The Most Common Mistake Made by Newbie Real Estate Investors

Do not become a landlord or fix and flip real estate investor without the appropriate reserve funds.

Without the appropriate reserve funds you will most likely be adding to our economy’s foreclosure backlog and just become another statistic. Take this advice seriously, it has been learned the hard way by many investors that have come before you. Refer to Murphy’s Law.

The Perfect Rehab?

How many rehab projects have you heard of that have had no hiccups, no delays, and no surprises?  Ask this to a group of real estate investors at your local REI club and you’ll quickly find out that the perfect rehab or long term rental doesn’t exist.  From surprise foundation problems to the guaranteed buyer/tenant that all of sudden cannot close on the deal; surprises are a part of this business.

Property Rehab Gone Wild

Even the most scrutinized and detailed rehab project cannot account for your contractor skipping town with a portion of your money or your tenant being arrested and sent to jail in the middle of the night.  Always include at least $5K in contingency funds or better know as “oh shit money” for every foreclosure or distressed property rehab project.  This is based on rehab projects of $30K – $45K in scope.

Do you know what happens when your perfect tenant stops paying rent after month 7 because they just lost their job or their ex stopped paying child support?  You have a non-performing asset that you must deal with swiftly in order for this property not to become your last in your real estate investing career.  If a tenant has no where to go, they typically will not just pack up and leave because they feel bad for their landlord.  There will be 3 months of no rent before the sheriff comes out to the house plus the $600 -

$1000 to process the eviction.  Then there are the turnover costs (hopefully a security deposit was collected) and the time involved to re-rent the property.

Many newbie rehabbers and buy and hold investors do not take these scenarios seriously and tend to underestimate the amount needed in reserves to properly cover themselves for the unexpected.

So How Much Should a Real Estate Investor Hold In Reserves?

If you listen to the strict bank underwriting guidelines, that will be typically 6 months of the PITI (principle, interest, taxes, interest) in reserves.  When I first started out, I tended to believe that 2-3 months was more than sufficient.  I obviously could do it better than anyone else and saw the six month reserve guideline as overly conservative.  Heck, my first buy, fix and hold investment was accomplished with only $500 out of my pocket; I thought I was a pro.

My opinion changed after accumulating a portfolio of properties and encountering some of the most unreal situations. Our current recommendation is to maintain 6 months of cash reserves for every single buy and hold property purchased.  There can be 5 months of perfect performing rentals and then all of a sudden 4 separate unrelated issues will pop up all at once.  When it rains it pours. If you, as a budding real estate investor, are not prepared to deal with multiple crises at the same time, you will not be in this game for long.

What If That’s Too Much Money to Save Up In Reserves?

Good luck then.  Call me when you’re entering foreclosure so I can buy your property from you for less than what you paid because so you’re so desperate to sell it now.

What’s everyone else’s opinion on this topic?  6 months in reserves for every single property.  Is that too much or too little?  Comment below, I would love to see what investors think.

Speak Your Mind

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