The 50% Rule in Real Estate Investment and How it Works
As a real estate investor, you want to profit from your investment. You’ll also need to know how long it will take to realize your returns on investment (ROI).
Remember, it’s always advisable to determine your business progress, regardless of size. That’s why you can easily realize your property profits with the help of calculations like the 50% rule.
This guide will show you how the 50% rule works and how it can help you in your real estate investment.
What is The 50% Rule?
The 50% rule in real estate means you take half of your monthly rental income to cater to the property expenses.
However, we don’t include mortgages in these expenses. Instead, expenses like property taxes, insurance, maintenance costs, capital expenditures, utilities, and property management costs.
Therefore, if your monthly rental income is Ksh. 200,000, you should use Ksh. 100,000 for those expenses.
The 50% rule is an excellent way to dive into the real estate business. If you are new to property investment, this rule can help you avoid some beginner mistakes.
This rule ensures that you don’t exaggerate real estate profits. You can easily track your real income by keeping clear monthly expense records.
How Does the 50% Rule Work in Real Estate Investment?
The 50% rule will tell you whether you made the right choice investing in real estate. After you get tenants on your property, ensure you record the monthly income.
Now, take half of the rental income and use it to cover expenses concerning the property.
The remaining half of your rental income should go to mortgage loan repayments and personal expenses. However, covering personal expenses with your rental income should be the last thing to do. Instead, you should evaluate the actual profits after the 50% share of expenses and mortgage repayment.
Benefits of The 50% Rule in Property Investment
- With this rule, you determine the growth potential of your rental business. You can save and eventually buy another property if you have a bigger share after the 50% rule.
- It helps you evaluate real property income. If you are buying a rental property, you’ll request the owner to give you income and expenses records. That way, you’ll know the potential of the property.
- With the 50% rule, you’ll know when to continue with the business and when to sell it.
Use of The 50% Rule to Determine Your Property’s Cash Flow
If you want to know the real cash flow of your business, you will first know the gross rental income from your records.
Now, take half of the gross income and set it aside for property-related expenses.
Afterward, take mortgage repayment from the other half. Now, whatever remains after paying the mortgage is the monthly cash flow of your rental business.
However, if you didn’t use a mortgage loan to buy your property, the other half is your average monthly cash flow.
A monthly gross rental income of Ksh. 200,000 means you will have Ksh. 100,000 for property expenses.
Suppose you pay a mortgage of Ksh.80,000; you’ll have a monthly cash flow of 20,000.
Accuracy of the 50% Rule
The 50% rule can help you know your expectations when starting out in real estate investment.
This rule is just a guideline for whether or not to invest in real estate. For instance, if you get that the remaining half is far less than your monthly mortgage repayment, you should forego the property.
You should only go on with the investment if you get at least 20% cash flow from your rental property.
The 50% rule will give you a rough figure of potential earnings if you want to buy a rental property.
If you get a higher cash flow amount after 50% and a mortgage investment, you can go ahead with the investment.
What is the 1% Rule in Real Estate?
The 1% rule tends to go hand in hand with the 50% rule. The rule will show you how much rental income you should expect from a profitable rental property.
The 1% rule insinuates that the monthly rental income should be at least 1% of the total property purchase price.
If you bought rental property worth Ksh. 20 million, monthly rental income should be 1% of that, which is Ksh.200,000.
If you cannot get that 1%, investing in real estate might be a bad idea. Instead, go back and search for the best locations with high rental yield potential.
The 50% rule will be a better blueprint to determine the cash flow you will earn on specific rental property.
Although the figures you get are close estimates, they should help you make the right investment.
Always ensure you scrutinize rental property before investing in it. Consider all aspects that will make you realise your ROI as early as possible.
Frequently Asked Questions
- What is the 10% rule of real estate?
The 10% rule means that you should buy 10% less than the sticker price of the rental property. You should have excellent negotiation and bargaining skills to actualize this plan.
- Is the 50% rule accurate?
Not exactly. But it gives the investor a rough figure to help determine the potential cash flow of the rental property.
- What is the best profit margin for a rental property?
As an investor, at least 10% ROI will be a good rental yield. However, not all locations can offer such high ROI. For instance, local towns in Kenya will give an average of 6% ROI.
- Is rental property a wise investment idea?
Well, if you want to retire early, you may consider real estate investment. Rental property brings income with little effort. So, it will be a nice investment that suits your retirement plan.