost items include, but are not limited to, advertising, leasing fees, HOA fees, condo association dues, management costs, legal fees, preventive maintenance, vacancy, rent loss, contribution to a replacement reserve account,property taxes, hazard insurance, liability insurance, utilities (at least during vacancies), trash removal, snow removal, cleaning, repairs, postage and any other expense paid by the landlord/owner.

You can get a pretty good idea of the magnitude of your overhead costs with just a little homework to nail down your expected costs for some of the big ticket items like property managment, property taxes, hazard insurance, and association fees, For a single dwelling unit, use one month rent as your vacancy allowance if you are in a strong rental market. For a soft market, you may need to allow up to three months vacancy.