The following is a guest post by Clint Darby of Rentals Done Right. Check out his blog when you get a chance.
Allow me make a confession to you – I am a conservative Real Estate Investor.
I don’t make apology for it, it is what it is. That doesn’t mean I do not take risk. On the contrary, if you asked my wife, I believe she’d tell you she has to reel me in from time to time. Though I do not mind risk, my conservative nature forces me to mitigate risk as much as possible. I do that by trying to be prepared.
Let’s face it – regardless of where you fall on the political spectrum, the economy smells worse than a gut truck. America is hemorrhaging jobs, incomes are down, foreclosures are up and real estate has tanked.
Governments around the world are paralyzed with the fear that their banking systems may fail. They have instituted “Stress Tests” for the banks. Basically what they do is put them through a simulated financial upheaval to see if they would survive. Most banks pass the Stress Test, many do not. I thought, “why not adapt this idea some?”
Why not perform a “Rental Stress Test?” Take your rental business and assume the worst – and see if you’ll survive.
I’ve mentioned elsewhere of how I use Excel before I make an offer I run numbers through my super-duper, top-secret spreadsheet. This spreadsheet has my assumptions (which are conservative BTW) and I just plug in the variables (price, interest rate, etc.). If the numbers work – I make an offer. If they don’t (or are marginal) I pas. Plain and simple.
Now, I can be a little paranoid. Well… maybe a LOT paranoid – but I like to be prepared. So in taking a look at the economy I try to imagine what could happen:
- Even more foreclosures
- Even fewer jobs
- Even lower incomes
All of that, potentially, points to – LOWER RENTS just to stay competitive in the market.
So here is what I did for my Personal Stress Test…
On my spreadsheet I used all my current data (mortgage, insurance, taxes, maintenance, vacancies, etc.) and I slashed my rent income to 80% of the market rate (or current rent whichever is lower).
If the property still cash-flowed it passed. If it did not – it failed. Now this does not mean that I plan on dumping the property, but it does mean that I have to stay on top of this property and keep it as lean as possible.
I have found that this “Rental Stress Test” has bled over into my purchasing criteria. You can’t be too prepared in the event of a bad economy. I’m not trying to bee doom and gloom, but I sure want to know what it is going to take to tank my real estate business.
I am very interested in your thoughts…