What Is the 50% Rule?
The “fifty percent rule” (or, “50% rule”) is a commonly used guideline for real estate investing that recommends that operating expenses should exceed no more than 50% of rent. It helps ensure that a rental property generates positive cash flow on a monthly or annual basis.
The 50% rule is best applied to residential real estate investing, including both single-family and multi-family rental properties. It can be used for commercial real estate but is not as well suited due to differences in expense ratios and other factors.
Like all real estate investing rules of thumb, it is more a concept to be understood than a hard-and-fast rule. Yet, it is a useful concept nonetheless.
So how do you use it?
How To Use the 50% Rule
The fifty percent rule calculation is simple.
It can be applied on a monthly or yearly basis.
Monthly 50% Rule
Start with monthly rent. Divide by 2 (or multiple by 0.5). The result is your suggested maximum monthly operating expenses.
Monthly rent / 2 = monthly operating expenses
For example:
You are looking at a property you can rent for $1,000 per month. Half of 1,000 is 500. Therefore, your monthly operating expenses need to be $500 or less to abide by the 50% rule.
Yearly 50% Rule
Start with annualized rent. Multiply by 0.5 (or divide by 2). The result is your suggested yearly operating expenses.
Annual rent * .5 = annual operating expenses
For example:
You are looking at a property you can rent for $24,000 per year ($2,000 per month). Half of 24,000 is 12,000. Therefore, your yearly operating expenses need to be $12,000 or less to abide by the 50% rule.
Operating expenses include:
- Property taxes
- Property insurance
- Maintenance
- Repairs
- Utilities
- Vacancy losses
Some may also include HoA fees and/or property management costs as well. Whatever you choose to include, once you subtract these out you are left with your net income. Subtract your mortgage payment to get your net profit or net cashflow.
Obviously, you can leave the HoA dues out if the property has none. However, property management is a little bit different. Most would recommend that you factor in property management even if you are managing the property yourself, accounting for the value of your own time and effort.
Of course, this “rule” is only a rudimentary tool to help make your P&L work. You should adjust it based on your specific strategy.
If the property doesn’t pass this 50% test, it may not be a good investment. (But it isn’t a guaranteed loser either.)
It is a very basic calculation, which is both a benefit and a drawback.
Pros: When to Use the 50% Rule
The 50% rule is applicable to both the purchasing and holding of rental properties.
Its primary function is to prevent investors from underestimating the costs of owning a property over time.
Its main strengths are:
- Setting Rent – The most obvious way to use the 50% rule is to set rental rates. Not only can you use it as a benchmark for initial rent, you can use it to adjust rent over time. This way, you can maintain a buffer that helps ensure your investment remains cashflow positive.
- Filtering Properties – The fifty percent rule can be used as a broad filter when prospecting for investment properties. For instance, divide the median rent in your target location by two. Then, use this as a baseline to eliminate properties with expected operating expenses higher than this number. Better yet, use it in tandem with other rules or metrics like the gross rent multiplier, 1% rule, 2% rule, or your own unique calculations.
Overall, the 50% rule is a fairly useful real estate analysis method.
Yet it is neither perfect nor comprehensive.
Cons: When Not to Use the 50% Rule
There are situations where the 50% rule falls flat.
After all, it is only a starting point.
Luckily, its weaknesses are fairly distinct:
- Additional Holding Costs – In its simplest form, the fifty percent rule does not take things like tax on rental income or property depreciation into account. Almost invariably, you’ll need to adjust it based on your specific investing strategy. For example, a “40% rule” or “60% rule” may be more appropriate for your market.
- Not Future Proof – The 50% rule is based on static figures. Therefore, it does not offer any protection against rising insurance premiums, changes in tax costs, inflation, natural disasters, or other unexpected expenses. Ideally, it needs to be paired with a system that accounts for such costs.
- Lacks Context – The fifty percent rule is a rule of thumb, not an ironclad law. Various circumstances can render it obsolete or in need of heavy modification. Your local real estate market, the greater real estate cycle, interest rates, and the regulatory environment—none of these are to be forgotten.
How well the fifty percent works for you is highly dependent on the situation and your strategy.
Regardless, understanding how the 50% rule works is part of a strong foundation. From here, you should be able to use it to develop your own system to estimate month-to-month cashflow on any given property.