Identifying profitable investment properties is the key to success in the housing market. Real estate investors who are able to consistently find positive cash flow properties can expect a sizable return on their investment every single time they buy a property. Needless to say, mastering the ability to zero-in on rental property cash flow is a must. So what is the most effective approach to investing for cash flow? And what are some of the methods that you can use to accurately assess the cash flow of an income property? In this article, we will introduce you to the 50% rule and show you how to use it when real estate investing for cash flow.
What Is the 50% Rule in Real Estate?
As you would expect, finding profitable investment properties starts with figuring out how to estimate cash flow. Generally speaking, the best way to calculate cash flow in an accurate manner is to carry out a thorough investment property analysis. But when you are in the midst of the property search, you can’t afford to analyze each investment property in detail. This is where the 50% rule comes in. In simple terms, this is a convenient tool that gives you ballpark estimates of each property’s cash flow. Using it allows you to narrow the search down to high potential real estate investments.
The premise of the 50% rule is fairly simple. This method posits that rental property expenses will make up 50% of the gross income. Such costs include everything from property taxes and insurance to repairs and maintenance expenses. Below is a brief example that illustrates how to estimate real estate cash flow with the 50% rule.
The investment property’s monthly rental income: $4000
Monthly expenses: $2000
Monthly mortgage payments: $1500
$4000 – ($2000 + $1500) = monthly cash flow
$4000 – ($3500) = $500
Now that you are familiar with the concept of the 50% rule, let’s delve into how to find cash flow properties using it.
How to Use the 50% Rule in an Effective Manner
It is important to keep in mind that the 50% rule should only be used as a screening tool. In fact, you still need to carry out an in-depth real estate analysis to properly assess cash flow. With this in mind, here is how you should use the 50% rule when you’re looking at different potential real estate investments.
1- Determine the costs that are included and the ones that are not
The first thing you need to be aware of when using the 50% rule in real estate is all the expenses that it factors in. Like we mentioned above, these costs cover most of the recurring expenses that are associated with operating rental properties. Here is a look at the main ones:
- Homeowners insurance
- Maintenance and repair costs
- Taxes
- Vacancy loss
- Capital repairs
- Owner paid utilities
Keep in mind that not all expenses are included in these estimates. In fact, the 50% rule does not factor in expenses that are not directly required to own and operate an income property. Examples of this include professional property management fees, HOA fees, and monthly mortgage payments. Much like the estimated monthly expenses, these costs are also subtracted from the gross rental income.
2- Make sure to get accurate estimates for the costs
To increase the effectiveness of the 50% rule, you need to take steps toward getting the most accurate estimates possible. While some variables such as mortgage payments are fairly easy to determine, others require more digging on your part. For example, you will need to contact the homeowner association and inquire about their fee structure. The same thing applies to other recurring costs such as trash collection. However, you can’t get an exact estimate for every expense. Costs like vacancy loss and repairs are difficult to determine beforehand. To offset this uncertainty, real estate investors should take a more conservative approach when estimating these numbers.
3- Use an advanced tool to accurately estimate the cash flow
After narrowing the scope of the investment property search with the 50% rule, your next step is to take a deeper dive into the property’s projected cash flow. There are several ways to do this. One such method is using the Mashvisor cash flow calculator. In fact, this is the most powerful tool when it comes to analyzing real estate deals and assessing profitability. Mashvisor’s cash flow calculator will provide you with the expected rental income of any rental property for sale. It can even help you figure out hard-to-estimate variables like occupancy rates. Moreover, the tool gives you an in-depth look at several profitability metrics like the cap rate and cash on cash return. Using the Mashvisor calculator is the safest way to weed out negative cash flow properties and identify high yielding real estate investments.
Other Factors to Keep in Mind When Investing in Rental Properties
Applying the 50% rule and using the cash flow calculator is a highly advisable approach when it comes to real estate deal analysis. However, cash flow should not be your only focus. There are several factors that might end up boosting the profitability of low cash flow properties. Here is a couple of them:
- High real estate appreciation: Investment properties that are located in high appreciation areas can be seen as good real estate investments even with low cash flow.
- Potential for higher income: In many cases, a property’s income can be increased with simple improvements. For example, making some simple upgrades can easily result in higher rental income. You can also increase overall income by adding certain income-generating amenities like a laundry room.
The Bottom Line
The 50% rule should be your go-to tool when you are sifting through the real estate market for positive cash flow. Still, digging deeper into the numbers and using a cash flow calculator are the essential complements that ensure profitability in the housing market. To start looking for and analyzing the best investment properties in your city and neighborhood of choice using Mashvisor’s cash flow calculator, click here.
Head over to our real estate investment blog to check out some more valuable real estate investing tips.