5 Reasons You NEED to Be Properly Capitalized for Real Estate Investing Success

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There are many aspects to investing real estate. Some require no money down, but most require a significant amount of money to get into. And after you get into them, some require even more money. Failure to be properly capitalized or being under capitalized could cause you to not only lose your entire investment; it could cause you to lose your personal assets, too.

Never underestimate the amount of capital that it will take to be a successful real estate investor. I see many people embark on an RE investing career, and think they can spend their last dollar attempting to “strike it rich.” There are no quick paths to riches, and with a higher return comes more risk, every time.

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5 Reasons You NEED to Be Properly Capitalized for Real Estate Investing Success

Property Flips are Expensive

If you are doing a property flip, you need money to buy a property, money to fix it up, money to pay the loan while you are fixing it up. You need money to pay utilities, taxes, insurance, etc. If you have ever done a flip, you know about the expenses that pop up.

Very rarely do you get a property that gets bought and fixed and ready for sale for less than your initial estimates. There is always something else that seems to draw your money in. As you peel back the layers, you seem to find something else.

The best scenario in this type of investment is to pay cash up front and eliminate any interest that you would pay for a hard money loan. Unless you have multiple flips going in at the same time and you have the cash, invest it in yourself.

Buy & Hold Properties Need Capital

In a buy and hold property, you need capital. In order to buy most properties, you need a down payment, a job to qualify and pay a mortgage, and great credit. The down payment for a non-owner occupied property is likely to be 25% to 30%. A bank will require solid credit, and you will likely even need enough capital to pay six months’ worth of all your mortgage payments in the bank. This is not for only the new mortgage you are getting, it’s for all of them.

Consider this: four mortgages at $1,000 per month is only $24,000 for six months’ worth of payments. My advice to you is, whether or not it is required, you better have enough to pay at least six months’ worth of expenses on all of your properties — or you should stay home. I personally would not do it without a full year’s worth of capital reserves.

Related: Raising Capital for Your Investments: What Are Private Lenders Looking For?

If the place you just purchased is vacant, in addition to the down payment, you need some fix up money and holding expense money while you renovate and market the property. Once you get the property filled with tenants, if you did not screen the tenants properly, you may need to evict. One surefire way to lose everything is to be too greedy and take the first tenants who said they would pay rent. Or skip an eviction because you do not have enough money to evict.

Failure to evict because you mistakenly believe that half the rent is better than no rent is a recipe for failure. An eviction will take up at least 5-6 months’ worth of capital in terms of lost rent, eviction costs, vacancy expenses, and fix up. Failure to have the capital available to pursue the eviction could cost even more.

Real Estate Partnerships Require Money for Shares

There are many ventures where you invest with a group of “professionals.” You are an investor, and they are the finder of the deal and creator of the partnership.

Your risk is somewhat limited, but you generally need a lot of capital to buy your shares. Even in this scenario, things can still go awry. If expenses were higher than expected, or revenue lower, your returns will be less. If expenses are a lot more than expected, the partners may have to dig in their pockets a bit deeper for additional capital reserves. If you do not have the capital to pony up, you may well have a smaller equity position in the deal, or worse yet a lower equity position when the final payout comes to fruition.

Even if You’re Not Putting Money Down, You Should Still Have Money in the Bank

There may be some instances, albeit very few, where you can get into a property with little down. If you are doing this type of deal because you do not like to put money down, good for you. If you are doing this because you cannot put money down, think again about your investment objectives.

Sometimes (ok, most times) a “free” property is anything but that. Unless you can close on the property, selling it at a profit on nearly the same day, you will likely get burned if you are under capitalized.

Note Investing Has Its Own Expenses

I will admit, I know very little about note investing. By definition, you need money to buy a note. As far as I know — and I have only bought two mortgages in the past — you cannot get a mortgage to buy a mortgage [actually, the property owner (mortgagor) gives the mortgage, and the bank (mortgagee) gives a note].

You need to pay for the entire note balance, less any discount. If the note goes sour, you need money to take the property back. Once you get the property, you can buy and hold it, or sell it. Either way, there are some expenses getting it ready to sell or hold. And that takes money.

Why Lack of Capital Can Be a Disaster

Lack of capital can turn a very sweet, high profit real estate venture into a money losing one very quickly. It can take a nice payday for you and turn it into a money pit, a divorce, a bankruptcy, a foreclosure on your own home, a low credit score, higher interest rates, or at a minimum, a lot of headaches.

Related: It Takes a Track Record to Raise Capital for Buying Real Estate

A hard money loan that was not quite large enough can be a problem if no one will lend you more money. Sometimes all it takes is a few thousand more, and you get a nice payday. Without the fast cash infusion, you could be on the path of a longer holding period while you build the capital yourself or a quickly downward spiraling attempt to salvage your original investment.

How much capital do you need? Each real estate deal is unique and different. When I was buying my 4-plexes, I always assumed about $100K to get into the property and $10K per unit for some fix up expenses. If I needed more, I had access to additional capital. Home equity loans, credit cards, and earned income are quick ways to get an influx of cash. If you use these sources, make sure you know what the maximum risk is. You do not want to continually go back to the money well, especially if you do not own it.

Plan Your Improvements Efficiently to Get Faster Cash

When I was fixing up my multifamily properties, I attempted to fix up as much as I could on one unit to get it rented as quickly as possible. I knew some fixes were easier to do in a vacant building, so I fixed those things on the entire unit when it was vacant.

I could replace all of the water stop valves, or water shutoffs, in a few hours, while the water in the building was to be off. Something like shutting the water main off was better done while the entire building was vacant. Paint, carpet and light fixtures could be done a unit at a time.

Plan your improvements in a multifamily property in a logical order; this will save capital on the project.

Whatever you do, keep some of your powder dry in case you have a money pit deeper than you expected.

Have you ever had an investment that needed more capital than you thought?  Have you ever made less money because you were not able to spend more?

Let’s discuss in the comments section below!

About Author

Eric D.

Eric is a 55 year old, soon to be former, computer professional. He started several years ago to replace his “work income”, with other alternate streams. He is well on his way to retirement at age 56, and is currently making more money at extracurricular activities, than he is working at his full time job. Whether that is Financially Independent, or just old fashioned entrepreneurial spirit, is in the eyes of the beholder.

27 Comments

  1. willie morales

    Hi Eric,

    Thanks for this article, this is what I was searching for. Since I want to get into multifamily investing and to use creative financing I was wondering the pitfalls of not having enough cash available for reserves, and I wanted to come up with a blueprint and this is it!!!. I can show this to some of my friends who want to invest in real estate. ………….Thank you again for posting this.

    Have a great day.
    Willie Morales.

    • Eric D.

      Thank you for the comment!

      I have only touched on the basics, there are a lot more downsides. Just as in a high-stakes poker game you cannot take advantage with a great poker hand if you do not have the cash, you could go broke even with a great property if you do not have enough to get you through the initial negative cash cycle.

  2. Michael Jones

    I couldn’t agree more. Everything cost far more, takes far longer, and sometimes is far harder. Especially if you do most of the work yourself because you’re the only one you can afford. Along with having enough capital is having enough time. You need enough capital to buy time. Good article.

  3. Great article. I know how it feels to run out of money for investments or deals. It happened to me when i first got into the industry, thank God I had aunt that rescued me. Therefore, i learned and got better in the past 2 years. Now days I run the numbers and calculate everything to the penny and always prepare for unexpected stuff and including vacancies, etc. I learned that murphy’s law is everywhere.

    Thank you.

  4. I can definitely relate. Several years ago I owned a company and I decided to diversify by buying my own small commercial building instead of renting. I paid too much for it, spent too much renovating it, then, when the core business ran into problems, I only then realized that the commercial property market runs in a different cycle than residential, and even with a small commercial building you need deep pockets. While you can make a lot of money in commercial real estate, you can also lose a lot. Now, I’m slowly building up a residential property inventory and no one bet is enough to put me under. I also have exit strategies for each property. If I ever did a commercial building again, it would be a residential/commercial split so I could use the residential portion to smooth out the commercial cycle and I’d get 3 opinions from people smarter than I am to make sure it makes sense.

  5. Great article, but there are ways to get into RE investing with much less capital. The more money the better (and easier) but for some, having 100k to start is not an option. If you are willing to work hard and educate yourself (great free resource here!) you can be successful.

    • Eric D.

      Thank you for the comment!

      Yes, there are ways to get into E investing with less. Buy off the MLS, at retail prices, FHA loan and live in it. Then, move and rent the old home.

      Not having enough capital, and not being able to judge what it takes, will make a great deal for the next investor.

      • Paying retail for anything in RE is a mistake, probably worst than being undercapitalized. At least you could sell or refi. Being under leveraged is also a mistake, and will hamper growth. Cash flow is key, and will smooth out many bumps in the road…

      • Eric D.

        You are correct. Most investors to do not even know how to get deals. And most good wholesale deals involve needing capital. You need to pay a bird dogger, or a home owner, to make the deal happen. Rarely are the properties in good enough shape to flip, or rent. And even a $1,000 per month in cash flow goes quick, and will not allow for very much rehabbing.

        When you are just starting out, an extra expense of only $10K can sink an investor. Between rehab costs, or possible legal fees to clean a title, $10K can come quick.

  6. Darryl S.

    This article hit the nail on the head. I know that everyone’s situation is different but I have seen people whom if they would simply give up some vices like beer and cigs and get a part time job to supplement their income they could easily have 5k to 10k in the bank in just a few months.
    Quote “you cannot outearn stupidity” Dave Ramsey financial radio host guru with financial peace university Nashville TN
    Keys to success
    1. Integrity
    2. Discipline
    3. Social Skills
    4. Supportive Spouse
    5. Hard Work

    • Eric D.

      Thank you for the comment!

      I used to joke that when I spent money on frivolous items, I was using my ‘smoking money’. Or my ‘Drinking money’. Since I do not drink but rarely, and do not smoke, it was money that I figured was mine to splurge, if I wanted.

      Saving is always more fun in the end.

  7. Susan Gillespie

    You make good points, Eric. This is my favorite: Never underestimate the amount of capital that it will take to be a successful real estate investor.

    Emphasis on “successful.”

    I recently went on a buying trip and can’t tell you the number of places I saw where people ran out of time and money, and the properties sat empty and in various states of disrepair. Many were investor-held properties, and now are new opportunities for the next investors who can bring money to the deal.

    This article should be required reading for people who are just getting started. I don’t think people focus enough on the unexpected issues, vacancies, repairs and surprises that come their way in real estate investing.

    • Eric D.

      Thank you for the comment!

      When you finally get your first ‘great’ deal as an investor, is an eye opener. Far too many people (i.e. newbie investors) think you buy a perfectly good property, off the MLA, and somehow make a ton of money.

      I wish it was that easy.

  8. Andreas Mirza

    I learned this lesson the hard way when I did a high end fix and flip last year that turned into a loss. As my house stayed on the market for longer than I expected, I ran into problems because I was running out of money to make my hard money loan payments. Another option I would add to your excellent article would be to be open to the idea of wholesaling deals or having equity partners. Yes, you’re giving up some of the profit but you’re also lessening your risk. If you don’t have the capital to withstand the shocks, be happy to make some profit without the risk of losing a whole lot more.

    • Eric D.

      Thank you for the comment!

      Often a flip only has a limited amount of margin, and that margin goes quick when you have to pay a lot of interest. Or if just a few small things go awry as you have found.

      Keep up the great work!

  9. Chase Thompson

    Absolutely couldn’t agree more with this post Eric! The only investing I do currently is notes. And like someone already commented, “Everything cost far more, takes far longer, and sometimes is far harder.”

    Now maybe note everything, but when pricing out deals I like to include a decent amount of cushion for all the things, and even then sometimes deals will still get the better of you.

    Loved you comment about ‘Drinking money.’ I always call it ‘paying my real estate investing tuition.’

    • Eric D.

      Thank you for the comment!

      Investing in Notes is something I have been looking at. I am still waiting on a comment that says, “I always have great deals that cost far less than I thought”.

      RE investing is a high profit game when it succeeds. But that is because it is high risk.

      • Chase Thompson

        Eric,

        Like most real estate investments, notes take a certain amount of due diligence to hedge the risk. And there are different notes with more and less risk.

        I don’t know anyone who will say the comment you mentioned. That being said, it’s another avenue and asset that is worth your time.

        If it wasn’t I wouldn’t be investing in them, doing a podcast about it, etc. 🙂

        They take work and have there own nuances compared with other real estate investing strategies. But the results and returns are there.

  10. Yes, I truly believe your stand in this matter. You have to guard your investment with limitations presented before investing. Proper documentation and process can help you in this. Keep up with the best strategies in your investments. Fail to guard your own stuff can lead to being empty-handed in the end. Overall, thanks for your practical ideas! I would love to hear more of this…

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