INVESTORS’ CORNER: The 50 percent rule

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I like shortcuts to help screen potential deals in a short period of time. Shortcuts don’t replace more detailed final analysis before a purchase, but they do help you view many leads before finding one that actually has potential.

One of my favorite shortcuts is the 50 Percent Rule. It’s a shortcut to estimate the net operating income, or NOI, of a rental property. The NOI is what is left over after paying all of your rental expenses except your mortgage.

The 50 Percent Rule says that on average you will only keep 50 percent of the rent you collect on a rental after paying for vacancy, management, taxes, insurance, maintenance and other expenses.

For example, if a house rents for $1,000 per month, after paying all of your operating expenses you will probably net 50 percent of $1,000, or $500 per month.

How does this help quickly screen potential deals? Let me give you an example.

On Monday morning my real estate agent emails me a house listed at $80,000. I quickly evaluate it, and I estimate the rent to be between $1,000 and $1,100 per month.

Fifty percent of $1,000 is $500 per month, and 12 months times $500 equals $6,000. That is how much net rent I’ll earn (before mortgage payments) each year.

Based upon pictures, I estimate that the property needs a minimum of $15,000 in repairs, and I’ll spend $5,000 in closing and holding costs until it’s rented.  So my total estimated cost would be $100,000.

Therefore $6,000 net rent divided by $100,000 total cost equals 6 percent.

This final percentage is called a capitalization rate, or cap rate. If you need a refresher, search Google for “chad carson cap rate” for a free 10-minute video I made.

The 50 Percent Rule allows us to quickly estimate a cap rate so that we can decide whether to pursue the deal or not.   I usually have a target cap rate for a certain neighborhood and type of property. In some neighborhoods, a 6 percent cap rate will be a great deal. In other neighborhoods, usually lower-priced ones, I might need a 12 percent cap rate or more to make it worthwhile.

Add the 50 Percent Rule to your toolbox and see if it helps you screen new deals faster.

Happy deal hunting!

Chad Carson is a member of Metrolina REIA (metrolinareia.org), which provides education, networking, and networking for real estate investing in the Charlotte region.  Chad also writes about real estate, money, and life at coachcarson.com