How would you like to know how to lose a lot of money?
Or have an empty property with no tenants and you are on the verge of repossession. Sure. Why not?
We don’t want to lose a lot of money but we sure want to know how it’s possible so that we can avoid doing it. After all, making a mistake is one of the biggest fears that keep people from getting started right?
From the past 7 years we’ve been in the property game, we’ve endured many expenses with running our property portfolio. In fact, Mark has a spreadsheet, pie chart and Excel formula’s to determine the reality of the running costs we are likely to incur..
(I don’t say anything, as I know he enjoys it;)
Investors who use the ‘rent vs mortgage’ to determine cash flow are oblivious with the reality of running a property business. That’s not property investment. That’s gambling.
You see, whether it’s deferred maintenance, general-wear-and-tear, or void related costs, the reality of holding a rental property is not cheap.
Of course, we would all like to paint a rosey image where we never hear from our tenants and the portfolio is running on auto-pilot…
But stick around for the longer term…and you will have a month where all hell breaks loose.
So how does this relate to You and your portfolio? Simple. Failing to hold a sufficient amount of liquid reserves can easily wipe out your portfolio.
Get this right and you’ll end up with a solid, recession proof income.
Get this wrong and you could be joining the other overseas, off plan, new build junkies one month away from bankruptcy (or worse)
I know you’re smart to have liquid cash reserves which are essential to keeping a healthy rental portfolio…
But ‘How much liquid reserves should I have for my portfolio’, I hear you ask.
Great question.
Because so many do get it wrong, there’s more contrarian opportunity and income for you when you do the opposite of the masses and protect yourself.
So, let’s make this interesting and consider three scenarios:
The Gambler wants to escape the rat race. He’s tired of his job and feels trapped. He knows more than all of his bosses, yet he makes less than them. He doesn’t feel like he has a way to grow or experience more.
So he decides to invest in property but has no additional cash reserves. He bought a low yielding property which was just ‘washing its face’, so he couldn’t reinvest any cashflow back into the business.
The ‘Gambler’ has all of his reserves in the equity line. The big downside is fairly self explanatory, but a change in interest rate rises, a big maintenance bill and the investor is heading for trouble.
Can you relate?
Then you have Average Joe – he loves figures, numbers and formulas to determine the amount of cash reserves he should have on hand for his rental business.
Such as:
- 5 months of mortgage payments, per property
- Maintains £2-4k in cash, per property
- Maintains £7k in cash, if he own less than four single lets
- Maintains between £15-£20k in cash, if he has have more than 5 but less than 10 single lets
The big advantage which Joe -has- he has built up his cash reserves in separate bank account specifically for his rental business.
Although this seems like an obvious point, many new investors get stung by never having separate account to track their rental profit and loss. They co-mingle their personal accounts with their business, which causes more hassle and headaches later down the line.
Then you have..
The Smart Investor: He does all of what Average Joe does, but has an additional £25,000 in liquid cash deposited in the bank.
The goal for the smart investor is to always maintain this lump sum for a rainy day. He will use excess cashflow to reduce his loan to value, and divert surplus amounts to different ventures within the property business – such as direct to vendor marketing and new acquisitions.
Perhaps you can relate to this last strategy?
Although it maximises security without tying up too much capital, it’s important to know the reality and not to dismiss it as something which may ‘never happen’
You see, Mark has analysed our last 6 years tax returns (I get bored of reading a post it note, so someone needs to keep an eye on the detail) and as an average across all of our properties, our running costs are about a third of the gross rent (management, maintenance, voids, safety checks, insurance etc).
Yes… it’s more stringent than the lenders 125%, but he likes the reality. He then works the long term cost of finance out, which is around 6%. An 8.5%-9% gross yield with a third taken off for cost covers the finance, guess what gross yield we look for!
You guessed it, 8.5% or better.
Now, don’t get us wrong. Owning rental property is one of the best ways to build up long term wealth, but we’ve been doing it long enough to know what works and what the REAL expenses associated with running the business entails.
It’s not sexy or glamorous, but it’s real and important.
Having sufficient cash reserves to weather a downturn is more important than adding to your portfolio. If the boiler goes on the blink, you must have cash or credit to get that working. Or have the failures of the tenant leaving at any time.
Remember, capital appreciation is a fact, not a ‘strategy’. You need to concentrate on achieving monthly profits in order to keep your business liquid. Your aim should be to buy investments “as if prices will never go up again” then you will be forced to only buy properties which give you great cashflow.
Having extra cashflow and a safety buffer will also cover potential rises in interest rates in the future and for any unexpected costs you may incur in case of an emergency
If you can’t cope with having cash reserves, then your property portfolio will crater WHEN this happens.
And if you’re just starting out, spend some time and money investing in advice and mentoring from experts. Whether it’s us or someone else, because the best risk reducer is knowledge.
Mark Homer