A thorough deal analyzer is essential for any real estate investor’s success, but a quick system that serves as a first assessment of potential properties is also beneficial.
Investors can appraise a purchase with limited information and determine whether the property is worth extra time and effort using calculations such as the 50 percent rule.
Continue reading to find out how the 50 percent rule in real estate works and add it to your toolkit right away.
The 50 percent rule is a formula used by real estate investors to determine how profitable a rental unit is.
When determining a property’s prospective profits, the regulation requires deducting 50% of the monthly rental income.
Because 50% of rental income should go toward expenses, this should not be taken into account when comparing the amount of money you could make from renting a home to your mortgage or loan payment each month.
Investors can use the 50% rule to make quick and informed decisions about rental properties.
Underestimating the cost of expenses is one of the most common mistakes property owners make when looking for deals.
This can result in decreased profit margins or, in certain situations, a contract that isn’t completed at all.
Investors will use the 50% rule when they first look at a deal to protect themselves from unexpected costs and expenses.
What Exactly Is the 50% Rule?
The 50 percent Rule states that your operational expenses should equal 50% of your total income (also known as a 50% expense ratio).
It’s a fairly basic computation.
For example, if a property can generate $2,000 in monthly rent, the rental property expenses I described will require $1,000.
This indicates the property will bring in $1,000 in net operating income.
Of course, if you have a mortgage on the house, make sure to factor in your monthly mortgage payment when calculating cash flow.
The same is true if your property is in an HOA-managed neighborhood or if you engage a property manager to handle day-to-day operations.
How Does The 50% Rule Work?
The 50 percent rule is applied by splitting the entire monthly rental income in half.
This is to account for any possible property-related charges.
Repairs, taxes, property management fees, utilities, and insurance charges are all included in the expenses.
This rule can be used by investors without knowing the specific expense amount.
In fact, this method is so popular because it allows investors to quickly and accurately look at possible deals with less information.
It’s worth noting that mortgage or loan payments aren’t considered “expenses” under the 50 percent criterion.
To figure out whether or not to buy a house, compare the loan payments to the rest of the rent money.
Why Is The 50% Rule Important?
When investors need to make a speedy decision on a property, the 50 percent rule comes into play.
The 50 percent rule might help you know when to move forward or pass on a business if you operate in a fast-moving, competitive market (which is becoming more common these days).
If the statistics on a property match the rule, it’s time to go deeper.
If the figures on the property don’t add up, you can move on without wasting too much time or effort.
The 50 percent rule can be applied to single-family, multifamily, condos, duplexes, and other types of residential real estate.
Its adaptability makes it particularly useful when you come across a promising deal and need to move quickly.
Example of a 50% Rule
Let’s imagine you’re looking at a single-family home in your neighborhood that has a $3,004 monthly rental revenue.
According to the 50 percent rule, around $1,500 will be spent on property costs.
That leaves $1,500 to compare to your loan payment.
If the property has a $1,200 monthly mortgage payment, this investment should cash flow at $300 per month in theory.
This figure might then be used to determine whether a more thorough inspection of the property is necessary.
Is the “50% Rule” correct?
While assessing expenses, the 50 percent rule is a decent guideline to use when evaluating a property for the first time. However, it should not be used as a 100% exact representation.
The rule’s goal is to help investors estimate expenses with some accuracy while avoiding underestimating costs, especially when they have insufficient knowledge about the property.
Investors are unlikely to have all of the information on a property in the early stages of a deal study, making it difficult to determine overall expenses.
As a result, the 50% rule should be seen as a recommendation rather than a hard-and-fast rule.
The 50 percent guideline, according to many investors, overestimates a property’s expenses.
The reason for this is that property taxes, HOA fees, and maintenance requirements are not uniform across the board.
In actuality, these expenses may not account for half of the entire rent, which should come as a nice surprise when you dig deeper into the figures.
The 50 percent rule also doesn’t account for vacancies, which means that there is no guarantee that you will be able to rent out a home all year or right away.
How to Make Money in Real Estate Using the 50% Rule
Consider the 50 percent rule as an appetizer, with a full-course analysis to follow.
Before continuing forward, compute other metrics if a property satisfies the test.
When considering whether or not to invest, the 50 percent rule should never be used as a final decision. Nevertheless, it can be used to determine when not to invest.
For instance, if you check the figures on a house and your mortgage exceeds half of the rental revenue, the purchase (or your loan) might not be the best choice.
As you may be aware, conducting due research prior to making an investment decision is critical.
If you want to make money with the 50 percent rule, you’ll need a good rental property calculator to help you out.
When it comes time to invest, be sure to ask questions of the previous landlord, research the market region, and examine all features of a property.
Meanwhile, take advantage of the 50% discount to quickly assess possible options and decide whether they are worth further study.
Conducting a comprehensive examination of every potential business that comes your way might be time-consuming for a busy investor.
Calculations like the 50 percent rule can come in handy in this situation.
By comparing rental income and anticipated expenses, you can quickly determine whether a home is worth a second look.
Run these figures the next time you come across a possible deal to discover how the 50 percent rule can benefit you.
Finally, remember that the 50 percent rule is only a suggestion.
In a real-world situation, your property’s expenses are unlikely to be exactly 50%, but it typically gives you a good idea.