Just like many things in life, investors are often looking to add more rental properties to their portfolios. This is a good goal to have as real estate investing has created more wealth in the United States than any other careers or investments. The key to building a solid, stable, and manageable portfolio without adding too much stress is to ensure that you have the proper financial footing as you grow.
Too often I have seen investors that spend every dollar they have to buy one or more investment properties. All investors need to have reserve capital as investment properties can require cash periodically when certain events occur:
- Vacancies could require the investor to pull money from their pocket to pay the mortgage instead of the building paying for itself.
- Turnovers can cost $1000-5000, which is often more than an investor takes in per month.
- Upgrades such as new kitchens or bathrooms can consume well more than a year’s worth of income from a property.
- Mechanical systems failure including furnace replacement, water heater replacement or even a roof are needed repairs that often can’t wait, and an investor needs to have access to capital to fund these repairs.
If the investor does not have the needed capital for the above event, they often make bad choices. This can lead to additional problems:
- Deferring needed repairs can result in additional damage to the property (such as not repairing an old roof).
- Tenants may be frustrated and move out because repairs are not completed in a timely manner.
- Leasing the property may be more difficult because the prospective tenants can see repairs have been door poorly or not at all. Or the property is not keeping up with the competition in the area that have more recent upgrades such as bathrooms and kitchens. This can result in lower rents or longer vacancy times.
- Investors may choose to make short term repairs such as attempting to patch a leaking roof or replacing some parts for a furnace that is past its useful life. This practice can cost more money in the long run as today’s problem may be systematic of a larger problem.
A good rule of thumb is that an investor should have access to $5,000 per unit that they own. This will allow them to replace a furnace, perform a larger turnover/upgrade, pay for most of the roof without stressing about how they are going to pay for these repairs. Having that money available will also help the investor reduce any anxieties about money and their property.