First Rental Property

Ten minutes is all I need.  This is the about the time it will take many of you to read this article.

This article is especially directed towards the aspiring real estate investors out there.

If you are new to the real estate investing world, and you are currently researching how to buy your first rental property, you will find this article very beneficial.

Throughout your research, you may have spoken to or read about the importance of treating your real estate investing like a business.

This is probably some of the best advice you will ever receive on the topic of real estate investing, and here is why:

• Real Estate Investing Is A Business

You may not own any properties right now.  Some of you may own one property, and some of you may own multiple.

Whether you own one or 100 properties, you are in business, and you have to treat your real estate like a business.

• This Is Easier Said Than Done

This is definitely easier said than done.

The difficulty that most people have with running their real estate investing like a business, is that they don’t know HOW businesses run.

People who invest in real estate come from all different walks of life.

I have met people who own rental properties, from all different types of professions.

These professions have included Miners, Truck Drivers, Teachers, Dentists, Lawyers, Contractors, IT Professionals, and the list goes on…

No matter what profession a person is in, when you tell them that they need to run their real estate investing like a business, they may have absolutely NO idea what this means.

If you fall into this category, that is okay.  As humans, we do not automatically have a business sense.

It has been my experience that most people that have a keen business sense have either grown up surrounded by business and business owners, or they have developed this keen business sense through many years of studying business and entrepreneurship.

• Here are some things you absolutely NEED to know

If you don’t know anything about business and how businesses work, here are some things that you absolutely need to know.

1) The most important thing for a business is it’s cash flow

The number one indicator of the strength and longevity of a business, is through it’s cash flow.  Specifically, the more cash flow that a business produces, the stronger it is, generally speaking.

If you are a real estate investor, you have to ensure that your business…your rental properties are producing cash flow.

2)  Businesses have to manage their operating expenses

Every business has expenses.  Also, every business has revenues.

Generally speaking, the revenues being generated in a business should always be greater than the expenses of the business.

If the revenues of a business and the expenses of a business at the same level for a long period of time, this can be problematic.

• Here is an example to help illustrate

You are a real estate investor and you own one rental property.

The monthly rent that you collect from the tenant is $1000/month.

The rent is the total revenue that you are collecting off of the property each month.

You have a mortgage on this property, and your monthly obligation for the mortgage is $800/month.

You also have to pay property taxes on the property.  You own $200/month in property taxes.

Therefore, your total expenses owed on the property are $800 + $200, which equals of course $1000/month.

Therefore, in this example, you have a mothly rental revenue of $1000/month and a monthly expense of $1000/month.

As you can see, the expenses on this property of $1000/month cancel out the revenues being generated each month.

This is what is called a ‘break even property’.

• Why ‘break even properties’ can be a problem

Break even properties do not generate any monthly cash flow as evidenced above.

If this property experiences any vacancies or if repairs and maintenance are required on the property, there is no cash flow being generated to pay for these costly expenses.

• Working Capital, and the importance of a Working Capital Injection

Businesses that are experiencing challenges with their day to day operation can often benefit from a working capital injection.

• What is working capital?

Working capital is essentially money.  Let me rephrase that.  Working capital IS money.  It can be injected into a business through a variety of different methods.  It can be in the form of a loan, a third party can inject the funds into the business, or the owner herself can inject these funds into the business.

The main purpose of a working capital injection is to aid the business with their day to day operations.

If we use the real estate investing example above, a working capital injection of $5000 could help the real estate investor to pay for any vacancies and repairs that come up on their property.  This working capital injection would be absolutely crucial to help the real estate business to continue on, as no cash flow is being produced on a monthly basis in the above example.  If you recall, the monthly rent of $1000/month is cancelled out each month by the $1000/month total expenses (mortgage and property taxes.)

• Working Capital Does Not Help Out a Sinking Business

It may seem to you at this point that a working capital injection is the ultimate solution for a struggling business.  This is not the case.

In the long run, a working capital injection can only be beneficial to the business, if the working capital (a loan) can be repaid.

If the working capital (loan) cannot be repaid, a business will continue to need further working capital injections, especially if they are still struggling with their daily operating expenses.

• How working capital is repaid

Ultimately, working capital is repaid through cash flow generated from a business.  Let’s look again at the real estate investing example outlined above.

Let’s assume that you as a real estate investor needed the $5000 working capital injection mentioned above in order to pay for vacancies and maintenance on the property.

Let’s also assume that the monthly revenue (rent) of $1000/month and the monthly expenses of $1000/month are unchanged.

This ultimately means that there are $0 (zero dollars) a month that are being generated in order to repay the working capital injection.  This is not a good thing.

This is not a good thing because the debt level of the business (your real estate investing business) is going to continue to to rise.

Here is how working capital SHOULD be repaid

As mentioned earlier, working capital should be repaid from the cash flow generated from a business.

In order to repay the working capital injection in the real estate investing example, the monthly revenue and the monthly expenses cannot be equal.  Either the monthly revenues need to increase, or the monthly expenses need to decrease.  Here is what I mean…

In our real estate investing example, we need the following to occur.

Let’s assume that we were able to re-negotiate the interest rate on our mortgage on the rental property.  Through negotiation, we were able to get a lower rate.  As such, our payments on the mortgage have decreased. Now our monthly mortgage payment is $700/month, instead of the previous $800/month.  Our property taxes have remained consistent at $200/month.

Now if you add up our expenses, we have a $700/month mortgage payment and a $200/month property tax payment which equals…a total monthly obligation of $900.

If we assume that our monthly rent has remained consistent at $1000/month, we now have a positive monthly cash flow on this property of $100.  This is because $1000 – $900 = $100

Therefore, if no other vacancies or unexpected expenses are incurred, it will take us a little over 4 years to pay back the working capital injection (loan).  I get this number by dividing the $5000 loan by $100 cash flow per month.  If you divide these numbers (5000 /100) you get … 4.17, which is like I mentioned, a little over 4 years.

So what do you think?

So what do you think about working capital?  Is working capital a necessary thing to have in order to ensure that a business survives?  How would a business survive without working capital injections?  Please leave me your thoughts.

Real estate investing becomes WAY easier when you treat your investments like a business.

Best Regards,

Neil Uttamsingh

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