I have talked about this subject many times before but because of a recent call from one of my students I felt it important to talk about this subject again. A few days ago one of my students called and told me she was facing a dilemma and was worried about losing her property. She told me that she had no money to pay for the annual property insurance coming due and for two years of property taxes. She didn’t have the money to pay for either. This seems to be a common problem many beginning real estate investor’s experience. This is a subject I knew all too well because years earlier I experienced this very same problem.
I guess part of this problem stems from inexperience and lack of knowledge. Although this is a problem for many, it can be solved very easily with just a little effort and discipline. I felt it very important to write this article hoping to save many newer investors the distress and sleepless nights this problem can cause.
My own personal story is a common one. When I first started buying income properties nobody told me that each property was a separate business. Nobody told me that each property must pay for itself from the rental income it produced or it wasn’t a good property to buy. Nobody told me that I must set aside money from the rent for the property taxes, the property insurance and for the maintenance of that property to be able to fluff and repair that property when a tenant moved out.
Owning several income properties at the time, I would collect rent each month, pay the mortgage payment then use whatever remained to live on. This strategy worked well for a while until the property insurance and the property taxes came due and I had no money to pay for either because I spent all of the excess money each month to live on.
When this happened I started borrowing the money I needed from friends when a tenant moved out so I could repair the property until the next tenant was in place and paying rent. I borrowed money for the property insurance and property taxes until I no longer had any equity remaining in my properties and nobody would lend me any more money. They saw I was on a fast sinking ship. That is when I finally had my AH-HA moment and I finally realized I had a serious problem I needed to get a grip on fast. I could no longer borrow money and feared losing my properties and ruining my name with lenders who had trusted me and allowed me to borrow their money.
Now back to my student with the problem. Once she explained her problem I made some suggestions based on my own experiences. I suggested she do exactly what I did when things were at their worst for me. I told her to open a checking account. Every month when each tenant pays their rent deduct from the rent received 1/12th of the annual property tax cost and deposit that amount into that checking account. Also deduct from the rent 1/12th of the cost of the annual property insurance cost for each property and also deposit it. Also start setting aside each month at least “Ten Percent” of the monthly rent to cover the cost of repairing that property when a tenant moves out and also deposit that amount into the checking account. Something else I do is set aside an additional “Five Percent” of the monthly rent so when a tenant moves out I have at least one month’s money to make the mortgage payment while the property was being fixed and until I had another tenant in place paying rent.
Believe me, when I finally started doing this my monthly spendable cash-flow diminished greatly, but when these expenses came due I had the money I needed available to immediately pay for those items. I hope my student has the financial discipline to do what I suggested; only time will tell. I hope those of you who are just getting started as a landlord will heed my warning and immediately start setting money from every rent check aside to cover these costs. Believe me, when you start doing what I am suggesting you will start sleeping better at night.
At the time, I had this problem I did not lose any of my properties, although I easily could have. If you want or need more monthly cash-flow to live on, buy more well selected income properties where the numbers work. Because each income property you buy is a separate business, if each property can’t generate enough rent each month to cover these costs and pay for the property, you can’t afford that property either.
I now have a new website and from now on you can only confirm any of my trainings by going to www.LarryHarbolt.com/alumni. Be sure to listen to my podcasts found on my website as well as iTunes by the name of “The Real Deal Podcasts with Larry Harbolt”.
Until next month
Good Luck and Happy Investing