How to manage risk

Question

I’m an investor in the works. I am now in a situation where I fear vacancies in my properties to the point of not being able to cover mortgage. I have 4 rental units which I do very well with and so far can manage, but I don’t know if I keep growing if I’ll be in too deep and over my head to manage risk. My current properties cash flow about $150 a month after all expenses which I think is OK. But I was wondering how more experienced investors manage this risk? How do I pass this fear and keep growing? Please advice.
 :roll:

Jason Hanson · Answer

I heard someone once say that "you have to have the stomach for this business" and that most people don't have the stomach to be successful real estate investors.

If you know what you are doing and you are a "good" real estate investor then you shouldn't have too much to fear. Because you know that you will always be able to get those vacancies filled quickly, or keep them from going vacant too often in the first place.

Ana Hyler · Answer

All_cash, the cash flow is $150 (average) per unit and this is after mortgage, taxes, insurance and all. My four rental units are all houses, from one bedroom to 3 bedrooms. I paid for them from $40000 to $65000 . I don’t think the cashflow is great….just OK.  My goal is to pay them off as soon as possible, but it’s harder then I thought. I’m happy to say though that one of them ($40000 one) it’s paid off.  I really need to work on my reserves ! Thanks for your input. It helps !

Ana Hyler · Answer

I love the idea of growing big….and the fact that this might be a way to diminish risk !  Awsome. Thank you for the help. I really need to get a plan together and build my reserves at the same time as I keep growing, but it is so difficult with a full time job, 4 teenagers and a 3 month old baby. But I will make it work, because I know this business will bring me financial independence at some point ! I love the quote “You have to have the stomach for this business”. It pumps me up !

Michael Rossi · Answer

In my opinion, you are just about at the point of maximum risk!  When you have 4 rentals, you are in a position where all units going vacant at the same time (or another major anomaly occurring) is certainly possible and those 4 empty units could be enough to do serious financial damage to you.  As your portfolio grows, your risk will diminish because the chance of an anomaly (like a 100% vacancy rate) affecting you greatly decreases.

Think of it this way.  If you have one rental and it goes vacant, your vacancy rate is 100%, yet you can probably afford to cover this vacancy expense out of personal money for a significant period of time.  The vacancy factor probably does not provide a significant risk to your financial health.  When you have four rentals, it is possible that through bad luck, they could all go vacant at the same time, which could result in significant losses that could break many new investors in a short period of time.  As your portfolio grows to 20, 30, 40, 50, or 100 rentals, your vacancy rate will approach the vacancy rate for your market and the chance of having vacancies that will wipe out your cash flow greatly decreases.

With only 4 rentals, having one vacant is a big deal.  With dozens of rentals, I ALWAYS have vacancies and they are just part of the business.  Who has the greater risk - an investor with 4 rentals or one with 100?

Good Luck,

Mike

Mark N.A · Answer

As Tim said, build your reserves.

Ask yourself how long you could continue if all of your properties were vacant.  What you most want to avoid are 1) foreclosure,  2) selling your properties at distressed prices, and 3) having to rent to anyone with a pulse just to get cash flow.

In personal finance, it is a general rule that one should bank at least six months worth of expenses in case one lost one's job.  Of course, that is a personal call.

Personally, I like to sleep at night.  It never seems to amaze me (or aggravate me) that my properties always seem to stay vacant longer than I anticipate, or that those properties always seem to cost more to recondition once a tenant leaves.

Good luck.

Frank Adams · Answer

Well abhyler, you may not like my answer, but MikeOH will say it if I don't! You have some conflicting points in your OP; (1) "I'm doing OK, and (2) "they cash flow $150/month".

I hope you don't mean they cash flow $150 combined! How much does that $150/unit/month represent? If it's on a smallish investment it may be OK, but if it's on places that cost you more than about $50K (doing the math in my head) it's not so good.

I always like to analyze my properties on a "cash on cash" basis. IOW, if I had paid cash for this place, how much would it be throwing off. So, subtract your monthly mortgage cost and calculate how profitable they would be.

Assuming they're not losing money I'd probably consolidate for a bit, not take on any more debt (of any kind), pay down all debt, but particularly pay off the SMALLEST loan. The attack the next smallest.

Good luck

all cash

Timothy W. · Answer

My first thought was this was an insurance question.  What insurance companies do to manager their risk applies to you as well though - build reserves.  And if you're exceeding your comfort level, that's not necessarily a bad thing - just don't go crazy.  4 units is an accomplishment.  You're doing well.