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Financial Discipline Required

June 19, 2011

It takes real financial discipline to invest and maintain rental properties. I was talking with a friend that knew I invested in real estate. He wanted to get into it, but did not know how to get started. He had no sense of what he wanted to do – he just wanted “in”. He has also admitted he is far from perfect when it comes to his finances. I don’t think this excludes someone from becoming successful in real estate investing, but you need to have some basic financial acumen. This is not a weekend game for funsies.

You need to:

  • Save for emergency repairs. You will need to have funds set aside for AC units going out, unexpected plumbing issues, and all the other unplanned repairs. These expenses are real and can add up quickly.
  • Save for vacancies. Your property will not always be generating revenue.  The time it takes to get a new tenant after a vacancy will depend on many factors: the time of year, location of your property, condition in which the last tenant left the property, your experience as a landlord, etc. Vacancies cost a lot more than I ever thought when I started out.
  • Property taxes and insurance. You must keep funds set aside and pay taxes, insurance, and all mortgages and loan payments timely. Expenses have to be planned for in advance.
  • Keep good records. It’s not just documenting revenue and expenses and keeping the necessary records for tax filing. I have huge folders
    of documents just to challenge my property taxes. With only our 5 properties we have multiple filing cabinets. Leases, loan documents, rehab receipts, and not to mention all the paperwork associated with buying properties.
  • Keep deposit funds to be distributed back to tenants.  You will need to refund deposits when tenants move out and some states require the deposit to be in an interest bearing account.

My recommendation to someone starting out would be to try and buy your first property where it cash flows several hundred per month. Although a property that cash flows just a $100 per month can still be a good investment, make sure your first one will cash flow several hundred dollars. This might involve putting a large portion down, but this will give you some breathing room and really help you sleep better. I bought my first one with liquid cash outright. Now January – March rent effectively pays my property taxes and insurance – just vacancy and maintenance left. This is probably too far to the right, but allow yourself a margin of safety especially on your first property.

In my opinion, only a small percentage of the people that I know really have the discipline to where they should be investing in real estate.  These house flipping shows where they are always 60 days away from bankruptcy is not the way you want to invest.

 

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