Focus on Things Other Than the Bottom Line

It well understood that we look closely at our bottom line. However, how many of us are disappointed in what our bottom line shows at the end of a project? How often do we then put blame solely on a contractor’s overage from things that just came up? Alternatively, how often do we call out our PM for not forcing cuts or keeping contractors in line?

Focus on Contingencies

Not every project will be on budget. More than likely, they will be above budgeted costs. In most cases of our investments, there are unknowns that will pop up during rehab or maintenance, and it will indeed affect our bottom number once the project is completed. How can you account for such occurrences?

Start by adding in an extra contingency for budget variances. My suggestion would be for a 10% contingency minimum, added to every budget estimate you may have. If you have multiple teams of contractors involved, add 10% to each estimate.

This is how you can be conscience of possible issues you need to address along the line, but you will be more confident in your final figures and bottom line. When the project is completed, and you did not need to utilize the full 10% contingency, the next step will seek to protect your operating accounts and future projects.

Focus on Reserves

Everyone needs to have a reserve account in this business. Too many young investors and even young real estate professionals fail badly but not doing two things. This is first not accounting for the need for reserves, but as well not accounting for taxes. The two items can be fatal for a young professional. Essentially, if project overruns hit you hard, if you do not have reserves and either you are funding partners or lenders do not allow extra money drawn, a project can be doomed. This forces you to seek alternative funding, which could cut even further into your bottom line with additional interest charges.

Not accounting for taxes, which will for sure be a post again soon (I just finished and filed my taxes for my businesses), can be killer for a business, as not paying your taxes can cause there to be liens and judgements, which can hurt your credibility, and be a tough item from which to escape.

The first way to save for reserves is to apportion a percentage of each project profit towards a secondary bank account, one that will be separate from your operational accounts. Suggestion is to take 10% from the closing of every deal and place into your reserves.

The second way to help fund the reserve account is to take any difference from your project contingency budget and what extra money had to be spent and place it into the account. For example, if the estimated costs of the project were $4,450 (light rehab), your contingency should be $445, bring your total budget to $4,895. If your total costs were to be $4,600 after the project was completed and sold (or moved into your rental portfolio), you would have $295 remaining. Take that amount and allocate it from your operational account into your reserve account. The only exception to this rule would be if the funds are fully borrowed and carry interest costs. If the money is borrowed money and not paid back, you will of course incur more interest. Not smart to hang on to the money.

Final Thought

What you will find is that your reserve account will grow. It will be available for the what ifs and just in cases. Monitor the account and based on your business model, you will have to determine a max amount you may want to keep in the account. Similarly, you will want to maintain a minimum amount in the account. Again, these items are specific to your business, your growth, and your estimated work to be completed / projects to be entered on an annual basis.

Having separate operating accounts is a wonderful way to assure that certain allocated funds are not touched. Obviously, there should be a wide range of accounts for your business, and working with a CPA will allow you to set up proper accounts and track correctly.

Thanks again for the read! Happy investing everyone!