It is possible to have too much emotional attachment involved in a property, or to get caught up in the offering process like you would a bid at an auction. Therefore, if you decide what your non-negotiable rules are when buying real estate, you have something to refer back to when you feel like something isn’t going your way during the underwriting process.
Non-Negotiable #1: Buy for cash flow
It is important to underwrite (run the numbers) a property before you buy it to determine if the property is a wise financial decision or not. During your underwriting process, you should determine if you can make enough cash flow on the property to make the deal worthwhile. If you buy for positive cash flow, and the numbers work out that the property will be producing positive cash flow, then you have a good deal. Make sure during this process that you are accounting for any additional costs that you will need to put in to the property. It is wise to take part of the cash flow and set it aside for any incidentals that may come up, and you need some liquidity (which ties in to non-negotiable #2). Usually, I do not purchase a single-family property if it will not cash flow at least $300 or $400 per month. Multifamily is much larger than that, and has different cash flow goals. I also think it is just as important to have a complete business plan with the property you are looking to purchase. What will be your hold term? What is your end goal?
Non-Negotiable #2: Have access to liquidity
Liquidity is money that you can use right away if you need it. It can be a savings account, bank account, or if completely necessary, a HELOC. When you buy a rental property, more than likely, you are going to have to fix or update something at some point. There are many different incidences, and hopefully when you go through inspections on your rental property, you find the major issues that you will need to put into the property beforehand.
A recent and relevant example for me is, I had someone run in to our rental property with a stolen car- no joke! Because the police never found out who the culprit was, there was no responsible party to pay for the incident. The house was knocked off of the foundation, and thankfully our renter was not injured. Insurance paid for the majority of the work needed, but someone was still responsible for the deductible… that someone was me. Therefore, if I didn’t have $5,000 set aside and able to use, the house would have either 1) remained vacant while I made the monthly mortgage payments, until I came up with the deductible, or 2) gone in to foreclosure because I couldn’t afford to keep making payments on the house without a renter for a long period of time. Both of these scenarios sound like a bad idea to me. It may be a good idea to make a “worst-case scenario” plan. What would you do if you had to make payments on the rental property for several months. Could you do that?
Non-Negotiable #3: Secure financing that you can live with for a long time
During your underwriting process, you should definitely be running the numbers with a mortgage in mind and obviously, the lower the interest rate, the better. You should be picking terms that you can live with for a long period of time, just in case something happens in the housing market. If a recession were to happen again, then you can ride out the recession while collecting your cash flow every single month. It’s pretty standard to have at least 20% down on the mortgage when purchasing a property, but I think having that 20% in to the property is a good idea anyway because it gives you a cushion for if your property depreciates. It also gives you a slightly lower mortgage payment, which helps for positive cashflow.
On single family homes, I typically secure long-term financing (30 year notes), and I recommend it, even if your business plan is to sell the property in 5 years. If you purchase a multi-family investment, it can be beneficial to secure a construction or bridge loan, as long as you have financing in place for when you will be refinancing. Some people may have the goal of paying off the house in as little time as possible so they can have a mortgage-free house, this is also a great business plan. You could secure a 15 year note if you can still make a positive cash flow, as long as you are certain that your monthly payment will be covered. The main goal is to be able to live with the financing you set in to place for a long period of time, and not have to feel pressured to get out of your loan right away for any reason.
Do you have a non-negotiable when it comes to investing? Share with us below…
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