by Eric D.
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.
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.
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.
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!
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