Tuesday, September 18, 2012

Real Estate: Real-life risks associated with leveraging.

A while back I wrote an article called "Cash vs. Mortgage, and a Scenario." There I explain a few key differences between paying cash for investment properties, or mortgaging them.  Today I reviewed my real-estate portfolio and was in shock about how much risk I am really taking on.  I want to provide insight for my viewers to see some real-life examples and to further motivate me to pay my debts off!

I went into my investment properties with nothing down, since I really had nothing to give.  This leverage allowed me to take on long-term debt without using any short term cash.  Having three properties in the portfolio provides 8 renting possibilities.  Assuming no property destruction and no tax benefits, here are the 8 outcomes:




As you can see above, vacancies result in serious financial consequences.  To help minimized risk, I have tenants sign 1-year leases which are staggered so the possibility of multiple vacancies is reduced.  But still, things still can happen that can put me in a bind.  Over the years I have established a hefty emergency real-estate fund for tough times ahead (though this could be easily wiped out should multiple vacancies occur over extended periods of time).

Having real-estate debt has always put a damper on my dividend investing contributions.  I often opt to pay additional cash onto the principal over purchasing a good-valued dividend stock.  This results in less long-term debt and risk.  If I manage to pay off the properties, here is how the 8 outcomes would look like:




After reviewing the chart, the risk here is almost non-existent.  All 3 properties would need to be vacant in order to have a negative cashflow!  If this was the case for me every month I would have a much easier time getting additional properties or helping the dividend-investing portfolio.

It is important to note; that when vacancies occur there are always repairs that need to be done (or house cleaning).  This is usually a minimum of $150 if you have a professional involved.  Insurance and taxes have been included in the scenarios above, making the data easier to digest.

Disclaimer: I am not a financial planner, advisor, or accountant. The financial actions mentioned were only suited for my own risk tolerance, strategy, and ideas. Copying another's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets.

5 comments:

  1. Nice numbers. If there was a holy grail to finance it would be "no debt". It drastically changes your scenarios.

    A landlord HAS to take vacancy rates into consideration.
    I have 1 unit I rent out. I calculate the following for each rent payment I receive...
    10% taxes
    10% maintenance
    10% property manager (so worth it)
    10% vacancy

    I only keep 60% but I have my bills and debt under control where that is profitable to me so I win.

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    1. Pulling I agree with budgeting for the rental properties. One thing to note is that the 10% invested in the property manager can usually bring your vacancy rate to 0%.

      When tenants give their 'notice' my property manager already has a list of people who are already interested in the property, and are just waiting to move in.

      Should someone bail out before the contract is up, they forfeit the deposit and the manager still acquires the next months rent, which actually puts me well ahead.

      If you keep 40% of the income aside for unforeseen expenses, just be sure that 60% of the income can handle the mortgage and insurance.

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    2. The 10% I pay for a property manager is the best money I have spent in a long time. Over 3 years I have had zero vacancy (though I still budget for it). This is with multiple tenants and recently month to month lease (just got a 6 month signed). My neighbor is trying to do it all himself to save money. He is always ending up listing his for $50/month lower then mine and usually 2-3 months of vacancy. On top of that is all the headache and work that I just don't have to worry about.

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  2. The very heart of your writing shilst sounding agreeable at first, did not settle very well with me personally after some time. Someplace within the paragraphs you were able to make me a believer but just for a while. I nevertheless have a problem with your leaps in assumptions and one would do well to fill in those breaks. In the event you actually can accomplish that, I will definitely end up being fascinated.
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    Property leveraging

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  3. Jafor thanks for stopping by. Its tough trying to estimate the results from month to month because of the numerous variables to consider. The best thing to do is budget for vacancies by setting some money aside when each month the units are rented out.

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