Three factors to consider when planning for financial success in property
Residential property investment is a proven way to increase your wealth, as I’ve discussed in previous articles such as:
- 5 reasons why property investment is better than stocks for retirement
- Why positive cash flow investment property will help you retire early
- Why off-plan property is a great investment strategy for all lifestyle goals
One question I’m asked by beginner investors is, how do professional investors always stay profitable? Of course, the main way to make a profit from property is to be sure that you are investing in the right property, and in the best places to invest in property UK. But what about once you are invested? How do you prepare for the worst that can happen?
The need to have a property investment reserve fund
The most successful property investors steal a simple but effective personal money management strategy: always have emergency cash set aside.
In your personal life, having emergency cash available lets you cope with anything that life throws at you. That broken gearbox on your car? Paid. An emergency medical need? Paid. Periods of unemployment are a breeze when you have an emergency fund. You don’t need to accept the first job that comes along, and you don’t need to slash your spending or go cap in hand for help from friends and family.
A property investor’s reserve fund does a similar job.
What should you consider for your reserve fund?
There are three factors to consider when calculating how much cash you should keep in reserve. These are:
- Repairs and maintenance
- Void periods
- Cash flow
Let’s look at these in turn.
1. Repairs and maintenance
Most maintenance work is small and can be handled easily by skilled technicians. The cost of these should not cause financial stress, but there are exceptions.
Older properties are more susceptible to larger repair costs. Roofs and external walls suffer damage over time. Central heating systems have a shelf life. On average, boilers need replacing every 15 years. White goods (such as washing machines, fridges, freezers and ovens) have a limited life, even with regular maintenance.
Newer properties generally have lower maintenance needs. Therefore, you’ll need to set aside less reserve cash to cover these. You’ll also have more time to build up a reserve for when it might be needed.
In this category, you should also include costs of redecoration, replacement carpets, and so on.
2. Void periods
Although I’m discussing void periods second, it is probably the major factor when deciding how much to hold in a reserve fund. Every buy-to-let investor suffers from void periods. When a tenant leaves, there will be a period during which your property is empty before your next tenant moves in. While you cannot guarantee 100% rented time, you can keep void periods to a minimum by:
- Buying in the best places to invest in property UK
- Investing in ‘every person properties’, which appeal to the widest audience
- Being a great landlord and keeping your tenant onside
When you suffer a void period, you will not only lose the income from rent that a tenant would be paying, but you will also still have to pay expenses such as:
- Mortgage payments
- Council tax
- Utility bills
- Maintenance (empty properties can sometimes cost more to maintain!)
So, when considering your reserve fund, you should set aside enough to cover any possible void periods.
3. Cash flow
Positive cash flow will help you to cover the costs of repairs and maintenance. The greater your positive cash flow, the easier it will be to build up the reserve you need to take care of all maintenance and repairs and to see you through void periods.
Of course, it is best to start with a cash reserve fund. You can use positive cash flow to build up your fund and replace any cash from the fund you have used for emergencies.
How much should you keep in a reserve fund?
How much you decide to keep in your reserve fund depends not only on the above factors but also on your attitude to risk. I tend to err on the side of caution. I hold more in reserve funds than other less cautious investors might. I enjoy the peace of mind and restful nights this safety net gives me.
Generally, I will set aside 10% of annual rent per property for maintenance and repairs, and a further three months’ rental income equivalent to cover unexpected void periods. The average void period in the UK is 22 days, so you can see that I am being ultra conservative in this approach. But that suits my attitude to risk and my approach to property investment.
Never use your reserve fund for this
Your reserve fund is the operating capital for your property investment business. Whatever you do, don’t be tempted to use it for any other purpose. It’s not for spending on holidays, new cars, clothes, art, or wine. You never know when your reserve fund will be needed. If it is not available to make repairs, for example, you could lose your rental income – and that could lead to you being forced to sell your property at a knock-down price.
Live with passion and fun,