Planning For Unseen Expenses When Investing In Rental Properties
Investor · Lansing, MI · Member since 2021 · 55 posts · 22 votes
Hello,
I recently listened to Dave Ramsey dissuade a caller from purchasing a multi-family building, and I believe he made several valid points. He said that one of the main issues is that the buyer didn't have the financial means to personally support the property, meaning he couldn't afford any unforeseen capital expenditures or if there was a high vacancy rate that this property would bankrupt him. I know buying a really good deal mitigates this risk, but what are some other ways that you can get past these issues when investing in rental properties with little money?
I am in a similar position as the caller, so I am curious to find a solution to this problem as opposed to simply not buying real estate. Please let me know any opinions you all may have, thanks.
This year I've had 45 rental units. And yes, unforeseen expenses come up. Roof was 9k. Tree removal was 4k.
when you buy a property, set aside cash as reserves. Simple as that. If an expense uses the reserves, use monthly cash flow to pay it back.
Unseen expenses to me is a weak reason to not buy real estate. Not sure the angle he's going for there.
This year I've had 45 rental units. And yes, unforeseen expenses come up. Roof was 9k. Tree removal was 4k.
when you buy a property, set aside cash as reserves. Simple as that. If an expense uses the reserves, use monthly cash flow to pay it back.
Unseen expenses to me is a weak reason to not buy real estate. Not sure the angle he's going for there.
Hello,
I recently listened to Dave Ramsey dissuade a caller from purchasing a multi-family building, and I believe he made several valid points. He said that one of the main issues is that the buyer didn't have the financial means to personally support the property, meaning he couldn't afford any unforeseen capital expenditures or if there was a high vacancy rate that this property would bankrupt him. I know buying a really good deal mitigates this risk, but what are some other ways that you can get past these issues when investing in rental properties with little money?
I am in a similar position as the caller, so I am curious to find a solution to this problem as opposed to simply not buying real estate. Please let me know any opinions you all may have, thanks.
Dave Ramsey’s whole philosophy is that debt is bad. He really doesn’t make a distinction between good and bad debt. Good debt being debt that makes you money, and bad debt like credit card debt and financing your vacation / large TV (etc) purchase.
I personally think he just caters to the less disciplined, and so for those his advice is on point.
With that said, real estate is widely recognized as one of the best vehicles to generate wealth. I’m not a huge fan of calling it passive income. I own just short of 40 units and self manage them. Yes, it’s a pretty easy gig… but definitely not passive by any stretch of the imagination. (Yes, if you property manage all them, I get it could be somewhat passive… but PM is a total rip off and from most I talk to, you still are a major cog in the machine even when you do have PM.) We choose not to go the PM route because the job is easy enough that we don’t like to give away the money to the PMs… who are glad to spend your money without s second thought. Best example - $800 to install a replacement a garage door opener that cost $150 and took 2 hours to self install. We just have all the main vendors on speed dial… The biggest being AC repair, Plumber, septic, and occasionally and electrician and roofer. 95% of daily issues are handled with one phone call. Many fail to understand that 10% of gross that the PM charges represents about 30% of your net profit on the financed rental. So if you take in $1,000 on a property a month - after principle, interest in taxes, insurance and your maintenance reserve, your net profit is probably about $300 a month - ballpark. So a PM represents about 1/3 of your net profit.
To your point - we budget about $125/month per property into a maintenance account - so for us about $3,000-4,000 a month for various repair services, and this number really holds up well for us. Does it replace an AC unit? A roof? No. Those capital expenses would burn through the maintenance account. But it does take care of all the basic things like replacing a hot water heater, AC maintenance, plumbing, calls, septic calls, etc. The maintenance account is a form of financial discipline to help you make sure you aren’t spending through too much of your rental proceeds. When you first get started, the $125 a month probably doesn’t function as well- as a single repair may be $600-$1,000 on occasion, but as you grow your portfolio, the combined maintenance funds will cover the majority of your basic monthly repairs.
As for the bigger expenses, my best suggestion is to not take many draws when starting out… Keep working your day job. We worked our corporate jobs until we had 20 rental properties under our belt. This allowed us to save monthly rental income, and build enough of a padded account to be able to absorb any of those larger expenses that come along. Roofs, AC replacements and septic field replacements come along on a regular basis… and just starting out a $4,000 AC, $8,000 Septic field, $12,000 roof repair is a distinct possibility - so you need a plan. The best plan is to buy your first few properties very carefully. Look at the condition of the roof… Buy a property that has a fairly new roof. This staves off that expense by probably a decade. Same for the AC. You won’t always be able to avoid every major expense… But with careful planning you should be able to fare pretty well. You would want to have some reserves. $5,000 for your first property would likely cover most big expenses you would run into excluding a roof repair. Back up plans can be borrowing against the value of the property, or a loan if you had unexpected issues. Yes, Dave would frown, but I would tell you the leap into real estate is worth the risk.
I would suffix that with the thought that now isn’t the greatest time to make that leap - with high financing costs and high prices across most real estate sectors. But deals do come along. Be patient, find good deals, and be willing and positioned to make the jump when the time is right.
Hope it helps!
Randy
As @Allan Smith noted, cash reserves is the answer.
When one buys any rental real estate, one needs to fund the down payment, closing costs, and cash reserves.
Create a separate “rainy day” account for your rental properties.
Build up that account over time.
The “proper” amount is a function of the age and condition of the property and or units.
For an older single family house, $5,000 to $10,000 should be the minimum.
For older apartments, $2,000 to $4,000 a unit should be the minimum.
Some may say these numbers are too high - but if you want to sleep at night - knowing you have the cash to deal with hot water heaters that burst, or HVAC units that fail or roofs that leak; trust me if feels good to have the cash allocated to deal with whatever “Murphy” sends your way.
You can “seed” this account with an initial sum and then add to it monthly from your cash flow as time goes.
Hope this helps.
The gospel of Dave can be treacherous, he is not entirely wrong but will steer you away from ANY leverage and thus cost you years of possible investing. I listened to him way too much at a point where I could have bought properties worth 2-3x now, and avoided buying because I didn't have the 20% down at the time. Chew the meat, spit the bone. Dave is right, expensive car loans, bad idea. Too much credit card debt, bad idea. Etc. That is the meat. He is wrong on telling everyone to avoid mortgage debt to grow in REI. He compares EVERYONES REI debt story to his folly in his 20's, something that 1. I am sure he could do better now at his age if he got just one stinking loan, and 2. If he had better loan products that were fixed and not structured to be called due, he never would have been….well called due.
The answer besides cash is becoming a deal finder. If you don’t have money, you need something else of value - I bet you have time or can make time. Time = money. And deals = money. If you find a HOT deal, the money will find you, especially the more hot deals you have..ask me how I know…partners and lenders will approach you as you build rapport and relationship. The trick is in investing to grow your mind beyond, what do I currently have, and to learn how to get what I really need. YES on paper someone needs money / reserves but there’s a lot of ways to have it…Just my $0.02 hope it helps.
The gospel of Dave can be treacherous, he is not entirely wrong but will steer you away from ANY leverage and thus cost you years of possible investing. I listened to him way too much at a point where I could have bought properties worth 2-3x now, and avoided buying because I didn't have the 20% down at the time. Chew the meat, spit the bone. Dave is right, expensive car loans, bad idea. Too much credit card debt, bad idea. Etc. That is the meat. He is wrong on telling everyone to avoid mortgage debt to grow in REI. He compares EVERYONES REI debt story to his folly in his 20's, something that 1. I am sure he could do better now at his age if he got just one stinking loan, and 2. If he had better loan products that were fixed and not structured to be called due, he never would have been….well called due.
The answer besides cash is becoming a deal finder. If you don’t have money, you need something else of value - I bet you have time or can make time. Time = money. And deals = money. If you find a HOT deal, the money will find you, especially the more hot deals you have..ask me how I know…partners and lenders will approach you as you build rapport and relationship. The trick is in investing to grow your mind beyond, what do I currently have, and to learn how to get what I really need. YES on paper someone needs money / reserves but there’s a lot of ways to have it…Just my $0.02 hope it helps.
UGH. Let me just admit I gave myself 30 seconds of listening to Dave. So ironic he just criticized getting a partner…and he made it sound like getting a partner means that partner is automatically hooked on drugs……..bleh. Listen to Dave on eating out less, side hustles, saving a little bit, all that stuff….there is such a thing as bad debt. But dude if you really want to do REI then you need to take in content besides Ramsey.
Have access to cash if you have an unforeseen bad month/year. 2018 was a terrible year for me with 6 houses needing major things. lol. I had access to the cash through 401k loans, Roth IRAs, credit card lines of credit and some money in savings to get me through. But I did it and glad I didn’t listen to DR with my RE investing strategies. I’ve scaled up to 17 properties in the last 7 years with on average 15-25k in reserves.
Investing in real estate is exciting to say the least especially when a great deal comes up that is hard to pass on and you have done your due diligence/ran the numbers. However, I would wait until you have sufficient reserves to be on the safe side for unexpected expenses such as HVAC issues, pipe leaks, among other things. Best of luck.
Hello,
I recently listened to Dave Ramsey dissuade a caller from purchasing a multi-family building, and I believe he made several valid points. He said that one of the main issues is that the buyer didn't have the financial means to personally support the property, meaning he couldn't afford any unforeseen capital expenditures or if there was a high vacancy rate that this property would bankrupt him. I know buying a really good deal mitigates this risk, but what are some other ways that you can get past these issues when investing in rental properties with little money?
I am in a similar position as the caller, so I am curious to find a solution to this problem as opposed to simply not buying real estate. Please let me know any opinions you all may have, thanks.
The most effective ways to prepare for unforeseen (and seen) expenses:
-Work with an investor-friendly agent that doesn't have "commission breath" and will push you to buy any property regardless of condition. The agent should do their best to estimate potential rehab costs and based on knowing your situation/cash position they should advise if it makes sense to move forward.
-Have an experienced home inspector on your team. Your agent should be able to recommend one and if you have questions or concerns. A good inspector will be able to stay mostly objective and give you the truth about the condition of the property. Bear in mind though that an inspector can't see through walls and there may be things that they don't catch. An inspection is mostly visual and based on just one moment in time. Your inspector will also be able to estimate the remaining useful life on major building systems (furnaces, AC condensers, roof, water heaters, windows, etc). You can use these useful life estimates to budget for major capex expenses over time. Just understand you're forecasting will never be perfect and some things may come up sooner rather than later.
-Have a comfortable cushion of cash reserves, whatever that means to you.
This year I've had 45 rental units. And yes, unforeseen expenses come up. Roof was 9k. Tree removal was 4k.
when you buy a property, set aside cash as reserves. Simple as that. If an expense uses the reserves, use monthly cash flow to pay it back.
Unseen expenses to me is a weak reason to not buy real estate. Not sure the angle he's going for there.
Agreed. When you own a rental property or any other business. you can't predict every future expense or problem. Things are going to come up that you just don't see coming. As the business owner/landlord you have to address the problems and be flexible (not over extended).
"what are some other ways that you can get past these issues when investing in rental properties with little money?"
you can't. if a big capex hits... you gotta pay for it. HVAC, roof, etc.
if you buy something in great condition, and you have it inspected, and the inspector tells you everything is new / in tip top shape... great, but then you'll still have these items. they'll just be delayed... 5 years, 10 years, whatever depending on the life of the item.
the mitigation is having the funds.
1. Accurate inspections, budgeting and underwriting (very conservative cash flow projections)
2. Cash Reserves
3. Home Warranty (far from perfect, many people don't like them for a lot of reasons mainly because they are a pain to deal with, but as a safety net for someone looking to get going despite not having super deep pockets yet, they are worth looking into IMO, just pick a company with a good track record, and often you can have your agent pay for it as a closing gift).
As you look to invest in real estate, it's important to also factor in unexpected expenses. For instance, if your property requires a repair such as HVAC or plumbing issues, these can quickly add up and become costly. It is recommended that you have sufficient reserves set aside in order to cover the surprise costs that may arise when investing in real estate. Be sure to do your due diligence and research any potential properties thoroughly before buying, so you know what to expect. With the right preparation, investing in real estate can be an incredibly rewarding experience. Good luck!
Thank you all for your thoughtful responses, I really appreciate it!