What is the 50% Rule in Real Estate?
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The 50% Rule Explained
The 50% Rule is a commonly used analysis tool that allows a real estate investor to quickly access whether or not a property generates adequate cash flow.
If a property passes the 50% Rule, it merits further due diligence and investigation as a potentially viable investment property – however, the 50% Rule by itself does not guarantee that a property is worth purchasing.
The 50% Rule is more of a pre-screening metric used to sift through a large number of properties and highlight the ones with the most potential.
Keep in mind, the 50% Rule does not include debt service, HOA fees, and property management costs.
The 50% Rule Formula
The 50% Rule is very simple:
Gross Income x 0.50 = Expenses
Suppose there is a duplex listed for sale at a price of $200,000. Each unit rents for $1,000 per month, making the gross income $2,000 per month.
The 50% Rule would have you assume that 50% of the monthly income (in our case $1,000), will be necessary to cover all monthly expenses outside of debt service, HOA fees or property management costs.
How to use the 50% Rule
Most investors will take the results of the 50% Rule and run further analysis to determine if a property has potential.
For example, some investors will factor in an estimate of total expenses (including debt service, HOA fees, and property management costs) to see if the property still generates net income of at least $100 – $200 per door.
Others may just want to see whether the property cash flows at all (even if it’s as little as $50 per month) because, upon further analysis, they might be able to negotiate a lower price or better financing terms for a better return.
Others still, may just want to determine whether the property at least breaks even, as they’re more interested profiting from appreciation.
The 50% Rule: A Helpful Starting Point
In summary, the 50% Rule is a very helpful guideline that allows investors to quickly sift through several properties. It’s not meant to be a conclusive answer but a simple check to see if a property is worth looking at with more detail.