Today I continue my series on the 5 Pitfalls of Real Estate Investing. Over the week we have covered Pitfall #1, Falling in Love, #2 Over-estimating ROI and #3, Different Strokes for Different Folks. Today’s post will cover a subject that could make the difference between you ending up with a solid investment rather than a real estate disaster.
Lack of Reserves: Investing in real estate is a long term strategy and with any long term investment there will be ups and downs. Often times, many investors that are new to real estate fail to realize that this can result in personal cash infusions.
Longer term investments in stocks, mutual funds and commodities also have ups and downs; however the results are night and day. For example, when a commodity such as gold fluctuates with market conditions the only immediate result is value on your monthly statement. The difference with real estate is that fluctuations in the rental market not only cause your monthly statement to change but can also create the need to support the property with cash infusions, especially if you have leveraged the property (i.e. used a loan to purchase). An example would be a softening of the rental market; this may cause extended periods of vacancy and/or a reduction in the rent receivable. This softening of the rental market could also result in the acceptance of a less-than-par tenant who could leave the property in a mess. In this example not only is your cash flow affected by the extended vacancy and lower rent, but now you have repairs that you didn’t plan for.
This is not by any means a reason to avoid investing in real estate; it’s simply something you need to plan for. Many investors do not plan for fluctuations in the market, resulting in this pitfall. The solution is very simple. When investing in real estate make sure you have the proper cash reserves. Many new investors will spend nearly all their cash on purchasing the investment property and will fail to set aside money for a future rainy day. I would recommend keeping a reserve account equal to 3-6 months of total expenses for the property. Make a commitment to keep all cash from the investment in a reserve until you reach a 6 month total. Once you reach the 6 month reserve amount you can take the excess cash flow each month from the property. Failure to do this can result in disaster. If you have leveraged (mortgaged) the property and have no rent income you will still be required to make the monthly payment. Missing those payments will result in losing the property to foreclosure and ruining your credit. If the property is damaged by a tenant and you don’t have the reserves to make the repairs, you will be left with a vacant property in such a condition that you either have to drastically reduce the rent or leave it sitting vacant. Clearly you can see that this pitfall can lead to an investment gone bad.
Real estate investments can be a cash cow over time. However, the words “over time” are important to keep in mind. If you plan for the fluctuations and the rainy days I am sure you will reap huge returns in the future!
Have questions or comments about real estate investment? Leave a reply below and I will respond.