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Finding Financial Balance To Invest In Real Estate
The ultimate goal of getting into real estate is financial freedom.
Many might find it fun and exciting. Or even a hobby. But if the objectives of the investor are not income and profits, then the game would no longer be fun very soon.
How can anyone find losing money fun…
It is because of this being a financial decision that many aspects of of personal finance has to be evaluated in order to achieve your long term financial goals.
While many insists that real estate is a game of leverage and in certain instances require zero capital, few actually take on such risks when walking into the industry.
Real estate for the most of us requires serious capital and resources.
You might be able to gear up highly to acquire control over a property, but you essentially still need capital to kickstart your rental property empire.
Cash flow might be able to tide you over once tenants bring in rental income. But that is the optimistic view.
Having a cash buffer, even for emergencies, will be able to let you run your operations without losing sleep over what might or might not happen the week after.
From a prudent perspective, if your cash pile will not allow you to go through 6 months worth of vacancy, you are taking on too much risks as nobody can predict how bad the rental market can get.
It’s not just about having enough savings for a down payment. Also consider:
If you have low capital limitations and not ready to pump your savings into a single asset like a house, then maybe other forms of investment would be more suitable for your risk tolerance levels.
2) Risk tolerance
There is an age-old saying that “the higher the risks the higher the returns”.
While every investor wouldn’t mind higher returns, not many can stomach higher risks.
Even though real estate is considered one of the most stable assets available to the average investor, they can still be huge inherent risks involved especially in more volatile markets.
Unlike a portfolio of stocks that might add some diversity of risks to an investor, a property investor will pretty much have all his funds “trapped” in a house.
This means that if the performance of the house goes south, there is little available to hedge a landlord’s losses.
Without going into the more advanced methods of risky real estating like wholesaling and rehab flipping, a typical rental property can carry a high risks as well.
Consider that you might be putting a lot of money up front, spend a lot on remodeling, and have no guarantee that tenants will be queuing up to rent from you at a fair market rental rate.
And we’ve yet to touch on the debt you have taken on…
The biggest reason why real estate is such favorite among new investors is the high leverage involved.
Gaining control of a $500,000 house with a 20% initial capital can be too tempting an investment for many to turn a blind eye to.
For most investors, they would never get out of debt for the life of their investing journey.
They would carry mortgages, owner financing, seller financing, private lending, personal loans and credit, etc.
In fact, for those who are risk takers, they might not even bat an eyelid to take on more in order to buy more real estate.
Yet for a lot of investors, debt is something to be scoffed at.
You truly need to ask yourself and review how tolerant you are to high debt levels.
Will you be able to sleep at night knowing that you have a huge mortgage payment to come next month… and the month after… and the month following…
Taking on so much debt will also affect your personal borrowing from the bank as lenders would assess your debt ratios and determine how risky you are as a borrower.
You might ask how is it that big time investors continue to be courted by lenders even when they have high debt levels.
Doesn’t high debt levels make them sort of a plague to lenders?
Well the answer is income.
When it comes to debt, debt ratio is what matters most to lenders when assessing mortgage applications. The higher this ratio is, the more risky a borrower is.
But having a high consistent income would offset the debt ratio downwards.
The higher the income, the safer a lender feels. So much that they might even be comfortable with higher debt ratios as long as the income is significantly high.
The other aspect of income is how much personal and family income you are currently generating?
Will your income be able to keep you and your family afloat?
Will current and forecast income be able to keep the business going?
If you current income is already driving your monthly budget into a deficit, you might want to reconsider your plans to invest in real estate.
It really is a capital intensive investment. And a lot of expenses you will not see until you are too deep into the investment to get out.
5) Financial goals.
No significant investment should ever be made without a thorough review of your personal financial goals.
If you currently have no long term financial goals, it could be time to grow up and put some clear thought into it.
Be as specific as possible.
Once you are able to identify or determine your goals, then you would have a clearer picture of whether investing in real estate will indeed be a giant step towards it.
When working out your goals, don’t forget to consider the possibility of changing it.
Things happen in life. And it’s no shame at all to acknowledge that your goals have to change due to major events that occur in life. For example:
- Death of spouse
- Having more children
- Career change
While it’s pragmatic to plan for these things, it is also important to note that we cannot predict the future with certainty.
Plan based on balancing the present and predictable future, yet don’t put too much weight on what might or might not happen in the future.