The Top Five are:
- Earnings
- Management
- Protection
- Leverage
- Exit
1. Earn or Burn
Earnings are the most obvious. The question to ask is, “After management and expenses, what is this investment
going to do for me?” Here, you must crunch the numbers in order to find out if the property is going to generate the cash flow it needs to sustain itself as a profitable venture. You don’t want a bonfire to fuel every month, so if the income doesn’t exceed the expenses, you could find yourself in a negative cash flow situation. Positive cash flow is priority, but don’t forget to take into account collateral benefits, such as appreciation, tax deductions and asset depreciations, when you calculate your overall earnings.2. In Management You Trust
Management can be a challenge to evaluate, but it is necessary when it comes to the overall strategy. Who will be taking care of day-to-day business with tenants and maintenance? If it is going to be you, do you have the resources necessary to do the job effectively? You might be able to save some money by doing it yourself, but many times, hiring a property manager is more cost effective, especially if you plan on owning more than a few properties. With management, it comes down to two words: control and trust. Who ultimately has control of your investment dollars? Do you trust this person to be responsible for successes and failures? Putting effective management in place for your real estate and investment projects can remove you from the day-to-day busywork and let you focus on other business while still retaining control and profits.
3. Smart Investors have Armor and Safety Nets
When you consider protection in your investment, evaluate and address the risk to eliminate it or bring it to an acceptable level. When organizing your enterprise, decide what corporate entity will be best for liability and tax purposes. There are advantages and disadvantages to C-Corporations, S-Corporations and LLCs depending on your liability and tax exposure. This is where a good CPA and attorney will come in handy. There are various forms of insurance to guard against a catastrophic loss or lawsuit, and in some situations, you may be able to hedge risk with other investments. Lastly, don’t neglect to evaluate the risk to your overall portfolio and net worth to ensure the business risk is at an acceptable level.
4. Do More With Your Financial Crowbar
Leverage is the tool of the wealthy, and it comes in the form of time and money. By adding leverage, you can do more by taking advantage of the time and skills of property managers and contractors. This leverage utilizes the time of others so you can focus on generating revenue. With proper planning, you can leverage investment money on real estate by obtaining private money or a mortgage to fund purchases and repair costs. Leverage is all about taking advantage of what you have in order to go further and get there faster. However, it is important to realize that adding leverage increases risk. The more leverage you have, the more risk you take on, so you must compensate for this with protection.
5. Exit and Reinvest
Your last consideration is exiting. Give some thought to the end of your investment and plan what it will take to get there. Some purchase property to renovate; their exit is generally selling for large profits. Those who choose to build passive cash flow and equity should consider getting initial funds out of the project in order to invest again. For example, say you buy a duplex to use as rental property with a positive cash flow of $400 a month after expenses and mortgage payment. If your out-of-pocket closing costs are $5,000, your exit will come in about one year; at this point, you will have your money back, and you will be able to invest it in another property.
Evaluate your investments, control and protect your investments, use leverage to further yourself and repeat the process again and again. It’s no secret that building wealth is the key to financial freedom. But if the key to building wealth is knowledge, education must be a priority.