How To Establish A Rainy-Day Fund

Most real estate investors have an optimistic view of their business. They think that every tenant will pay on time every month and their property will never need any improvements. They think they can find a way to generate profit on every rehab deal and their initial budget will be their last one. It is only when things don’t go as planned do they find themselves in trouble.

The reality is that the unexpected happens to every investor, regardless of experience or the situation. How prepared you are for it helps separate the average investor from one who struggles. Preparing now, before you need to, will help soften the blow for whatever comes your way. Being a step, or two, ahead is always better than scrambling around when the unexpected strikes. If you don’t have a rainy-day fund to help offset these issues you are simply setting yourself up for failure. Here are five tips to help establish, and maintain, your business rainy day fund.

• Save 10% Of Rent Received. There are literally dozens of things that can go wrong with your rental property. You may not have any issues for weeks, then out of the blue get multiple calls back to back days. It is essential that you are ready to seamlessly handle anything with the property from fixing a clogged toilet to dealing with an eviction. Think of the financial impact on your business if your tenant stopped paying. Not only would you need capital to cover your mortgage, but you also need money to evict your tenant. Without money things can quickly go south with the property in a matter of a few short months. The same is the case if you need to fix your roof, the foundation or even replace an appliance. You should take 10% of the monthly rent received and put it in a separate account. It will take months, even years, to make a significant dent but it is a good way to get the ball rolling.
• Save 10% Of rehab Profits. If rehabbing is your niche, you probably know all the unexpected items you face on every transaction. It is not a stretch to say that a half dozen unexpected items happen on a given deal. The best way to combat this is by keeping your estimates in line with reality and staying strict with your budget. You can also put some money away on every deal generated. You should put 10%, or more, from every rehab deal into an account strictly used for your rehab business. 10% certainly won’t break the bank, but it can help you pull title, or get the ball rolling on your next deal without starting in a hole. As is the case with your rent received, saving a little bit is better than not saving anything at all. It may not seem like much initially but after closing a few deals you will have enough capital saved to brace for the unexpected.
• Cut Expenses. There are two obvious ways to save money: generate additional income and cut expenses. Without trying too hard you can probably shave a decent amount from your monthly expense ledger right now. With the money saved you can use that to jumpstart, or add, to your savings. Start by making a spreadsheet of all your monthly business expenses. Even if you can’t outright eliminate the item there is a chance you can find a way to reduce it. A few bucks here and a few there can quickly add up. You may not see the benefit right away in reducing your expenses, but after a few months and with compounding interest you will quickly see the impact.
• Don’t Dip Into Funds. The idea of an emergency fund is to only use the funds in the case of a real emergency. A real emergency can be dealing with an unexpected vacancy or having to replace a significant item in the property. It can be to rescue a marketing campaign or to perform due diligence on an out of the blue potential purchase. What it shouldn’t be used for are lunches for you and your team or vanity items for you personally. The minute you start to dip into your emergency funds for unwarranted items you set the precedent and will certainly do it again in the future. Keep the funds secure for when you really need them and for only genuine emergencies.
• Explore Other Capital Options. A rainy-day fund may help act as a short-term bridge to get you through a minor problem before it gets too big. They are not intended to cure all the problems with your business. You should at least explore the option of having a significantly sized line of capital behind you. This can come from a home equity line of credit, an IRA or even a 401K. You don’t need to take the step of opening them, but you should know all the details regarding repayment, interest rates, penalties and fees. You should understand what is needed if you do intend on moving forward and how long the process will take. Having capital when there is a large-scale emergency can save your business.

The more you have in savings the less reliant you will be on credit. Repaying a credit card or a hard money lender at double figure interest rates is not a recipe for a solid business. Every real estate investor should have some capital stored away in a rainy-day fund.