The “50% Rule” is a rule used to roughly estimate the amount of long term expenses a rental property might generate by multiplying the gross income by 50%. It is used to generate a quick number used to determine if further analysis should be completed.
Let’s take this and apply it to an example.
There’s a property you are looking at that is a single family home that would sell for $200,000. With current mortgage rates of about 4%, you would be able to put down 20% on and would have a mortgage payment with taxes of about $1000 per month. You could rent it for $1500 per month. Now, to quickly estimate if you should pass or move on without doing anymore research into the property, you estimate the long term expenses by following the 50% rule. $1500 multiplied by 0.5 is $750.
At this point in the example, you should either look to maximize your rent by increasing the value of the rental, decrease your mortgage per month by putting more money down, or pass this opportunity on and analyze another rental property.
The 50% rule is a simple guideline to follow. If you analyze a lot of properties, one day, you might feel more comfortable to change that number to reflect your market. You could have a 60% rule or a 45% rule.
If the property passes the 50% rule, your should now dig deeper and start to figure out the Cap Rate to figure out how quickly you can get your money back out of the property. Check out my article about Cap Rate.
When doing these calculations, remember to stay critical and don’t fall in love with a property. Try to stick to the numbers, estimate conservatively, and do not make any not rational decisions.