Tuesday, November 2, 2010

Terminology Tuesday - The 50% Rule

(Note: I think it's important to know the terminology and words used when learning any new business including mobile home investing. I came up with 'Terminology Tuesday' as a way to go over the terminology used in the mobile home business. It's important to know the terminology when talking to people in the business so you're all on the same page).

Since there have been many folks who have asked about the holding costs involved when buying and holding properties, I've decided to touch upon a small little rule I have learned as a prior landlord - the 50% rule.

So, what is the 50% rule? Here's a video from a fellow BiggerPockets member that explains it in more detail:

Video Link

As a prior landlord, I can tell you - the 50% rule is true for most cases when buying and holding properties. To be honest, a lot of folks who buy and hold properties forego a lot of small expenses when determining their overall net profit - it's really important to factor in everything to see a realistic picture.

So, what does this have to do with mobile home investing? Well, a lot of folks have asked me this question, "When you mention 'cash flow' in your case studies, is that what you really net? Or, are there other expenses taken from that amount?"

The answer to that question is yes. Yes, I do net that amount of cash flow. And, no there are no other expenses taken from that amount. I receive the same amount every month - rain or shine.

And, this is the difference between ownership (aka being a landlord) and control (aka being the bank). To me personally, it's not about ownership - it's about control.

As a prior landlord, I found it extremely difficult to keep up with the costs of ownership (i.e. maintenance costs, rising tax assessment values which in turn raise property taxes, increases in insurance, etc). Every year, it seemed that costs would increase. And, these increases would eat into the cash flow I received.

Even more, on top of that I still had to deal with the debt service (aka what I owe the bank). So, who got paid the same amount every month no matter what? It wasn't me - it was the bank.

So, the difference with doing "Lonnie" deals is the fact that there is more control and less to maintain. With mobile homes (as personal property), they are seen as depreciating assets in the eyes of the government. Think about it kind of like a car - their values go down year after year. Well, it's the same as with a mobile home.

Now, many of you may be thinking "Well, that's not good." And, it has been one of those points challenged to me. In fact, I have a good friend who questions why I even bother buying depreciating assets. In her eyes, if the value goes down year after year - then what's the point?

Well, for me personally it's not about appreciation - it's about cash flow. And, so what if the value goes down year after year. Each month, I am receiving the same amount of cash flow no matter what. But, this is what's important to me - cash flow will feed me, appreciation will not.

Though, my friend (who is extremely smart with an MBA from an Ivy league school) begs to differ. Her thought is to buy for appreciation because she tells me - that's where the real money is at.

Furthermore, she thinks the effort and amount of time involved put into this business should reflect the dollars earned. To her, my cash flow earned is really not that much as her earning 100k flipping a home (that she needs to wait 5-10 years to appreciate). But to her, it's worth it.

(Note: Did I mention? This is a friend who has tried to get me to invest for appreciation - she tells me I am missing the boat on a lot of potential properties that will appreciate in the future if I don't buy now).

In fact, she even challenges me in saying that she will become a millionaire because if she buys 10 homes and they appreciate 5-10 years from now and she receives 100k from each of them - she will be rich. So far, she is halfway to her goal. Though, all her homes are negative cash flow.

(Note: I have no desire to make a million dollars in one lump sum. I invest for cash flow, not appreciation).

Every month, my good friend has to shell out money to cover her expenses. But, in her mind - it's ok. She tells me she will make it all back - just watch and see. And, that in this game - she is the turtle and I am the hare. She reminds me the turtle is the one that wins in the end.

Now, in school - I wasn't really good at math. But, it seems to me that having multiple negative cash flow properties isn't really for me. And, having properties that cash flow every month is better. But, that's just me.

The reason why I enjoy doing "Lonnie" deals and investing in mobile homes is because the expenses tend to decrease, not increase. Every year as the value of the mobile home goes down, the taxes go down with it. And, since there is essentially no debt service to pay (since they are bought with cash) - the rest is pure cash flow. In essence, I get paid today - not tomorrow.

For those out there who have been contemplating the mobile home biz, this has just been my experience. Different things work for different people. And, I can honestly say - mobile home investing has worked for me.

Happy investing!

(Note: If you've been thinking about mobile home investing but still are not sure, this article may help).

p.s. Feel free to leave comments on any post either here and/or my Facebook Page. Comments are always welcome, thanks for reading!


Tom said...

Thank you for clearing this up. Did you get my e-mail? I had a question on a deal for you.

abdul said...

There are also other Landlord Insurance products such as Landlord Building Insurance and Landlord Household Contents Insurance, plus Tradesmens Insurance and Tenants Insurance.
landlord building insurance

Jim said...

Good post.

mobile home parts said...

How about this way of looking at it?

"Building" wealth requires positive cash flow. "Growing" wealth requires asset appreciation.

If you can lose money for 20 years on a piece of property, you must have a lot of capital already, and yes potentially make a larger total in one lump sum at the sale. But if you are using a moderately-sized egg of capital, then you had better be cashflowing in the right direction to avoid going bust!

Mobile Home Gurl said...

(Tom) Thanks, Tom! Yes, I received your msg - I just replied back. Hope it helps!

(Jim) Glad you enjoyed it Jim, thanks for stopping by!

(mobile home parts) Sounds good to me! Actually, my friend has made a lot of money (over 6 figures) each time buying and selling properties over the years. Though, she has to hold during the bad times (with negative cash flow of course) and has been able to sell during the good times. I guess the only thing is the negative cash flow - it's dependent on her job (she makes a really high income). For her, she would rather play for the big pot of gold than the small residual income. But yes, if she were to lose her job than it would be hard to keep those negative cash flow properties...that's for sure.