This question is directed mostly toward those of you who have a "day job" and real estate is only supplemental to your income and/or retirement fund.
I will likely be buying a third property (for a total of two rentals and one primary residence) by the end of this year. At that point, I will be a the absolute theshhold of debt that I can manage with my paycheck if (in theory) my two rentals went vacant for a prolonged period of time. Any rentals I acquire after my third property will absolutely have to perform to pay for itself. So, future property number 4 will be a on a different psychological level in regards to risk.
So, I was just wondering, have any of you come up to this threshold I have described? Was it even something you considered? Did it change your approach to subsequent properties? Did it cause you to have larger cash reserves? Did you decide to form an LLC?
Really just looking for food for thought for an investor approaching this point in his/her portfolio life.
Brian Hoyt, what I have to say is akin to what Jeff said.
I think it is probably best to have the mindset that each property stand as it's own business. That being said it is good for you to think conservatively about how you would "back this property up" should there be problems. But I'd look to...
1) having at least 20% in the property
2) 50% rule (so you are realistic with your expectations)
3) cash reserves
I think the amount of properties you'll own would become limited by the chunks of money required for down payments and renovation costs, not so much by lack of cash-flow.
Normally your posts are spot on, but after reading the title a couple of times and the content, I found it rather unclear.
Perhaps you can distill this to 1 or 2 precise points in a followon post?
Brian, I understand totally what you are saying.
When I bought my properties, 3 at once, I had no reserves and nothing but a couple of part-time jobs. The tenants HAD to pay their bills and repairs came from cash flow.
When your back is up against the wall you become much sharper, very frugal, and very creative. I had a lot more to gain than I had to lose. 90% levered, 10% equity, no reserves.
Going forward; 90% equity, 10% levered, lots of cash.
If you don't want to stick your neck out then go slow just as you are. I gather from your posts that owning lots of RE and relying on RE as your primary source of income is not something you have planned for your future.
You might toss ideas around about long-term goals and see if the pace you are going will allow you to accomplish your goals.
I am getting a pension which is exactly the same amt as my RE income figuring according to the 50% rule. Unfortunately, even the gov't (transit authority) can't be counted on and now realize RE the safer of the 2 retirement vehicles. Oh well, no matter how it works, will be fine.
Have seen it said working full-time and having 4 houses about all you can handle. That has been my experience, but many on here do fine with owning many properties and working full-time.
To me, having even 1 rental F&C in retirement would be a fantastic benefit.
Jeff S.,
As an aside:
Yes, you are correct, I do not plan to make RE my primary income source except for maybe in retirement. Alghough I do wish to make it a significant secondary source (significant to me would equate to around 1000 to 1500/month in my pocket after 50% rule - more would be welcome..). That would be as much 300-400K in pure cash over 25 years plus whatever interest it might get in a mutual fund (or where-ever I park it)plus an estimated 1.5MM in free and clear assets. Add to that my growing 401K and any other investments, and I am quite happy with that. If I am lucky enought to stay married to my beautiful wife, that will be additional financial boosting.
I began my career as a civil engineer about 3.5 years ago and my salary has climbed by double digit percentages each year for the last couple years. I expect this to continue for the next 4 or so years (at a decreasing rate). At which point I will probably flat line somewhat. When that happens I will have lots of options if I'm not satisfied with my current situation.
I know a lot of investors tout and toot about making more money for their time than working a day job, blah, blah, blah, but of those who actually pocket more than I do from my annual salary (especially my projected salary in 4 years) AFTER re-applying their investment proceeds, they are working much harder than I care to. Over the past 4 years I have been working full time, going to engineering graduate school part time (one to two classes per semester except for one summer), bought and rehabbed my personal residence and a rental.
After I complete my master's degree (end of this year), I think I could handle about 10 rentals time wise. My local mentor told me that she found that the same system for 3 rentals was about the same sytem for 10 rentals. Once I'm in a position to hire out maintenance, managing the units should be even that much easier.
This is my rough plan, subject to change.
Brian Hoyt, what I have to say is akin to what Jeff said.
I think it is probably best to have the mindset that each property stand as it's own business. That being said it is good for you to think conservatively about how you would "back this property up" should there be problems. But I'd look to...
1) having at least 20% in the property
2) 50% rule (so you are realistic with your expectations)
3) cash reserves
I think the amount of properties you'll own would become limited by the chunks of money required for down payments and renovation costs, not so much by lack of cash-flow.
Brian Hoyt
I'm in your position in that I work full time and manage rentals on the side. I agree with your initial post that it is extremely comforting to know that you could cover all PITI payments on rentals with your salary. I moved at a relatively slow pace in the
beginning which gave me a couple of years to confirm that, if priced right and maintained, my units (particularly SFRs) would rent with very little vacancy costs. If you're cash flowing well enough, you don't need your job to cover those payments. I found that after a while of seeing cash coming in, and with enough data, I felt comfortable the rentals would pay for themselves and didn't worry about whether I had adequate income from my full time job to cover rental expenses.
I will say (as almost everyone on the boards does) that as the number of units increase, you do need to increase your reserves proportionally. I think (and this is just a perception) that many investors think in absolute terms. For example, they think $10,000 (or some other number) is a lot of money generally but they don't realize (until it's too late) that it's all relative to the number of units you own and, by extension, the amount of risk to which you are exposed. My experience has been that it comes in waves (vacancies, repairs, etc.) and you've got to have the funds to ride it out.
Finally, I see very little difference between managing 3 and 10 units. I think the biggest time suck and stressor for full time workers like ourselves is the acquisition and rehab. Once that's done, managing them is a cake, particularly if you do a good job fixing stuff on the front end.
I think you should wait until you have six months of reserves for each property. It's just not worth the risk if something goes a little sideways and you cant cover your payments. Any dings to your credit is going to seriously hamper your future borrowing power if you stick with SFR for now.
John Chapman,
Thank you for that great feedback.
I agree about the cash reserves and each unit supporting itsef regardless of my seperate income. My only rental property thus far is free and clear and my next will have a PITI of 450 and rent will be 750. It works out to be about 115/month profit after 50 percent rule, but I believe it will initially be much more profitable. It is in very good condition and I will self manage, - so should not be a problem. Any future rentals I hope to operate on a similar model.
I also agree that the acquisition and rehab are the number one time eaters. I can see the rehab that I did during nights and weekends over two months taking more time than regular management over the course of three years.
I have a personal house with a slightly underwater mortgage and two paid for homes in a C level area. Both rented out yesterday! My plan is to not depend on any income on my rentals. I do not have the credit nor desire to borrow so my next house(s) will be cash buys. Conceptually, I would want to hit 10 or more homes before I start collecting any income.
Brian, I too have spent most nights and every weekend for the past 8 weeks doing my part in the rehabs. I am beat! I hope to sub out more work in the future. We will see.
I do real estate on the side. I have a full time job but still manage my (7) properties. I have near 6 months reserves for all of them. My properties are also distributed around my city and not all in one spot. They all pay for themselves very easily and I try to net $500 from each per month. I also don't have a dime of my money in any of the properties... I rather use the banks ;)
You need to form a company to put your properties in. LLC is okay but I prefer Incorporated. You reduce your liability by doing this. You could form a company for each property you have so in case something happened they couldn't come after your other rentals as well. Regardless you need to get them out of your name. Another good idea is to carry an umbrella policy up to 2 million or so. Its like $250 a year and well worth it. People will sue for anything these days.
Here's how I approach the issue: How much reserves are needed for the 'neediest' property? How much will that property cost you if it goes vacant? Then I figure 6 months of carrying cost for that property and put away that cash. That allows me to survive if that property goes vacant or has repairs. So, lets say the most expensive property needs $8,000 to keep you solvent for 6 months.
Then I use the square root rule. The idea is that it's unlikely that both properties will fall vacant at once. So my reserves for 2 properties will be SQRT(2) * $8,000 or $11,300. For 3 properties my reserves would be SQRT(3) * $8,000 or about $13,800. And once I have this in place I'm ready to start saving for the next.
The issue comes if you ever have more than 1 empty. If that happens you have to act quickly. Maybe lessen tenant screening, maybe lower rent to get one filled. But having reserves allows you to react to the challenge. But keeping the reserves lower than 2X for 2 houses allows you to start saving for the next soon.
Agree on that you need to use a other strategy in the next house. Have you thought off investing in others projects, with returns on invested amount? This way you go outside the repairs and other hassles. If you do all work yourself, it must be timeconsuming ?
Michael B. I disagree that properties are unlikely to become vacant at the same time. My bigger problems with vacancies resulted from outside economic forces that affected all properties at the same time. First time was easy financing where tenants moved out to buy homes and the second time was the tech bubble bursting when I was investing in the tech corridor.
Hey Brian,
I'm at almost exactly the same stage in the game as you. We've got two properties, and are expecting to be ready for #3 by the beginning of next year. In the price range we're buying, we can get up to about 6 and handle PITI from my day job (barely) with 100% vacancy. From there on out, the risk gradually increases. At property #6, we can withstand 100% vacancy, by #12, only 50%, by 18, only 33% and so on.
We plan to mitigate that by building appropriate reserves, and just as important only picking up properties that produce enough income to rebuild those reserves should they be called upon.
The reserves are something we are working on now, in parallel to saving for more properties. I believe that even when you are in a position to bail out your business with your day job, that you should still run your business as if you didn't have that ability. Hence building reserves now when they are technically less needed rather than waiting until later. We have a baseline amount that we will not allow our bank account to fall below. That is our family cash emergency fund plus reserves for properties. Each time we add a property, we will add 6 months PITI for the new property to the baseline.
One of the criteria you might want to lock in is for each property you buy to be self sufficient. Each one should pay for all expenses and have cash flow left over each month. By doing this you can supplement wherever you want with funds from the day job.
I think the bigger your business comes the less you worry about this kind of stuff. That would be like a McDonald's franchisee saying they're not going to build another restaurant just in case they have 3 freak months with revenue plummeting.
Before any business expands (a part time or full time), they need to have a criteria (for McDonalds: cash reserves, traffic count, area income, local competition, etc). Many people here have already mentioned their formulas.
You need to change your mindset to grow. If you're buying right, have sufficient reserves and have a disaster plan (maybe liquidating a property, negotiate a temporary assistance plan with lender, personal income) you should never have to depend on your job income to support your real estate business (except in the event of expansion).
Growing is such an enjoyable part of this business. I ran such a tight ship in the hyper growth mode. Unfortunately it's a lot less feasible for to have my hands on everything nowadays.