There are about as many ways to finance real estate as there are ways to cook an egg. We will definitely not go into all the various options here. But more importantly, I want to share the common mistake made by many people. I would say of all the ways people fail at owning rentals, this is top of the list. I consider this the foundational error people make when purchasing a rental, and something to be very careful of.
When we look back at the market crash of 2009 and the real estate fall of 2010-2013, those who fumbled their rental ball and could not pick it back up were those who were over leveraged by having a mortgage consisting of most of the property’s value. Over the past 12 years, the owners who have struggled the most, had the most frustration, stress, and turmoil were those who did not have enough cash flow for the property to be self-sustaining. They also did not have adequate reserves (discussed in play #2) so when there was a significant expense or lack of rental income for whatever reason, they had to draw on personal funds to keep their property moving ahead.
Having a mortgage and using leverage to boost the potential return of your property is an important play in the real estate game. However, I encourage people to use conservative leverage. What this means is that you are able to have a healthy balance of equity and leverage to allow the property both higher returns and self-funding. A rule of thumb you can use is to see that your cash flow after all expenses, mortgage payments, budgeted property mgmt fees, budgeted vacancy and maintenance (essentially everything), is greater than 20% of a month’s rent. So essentially you could generate a full month’s rent from the cash flow every 5 months or less. Any less than this and it may run into some financial difficulty which will need funding from reserves or your personal accounts. Any more than this and you may not be getting the best rate of return. Again, it’s about balance.
