WHAT IS THE 50% RULE OF REAL ESTATE INVESTING?
The 50% rule is a easy way to estimate the year end cash flow of a property. Simply put, you can assume that over the average span of you owning and renting the home, 50% of your rental income will go towards expenses. Those expenses can include maintenance, capital replacements (ie, new appliances, roofs etc), property taxes, insurance, and more. You can quickly determine what your profit on a house would be by applying this 50% rule to any house you are considering.
For example, if you are considering a $100,000 all in price on a home, we already know that the 1% rule would mean that you needed to be renting this home for $1,000/month. If you had the home rented all 12 months, you would have a gross rental total of $12,000/year. Sounds lovely, right? Now we apply the 50% rule. That $12,000, turns into $6,000/year once you apply costs. Now, if you put 20% down on that same $100,000 house (which would be $20,000), that means in the first year, you'd earn $6,000 on your $20,000. That's nearly a 30% return. For this reason, many people advocate buying homes with loans because you can spread your investment over several houses, making your returns higher. However, your risk also increases with debt. We'll cover more on that topic later.
Applying the 50% rule means you are applying this math across the ownership duration of this house. The first year, you might sneak by with only $4,000 in costs, meaning you are ahead. However, that next year, you might need a new roof, and your total is now $8,000 on the year. The idea behind the 50% rule is that everything will average out over the course of time. It is simply an easy way to judge what total profit you can claim from the home.
Clearly, this is a simple way to calculate profit. Actual accounting is far more accurate and in depth. However, this is a fast and easy way to size up the potential earnings on a home before you decide to buy it!
Have you ever considered the 50% rule when purchasing a home?