Hi Folks,
I hope that all is well with you.
The reality is that many new real estate investors know absolutely nothing about business.
This can be a great disadvantage to newbie investors.
Knowing how businesses operate is very important information to know when you are entering into the real estate investing arena.
If you do not know how businesses operate, there is a good chance that you will fail as a real estate investor.
After all, real estate investing is just like running a business.
A fundamental component of any successful business is the…
‘Operating Line’
I have talked about the operating line before in previous posts, however, this is such an important concept that I feel that it needs to be talked about again!
What is an Operating Line?
In simple terms, an operating line is almost like a Line of Credit. It is a revolving credit facility. For example, a business could have an operating line in the amount of $100,000. If a business uses $20,000 of their operating line, they will then have $80,000 still available to use. However, the moment the business pays off the $20,000 that they owe, they will immediately have a full $100,000 available to use again.
Why are Operating Lines Important for Businesses?
Operating Lines are very important for businesses because they allow businesses to pay for things. The cash flow of a business may be such that they do not have the necessary funds available to pay for items at a given time. The purchase of these items may be crucial for the business to have. Since the items are crucial for the business to have, they must purchase them. If the business does not have sufficient funds on hand required to purchase the items, they have to then use their Operating Line in order to make the purchase!
What are the rules for using an operating line?
The rules for using an operating line are important to know. In Canada, where I am located, major Canadian banks lend to businesses between 10 to 15% of their gross annual sales for their operating lines.
Using this percentage, if a business does $1 million dollars in gross annual sales per year, the amount that a (Canadian) bank will lend the business will be between $100,000 and $150,000.
How do I implement this information into my real estate business?
With this knowledge of how Operating Lines work, we can now begin to figure out how much of an operating line someone should use for their real estate investing business.
Let’s say that someone owns 2 rental properties. The rent that they obtain on a monthly basis is $1,500 per property. Therefore, they are receiving $3000 ($1,500 * 2) in monthly rent.
We now have to multiply $3000 by 12 months of the year in order to give us the gross annual rent collected.
$3000 * 12 = $36,000.
Therefore, as you can see from above, $36,000 is the gross annual rent collected.
If we take this number ($36,000) and multiply it by 10 or 15% as mentioned above, we get…
$3,600 to $5,400
This means that the recommended operating line amount (as per Canadian banks) is between $3,600 to $5,400.
Let’s look at a real life example…
OH Boy!!! You just bought your first rental property and….your Air Conditioner just broke down. It is the middle of the summer and it is HOT outside. You need to replace the air conditioner ASAP for your tenants! What do you do???
You get a bunch of different quotes to repair the air conditioner. You find out that it is going to cost you $2,500.
You don’t have the money saved up in order to pay for this repair. What do you do??
You use your operating line
In this scenario, the max amount that you can spend on your operating line is $5,400.
The expense for the air conditioner is $2,500, so it is well within the budget of what you can spend.
Is using an operating line this easy?
For the most part yes. However there are some complications that can arise when you use an operating line.
I will address those complications in Part II of this post.
Stay tuned!
Best Regards,
Neil Uttamsingh
ps: First Rental Property will be making a HUGE announcement later this month. Check back in frequently to the blog. You will not want to miss this news!!!!
