Every real estate investor has their own risk tolerance, and as such, plans for emergencies differently. I like to think I’ve got a pretty good emergency plan, but honestly, it’s never been truly put to the test.
When I started buying investment real estate ~6 years ago, I tried to adapt a conservative mindset and learn from experts. Not just any experts, I specifically wanted to model after investors who built long term businesses and had survived large “black swan” events.
I can’t say my disaster plans are the best in the world, and only time will tell if they’re robust enough to survive our current economic challenges. In this post I’m sharing some of my disaster plans and emergency fund numbers, specific to the 4 x fourplex investment properties I own.
(I’m open to any feedback you have. But please be courteous with your commentary – in the grand scheme of things I’m still a relatively new investor!)
Beginning with a Conservative Mindset & Strategy:
A few basic investing principles have always made sense to me. These are:
1. Buy cash flow positive properties. (Much easier said than done!) Robert Kiyosaki first introduced me to this concept in Rich Dad, Poor Dad. For the Fourplexes I own, I bought them with the assumption that they could service themselves financially, and not rely on my personal income. The total rental income exceeds their total expenses.
2. Don’t over leverage. My biggest fear is owning a property that’s worth less than the money owed on it. Lucky for me, after the 2008 GFC all the banks and mortgage companies tightened their lending standards… I was always required to put a 25% down payment on all my investment properties, so over-leveraging upon purchase wasn’t even an option.
3. A healthy emergency fund. Again, this is something that most banks required before letting me close on a new loan. I had to prove I had ~3 months of expenses sitting in a separate cash reserve account. I’ll explain my current overall cash reserves in more detail below.
4. Professional property management. Management companies are professional rent collectors, and this is their #1 priority (because they get paid based on how much rent they collect).
These 4 things alone aren’t enough to protect against all disasters. But they are a good starting foundation for long term success.
Larger Potential Black Swan Events:
If one of my properties burns down, I have insurance. If a tenant sues me, I have insurance. For the most part, I’m protected against common (yet unlikely) types of disasters.
But there are 2 major scenarios in which my fourplex investments would suffer severely, and I could potentially lose everything:
1. Mass Vacancy or Loss of Rental Income:
In small doses, this isn’t a big problem. Short vacancies, missing rent, and evictions are generally expected (and even built into projections before acquiring a rental property).
All together the fourplexes have 16 units, and my average occupancy has been around 90%. This means that I almost always have 1-2 units vacant at any given time that aren’t bringing any income.
If vacancy increases, let’s say up to 3-4 out of the 16 units, the properties (overall) would no longer be cash-flow positive. They would only bring enough income to cover their expenses. Nothing else.
Any more vacancies than that means I start to dip into my emergency float account…
Emergency Reserves = 6 Months PITI
When I bought the fourplexes, I followed the advice of Coach Carson and set aside 6 months worth of expenses in reserve accounts. This covers the PITI for each fourplex, which stands for Principal + Interest, Tax and Insurance.
The 4 buildings have a total monthly PITI of about ~$6,000. So I have a little over $36k in cash reserves that I can tap into if tenants leave or stop paying rent.
This 6 months is almost a worst case scenario… It is likely that some units will always be occupied, and some tenants would always be able to pay rent. Let’s look at a sliding scale of how long my emergency reserves will last if 1, 2, 3, 4…. etc. units are not generating any income:
It’s important to note that my 6 month *fourplex* emergency funds are completely separate from my *personal* emergency fund. So in a worst case scenario, if I fully deplete my fourplex emergency fund after 6 months of no rent, I could potentially keep paying the PITI with my other personal saved money.
2. Another HUGE Housing Crisis: Local or National
Another potential disaster would be if demand drops so low that the “market value” of my buildings are lower than my outstanding mortgages. This could be a national disaster (drop in the overall housing market similar to 2008 or worse), or potentially a regional disaster that collapses the specific city I’m based in (like hurricane Katrina or something).
A recent market analysis valued each of my fourplex buildings at about $280k. The highest outstanding mortgage I have on 1 building today is $180k, and the lowest one sits currently at about $140k.
So for me to be underwater, we’d have to see a 35-50% reduction in value. Highly unlikely, but not impossible!
Our Current Pandemic:
There are too many unknowns right now to predict how everything will play out, but it’s safe to say that 1 or both of my worst case scenarios might actually happen this year. Yay 🙁
As of this writing, I’m not 100% sure which of my tenants will be able to pay rent next month or not. Things could drastically change week by week. All I can do is work as hard and fast as I can with my property managers to solve problems as they arise.
Help for Renters:
My property managers are already proactively communicating with tenants. They are finding out who is out of work, who can pay rent, and who can’t. They are offering payment deferral plans, extended rent deadlines, no penalty or late fees, etc..
Our managers are also accepting credit cards for rent payments (no transaction fees), encouraging personal loans from friends (if people can), and help finding work or filing for unemployment.
Both my property management company and the State of Texas have advised my tenants that we will not kick them out for not paying rent. Everyone needs a shelter in this pandemic and health is priority #1!
Looks like other landlords are doing the same types of things:
Help for Landlords with Mortgages:
Even though I have an emergency fund, if that runs out there could be options for loan payment deferrals to my bank, the tax department, and possibly my insurance company.
I received the following message from my bank yesterday regarding payment options…
“If you can continue making your mortgage payments, you should do so. If you are unable to make your mortgage payment, we are offering the following protections for up to 90 days.
Please note this is not a deferment of payments until the end of the loan. Payments will be due at the end of the 90 day period. Before the end of the relief period (90 days), we will be in touch to explain possible options that may be available for you to repay any unpaid amount if you are unable to bring the account current.
We will not charge late fees or NSF fees. No negative information will be reported to the credit reporting agencies if you participate in the program, previously reported information including delinquencies will not change. We will suspend all foreclosure activity. You will not receive collection calls or letters.”
It seems like full details are still being figured out. But for now, they’re offering 90 days of no payments or penalties, with a lump sum due at the end of the 90 days.
This isn’t that appealing to me given the fact I can afford to pay at least the next 90 days with my emergency fund. Nevertheless, it’s nice to know big banks are supporting homeowners!
All Things Considered:
I have no idea what the future holds or what challenges will be thrown at me. But, I rest well at night knowing:
- I’ve planned for emergencies the best way I know how.
- I have a decent emergency cash fund to help me and my tenants if needed in this tricky time.
- I have good partnerships in place with my lenders and property management companies, and we can solve problems together.
- Every landlord is in the same boat as me.
- If I lose everything and go back to zero, I have the knowledge and determination to start rebuilding!
That’s all for now!