As a real estate investor, you want to profit from your investment. You'll also need to know how long it will take to realise your returns on investment (ROI).
Applying certain rules of thumb can help when determining whether a real estate investment is likely to be profitable. The 50% rule in real estate estimates that real estate investors should expect a property's operating expenses to be roughly 50% of its gross rental or lease income.
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 at most Ksh. 100,000 for expenses. These expenses include property management costs, taxes and other management costs. The amount also includes periods where your rental property is vacant. The remaining amount is your net income.
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 Accurate Is the 50% Rule?
The 50% rule for real estate investments is a guideline and not cast in stone. The rule is designed to help you as a real estate investor estimate what you may make as rental returns in case you invest in a specific rental property. Again, the 50% standard is intended to prevent investors from underestimating the costs of owning and running the property.
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.
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 find a house with a more than 1% return, then that’s a good investment.
Example calculation:
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.
This 1% rule is also a guide. In certain neighborhoods, you can get returns above 1%.
Conclusion
The 50% rule will be a better blueprint to determine the cash flow you will earn on specific rental property. Of course, there are other things you'll want to consider beyond the 50% rule for real estate
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.
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