One of the strategies I feel is most important for up and coming real estate investors is what I refer to as leverage your real estate and bank your cash-flow. Many famous books have been written over the years (The Richest Man in Babylon & The Wealthy Barber come first to mind) talking about the concept of paying yourself first. I feel as though real estate investing should be no different, let me explain.
I am a firm believer in using other people’s money (mainly banks) to buy more and more real estate. There is no shortage of available cash out there to fund profitable real estate deals. For clarification sake please notice that I did use the word PROFITABLE as it is key here. You can be leveraged to the hilt but as long as you remain profitable more money is always available to you.
Now, since your deals are profitable there is an excess cash-flow coming off of your properties each and every month. The key to long term wealth and risk mitigation here is to bank (or invest in stocks, bonds, mutual fund, gold etc.) a portion of that money each and EVERY month. The second and perhaps most important part of this strategy is to NEVER use any of that money in any future real estate deal. Once the cash comes home it should stay there. There will be plenty of money, aka equity, being freed up for future real estate deals. This approach helps you diversify your portfolio and ensures you always have cash in the bank. Having all of your money tied up in real estate is not a fun place to be.
Now back to mitigating your risk; interest rates are currently at all time lows. Variable rates in Canada are around 2.2% and 5 year fixed rates are around 3.69%. They are however not going to be this low forever. There is a temptation to get in on deals that seem profitable now but should rates rise by even 1% the profit would evaporate and it would become an anchor. So what you want to do is calculate your profitability on a high rate ( I would recommend 5-6%) thus ensuring you have a good buffer. Secondly I would recommend you take the variable rate but make the payment of the fixed rate.
This approach does several things for you:
-
It takes away the temptation of getting in over your head by paying only the minimum of the current ultra low variable rate.
-
Prepares you and takes the shock out of interest rates rising as your payment now wont change for years.
-
Dramatically reduces your amortization period and thus supercharges the speed at which you are building equity which can be utilize in your next deal.
Let me create a realistic example of how this type of scenario could play out for you using real numbers.
Your purchase a triplex for $650,000, your put 20% down ($130,000) thus leaving you with $520,000 left to be mortgaged. Each suite is rented for $1200 a month thus giving you a monthly income of $3600. The monthly expenses (taxes, utilities, insurance etc.) for the building are say $500. You have a net income of $3100.
At the current variable rate of 2.2% you could be tempted by the low monthly mortgage payment of $1971 (30 year amortization) but avoid temptation. Take the variable rate mortgage but increase your payment to what it would be at 3.69% ( $2382 per month thus paying an additional $411 directly to the principle each and every month). Also note that the payment at 6% APR would be $3093 per month thus making this a safe deal for you (again looking to mitigate risk).
You now are left with $718 of cash-flow each and every month. Going back to what I was saying earlier make sure you bank a portion of this monthly cash-flow (10% minimum but more is always better) and never allow it to find its way back into the real estate market. Take another portion of it and set it aside in your emergency fund as unexpected expenses will always come up. Now you are left with a portion to do with as you please and for the most part your risk has been mitigated, your cash (or investment accounts) accounts are growing as is your equity.
I read once that money in real estate is made when you buy, not when you sell. I whole heartedly believe this to be the case, if you follow the steps I outlined above and buy only profitable properties it really is tough to lose money.