Whether you’re a first-time real estate investor or an experienced landlord dipping your toe into the pool of commercial real estate, the 50% Rule could be your saving grace. But what is the 50% Rule and how does it apply to commercial investments?
The 50% Rule for Real Estate Investing
The 50% Rule isn’t the most accurate, but it’s a good jumping off point for calculating expense estimates for a property. Investors take the property’s gross rent, multiplying it by 50% (hence, the name), which will provide them the estimated monthly operating expenses. If your commercial space rents for $24,000 per month, the 50% Rule estimates your cost of upkeep would be approximately $12,000 per month.
For most investors, they don’t want to deal with the headache of upkeep expenses. They want to use commercial real estate investments as a tool to receive passive income. Put your money in, receive your payouts quarterly or annually.
If you’re a high networth individual, working with a private equity real estate (PERE) firm could be the way to go. First National Realty Partners reviews the eligibility of potential investors to determine if they’d be a good fit. With a PERE or a real estate investment trust (REIT), investors simply send their money, the money managers choose the property and manage it, and the shareholders receive their income–it’s that easy! To learn more about the difference between a REIT and a PERE, be sure to check out our other articles.
How the 50% Rule Works
If you’re investing on your own, meaning, you’ve purchased a property as a commercial investment and are responsible for building maintenance, tenant management, and more, you need to understand the 50% Rule. As we mentioned before, it’s simply dividing the monthly rental income in half to estimate expenses.
- Repair and maintenance costs
- Property taxes
- Property management fees
These expenses can vary month to month, because utilities such as gas or water can fluctuate, and repair or maintenance costs vary on a case-by-case basis.
Note that mortgage costs, taxes due on rental income, and property depreciation are not included in these expense estimates. Loan payments and mortgages should be compared to the remaining half of the rental income. This way, you can determine whether or not a property is actually profitable to you.
Why Estimating Costs Matters
Commercial real estate investment properties move fast. If you’re looking at potential properties in a competitive market, the time it takes to thoroughly analyze a property can cost you the property altogether. This 50% Rule allows you to quickly estimate the costs and compare the remaining rent income to your other expenses (loan payments or mortgages, taxes on rental income, and property depreciation). Whatever is leftover is your actual profit.
With this method, you can quickly calculate your profit margin and make rapid decisions on properties. If the numbers fit the rule, you can move forward with a more in-depth analysis. If the property doesn’t make sense with the remaining profit, you can pass on the property without having wasted much time.
If you’re looking to purchase commercial real estate properties for investment purposes, the 50% Rule is a quick way to calculate your cash flow in a competitive market. All you need to do is divide the monthly rent in half, with one half going towards expenses and the remaining half including your mortgage or loan payments, rental income taxes, and depreciation costs. Whatever is leftover from that, is your estimated expected cash flow from that property.
Looking for more tips and tricks about investing, or wondering if there is an ETF for commercial real estate? Check out our other posts for expert financial and investment advice!