Are you counting on rental income every month to support your lifestyle before you know what the property needs?

One of the lessons from The Richest Man in Babylon that stuck with me is the idea that your money should have children, and those children should have children of their own. In real estate, I think a lot of investors make the mistake of eating their kids.

 The property finally starts producing income and they immediately spend it. But before that money ever makes it to your pocket, maybe it should strengthen the property first.

Even if you have sufficient reserves, I don't believe you should automatically distribute or spend that money every month.

Why? Because I have a view of rental properties that I've shared with investors for years. I call it the yo-yo effect.

It's the money you get from the property and how often you end up turning around and putting that same money right back into the property.

You get the money.

Then the furnace goes out.

You get the money.

Then the tenant moves out.

You get the money.

Then the plumbing fails.

That's the yo-yo effect. So yes, you made money. But did you really?

Or was the property simply holding that money for the expense that was coming next?

That's why I don't recommend drawing on rental income prematurely.

Do you have sufficient reserves?

As I've written before, reserves should be viewed through four buckets:

Maintenance/Vacancy/Operating/Capex. And each one matters.

So before you start spending the spread or profit generated by an investment property, make sure those reserves are where they need to be.

I prefer to let the property operate throughout the year. Let the income accumulate. Let the expenses reveal themselves. Let the surprises happen. Because they always do.

Yes, you do have reserves. Yes, you have future plans that have been accounted for. But life in real estate brings on unpredictable things.

When a contractor says it’s going to cost $3,000 ballpark, and they haven’t walked the project, they haven’t dealt with the unexpected stuff hidden behind the walls. The inclement weather that may come about. The adjustment in permit requirements the city may throw at you.

That’s why I recommend a business-structured approach to distributions. Things are accounted for. And when the next unexpected thing pops up, you have options.

Because you need to be ready before you need to get ready.

Personally, the yearly evaluation for distribution is a way of disconnecting living expenses from investments.  It’s a litmus test and it builds discipline.

Then toward the end of the fourth quarter, you assess the performance of the investment. You review your reserve requirements. You evaluate your future plans for the property. Then you make an educated and unemotional decision about whether it makes sense to distribute some of that money.

If it does, great. If it doesn't, leave it alone.

This is a mode of operation. It's a philosophy.

Yes, it’s your house. Yes, it’s your investment. Ultimately, it’s your money. You can do whatever you want with it.

But, having worked with thousands of investors, I’ve learned that if you’re investing and counting on rental income every month to support your lifestyle, you will inadvertently apply a level of stress to the investment.

And that stress doesn't stop with you. It gets passed on. It gets passed on to the relationship you have with your property manager. If you don't have a property manager, it gets passed on to your relationship with the tenant. It gets passed on to the decisions you make regarding repairs. And ultimately, it affects whether you enjoy real estate investing or not.

My personal view is that investors who allow reserves to build up without the stress of expecting monthly distributions tend to enjoy investing a whole lot more.

We promote Performance-based investing that’s sustainable over time.
And that’s why we’re selective about the investors we manage properties for.
That’s what I mean when I say you and your property manager need to be in alignment.
If that’s not your philosophy, that’s not a judgment call. It’s not a provocation.
It’s simply a statement about investment philosophy.

My younger self thought cash flow was what I could take.

Today I look at it differently.

Cash flow isn't what you take.

Cash flow is what the property generates.

Whether you get to keep it is a completely different conversation.

And that's a conversation I prefer having in the fourth quarter.

How do you decide when to take money out of your rental properties?