Definition: THE 50% RULE IS JUST A BASIC ASSUMTION THAT 50% OF YOUR RENTAL INCOME WILL GO TOWARD ALL OPERATING EXPENSES. OPERATING COSTS EXCLUDE PRINCIPAL AND INTEREST PAYMENTS, BUT INCLUDE EVERY OTHER EXPENSE YOU MAY INCUR ON THE INVESTMENT PROPERTY. (Paraphrased from REICLUB)
Your first thought may be that 50% is WAY too high and sometimes it is. However, this “rule of thumb” has been used by seasoned investors for years for one reason – it just seems to work!
For example, you may have 3 years with a great tenant, few repairs, all goes great. Then that tenant moves out, you have repair expenses, advertising, utilities, loss of rent, etc. You get the property re-rented, all going great again, then the water heater starts leaking and you must replace it. The roof is going to need replacement at some point, along with the furnace, etc. Over 10 years, you can see how the yearly figures might not be accurate and you can see how the 50% rule comes into play over time.
One of the biggest mistakes Investors make is not budgeting for repairs. Your rental property may have a cash flow, but you need to expect to use a portion of that money on repairs, upgrades and capital improvements along the way.
Successful rental property investment is usually achieved over a long term. The tenant is paying your mortgage, the property value usually increases over time and at some point, the mortgage will be paid off and when you sell, you reap the rewards the tenant paid for.
In my opinion, the worst thing a rental property owner can do, is rent a property for say 3 years, not have the cash flow they want and sell it. This is especially true when there is a good tenant in place with intent to stay indefinitely.
What Operating Expenses does the 50% Rule include:
Property Management Fees
Capital Expenses (or saving for capital expenses)
Remember….Principal and interest payments are NOT included.
Conclusion: The 50% rule allows you to look at cash flow over the long run. If it ends up being less – that’s extra in your pocket! But, at least it gives you an idea of what to expect over years of rental property ownership and helps you budget over time.
Note, the 50% rule is typically not used for multi-family dwellings, only single family dwellings.