Like many rules of real estate investing, the 50 percent rule isn’t always accurate. However, it can be a helpful way to estimate expenses for a rental property. To use it, an investor takes the property's gross rent and multiplies it by 50 percent, providing the estimated monthly operating expenses. That sounds easy, right? If the property rents for $4,000 a month, operating costs should be approximately $2,000.
Typically, investors should add up the operating costs of the rental property:
Notice that mortgage costs are excluded, as are taxes on rental income and property depreciation. In some markets, investors argue for excluding HOA expenses, but most investors include this as an appropriate operating cost.
Like most "rules" associated with real estate investments, this one has value and limitations. Nevertheless, it can be a handy “back of the envelope” formula for determining how much a property will need in monthly expenditures. It can produce a rough estimate, but investors should evaluate the property and its potential operating costs individually.
Suppose you are considering buying an apartment building and using the 50 percent rule to assess operating expenses. For example:
There are ten units in an apartment complex, each renting for $3,000 monthly, for a total of $30,000. Suppose the expenses are estimated at $15,000, leaving $15,000. From that amount, you need to be able to cover the mortgage expenses, your overhead, and profit. This quick, albeit rough, calculation can help you decide whether to continue performing a more detailed evaluation of a potential acquisition.
While the 50 percent rule doesn’t provide enough detail to move forward with a purchase, it might make it easier to decide to pass one up. Here’s another example.
You are considering buying a duplex as a rental property. Each unit will rent for around $1,200, providing $2,400 monthly. However, if the mortgage payment for the property is $1,800, that will absorb substantially more than 50 percent of the rent. This will leave only 25 percent for expenses and profit. In that instance, the rule can help you decide it’s not a wise investment.
One challenge with relying on the 50 percent rule for estimating deal attractiveness is the variation in operating expenses. For example, some buildings pass the utility costs to residents, which could significantly reduce costs. If the building is older, a series of costly repairs may boost the expenses past the 50 percent threshold. Similarly, if the property experiences a series of insurance claims, the coverage cost may increase. HOA charges are subject to unexpected increases. On the other hand, if the previous owner was not frugal, they may have overspent on some things you can save on (like landscaping or maintenance). So, when evaluating the ratio, you may want to consider the trends and potential as well as the current costs attached to the property.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions.