What Is a Good Expense Ratio for a Rental Property? (2024)

FAQs

What Is a Good Expense Ratio for a Rental Property? ›

Operating expense ratio (OER)

The 50 Percent Rule

This rule works by subtracting 50 percent of a property's monthly rental income for expenses and maintenance. For example, if a property could yield $1,500 a month in rent, you would need to designate $750 for expenses and not consider that when considering its profitability.

OER is used for comparing the expenses of similar properties. An investor should look for red flags, such as higher maintenance expenses, operating income, or utilities that may deter him from purchasing a specific property. The ideal OER is between 60% and 80% (although the lower it is, the better).

How the One Percent Rule Works. This simple calculation multiplies the purchase price of the property plus any necessary repairs by 1%. The result is a base level of monthly rent. It's also compared to the potential monthly mortgage payment to give the owner a better understanding of the property's monthly cash flow.

For a piece of property like a typical house, duplex, or triplex, your expenses are going to be equivalent to about 35 to 45 percent of your gross operating income (GOI), or how much money the property brings in.

According to the 50% rule, a property's operating expenses will likely equal half its gross annual rental income. So, if your property generates an annual rental income of $20,000 after considering vacancy rates, you can expect your operating expenses to be roughly $10,000 for that year.

One popular guideline is the 30% rent rule, which says to spend around 30% of your gross income on rent. So if you earn $3,200 per month before taxes, you could spend about $960 per month on rent.

High and Low Ratios

A good expense ratio, from the investor's viewpoint, is around 0.5% to 0.75% for an actively managed portfolio. An expense ratio greater than 1.5% is considered high.

Generally speaking, an investment ratio above 1% is considered too high and should be avoided by most investors, since it far exceeds industry averages. But there may be instances when it makes sense to pay a higher expense ratio, depending on the type of fund you own and your objectives.

50% of your net income should go towards living expenses and essentials (Needs), 20% of your net income should go towards debt reduction and savings (Debt Reduction and Savings), and 30% of your net income should go towards discretionary spending (Wants).

What is the best ratio for rent and income? ›

The gold standard in the industry is 30%, meaning no more than 30% of a tenant's gross income should go to rent. People who spend more than 30% of their gross income on rent are considered to be housing-cost burdened, according to the U.S. Department of Housing and Urban Development (HUD).

The 1% rule of real estate investing measures the price of an investment property against the gross income it can generate. For a potential investment to pass the 1% rule, its monthly rent must equal at least 1% of the purchase price.

Limitations of the 1% Rule

For example, if the median list price in a metro area is over $1 million, the 1% rule would necessitate rents of close to $10,000 per month. In this case, investors would forgo the 1% rule for a more realistic assessment of what makes a viable investment.

Costs excluded from operating expenses include mortgage payments, capital expenses, and depreciation expenses. Other costs to consider when investing in a rental property include appraisal and inspection fees, business and license fees, and closing costs.

Short-term Rentals

According to industry reports, the average profit margin for a short-term rental property can range from 25% to 50%, with some properties earning even higher margins. However, it's important to note that these margins can be affected by a variety of factors.

Gross operating income includes revenue from:

Rent. Parking fees. Amenity fees and reservations. Vending machines.

Use the 30% Rule

So if your salary is $5,000 per month, your target rent payment would be $1,500 or less. The idea is that if you're using 30% or less of your income on rent, you'll be able to afford to pay your day-to-day expenses and set aside money to meet your financial goals.

The 50-30-20 rule recommends putting 50% of your money toward needs, 30% toward wants, and 20% toward savings.

The 2% rule is a rule of thumb that determines how much rental income a property should theoretically be able to generate. Following the 2% rule, an investor can expect to realize a positive cash flow from a rental property if the monthly rent is at least 2% of the purchase price.

The 30% Rule Is Outdated

To start, averages, by definition, do not take into account the huge variations in what individuals do. Second, the financial obligations of today are vastly different than they were when the 30% rule was created.