Enough of an EF for me?

**littleroc02us** · 01-12-2011, 06:17 AM

Personally I would say no, unless you could explain how getting an investment property while your monthly cash flow is only $700. What are all your expenses? An EF fund isn't for investment properties, is for emergencies. Until I see a budget I can't see how this makes sense without a huge amount of cash set aside for expenses for the new investment property.

**disneysteve** · 01-12-2011, 06:33 AM

I agree that there isn't enough information here. What is and is not included in the $4,300/month expenses? Does that count retirement savings? How much would you spend for the investment property? I assume the 15K is just the down payment. What would the monthly expenses be including mortgage, taxes, insurance, maintenance, property management, etc.? Do you have enough to support the property if it is vacant for a month or two or six?

A couple of problems with counting on your home equity as part of your EF:
1. zillow is not a trustworthy source of value information.
2. If the "emergency" is loss of your income, you wouldn't qualify for a HEL/HELOC and would be unable to tap that equity. The only way that works is if you know about the "emergency" in advance and could apply for the loan while everything is still okay.

I'm not sure I understand your action plan to rent out your house in necessary. What does that accomplish and where would you live?

**Scanner** · 01-12-2011, 07:15 AM

Okay, I have my monthly expenses on another computer. . .I'll post the breakdown. Yes, I clear $700/month, which I invest in a SEP-IRA now.

Um. . .let's see. . .I know. . .zillow is just a ballpark. Actually, beleive it or not, I think it's worth more since I've done improvements to it (electrical - restored hardwood floors) but I try to estimate conservatively. I think zillow is actually conservative (in this case). But I'll know more when I get an appraisal for a refinance in a month or two. Then I'll have two sources.

I would also keep a HELOC revolving before the emergency yes. . .

Well, the "action plan" is that I don't beleive in just waiting out emergencies and tapping $50,000 of cash like some pundits seem to pundit. IN other words, if I was totally disabled let's say. . .as bitter as a pill it is to swallow, I wouldn't need a 3/4 bedroom house to co-parent kids and I would "retreat" to an efficieny apt. (knock on wood) and either sell or rent it out. I estimate I could rent it for more than the mortgage + taxes + insurance.

I am not sure I agree with just siphoning gobs of cash away, even if I have it.

I am still compiling hte "business plan" for LLC on the property rental but the cash flow should immediately be positive with a 15 year mortgage, by about $200-500/month but I wouldn't see it - it would be rolled into the home equity, especially if we borrowed through an ARM.

I'll see if I can post my monthly breakdown later.

**jpg7n16** · 01-12-2011, 07:59 AM

If your expenses are truly $4300/month, once you get the new property what will they be? I'm guessing you'd add a mortgage payment, taxes, insurance, and a budget for repairs/expenses of home ownership - so prob add $1200-1700ish. That'd be new expenses of 5500-6000.

So you would need somewhere between 3-6 months in cash: 16,500-33,000 or 18,000-36,000

I'm not a Suze Orman person (never watched her) but $20k would likely be a little more than 3 months held in cash. If you work in a risky field, or have several people who rely on you, that may not be enough.

I think of the EF as a way to avoid taking on debt or cashing out accounts. So I can't call HELOCs or Roth withdrawals part of my EF - since they are the very things I'm trying to avoid.

**Scanner** · 01-12-2011, 08:18 AM

When I punch the #'s, the property would be "self-sustaining" with my downpayment + partner's downpayment and that' factoring in a 3% home value = cost of repairs per year. In fact, that is what I am saying - mortgage rates and properties are getting so low, you can put 20% down and immediately be turing a profit in rent ( a small one, which is rolled in)

So, no. . .why would I invest in a property with a negative cash flow proposition? And I am estimating a 1 month per year vacancy rate (8.125%?).

**scfr** · 01-12-2011, 08:23 AM

Forget about Suze Orman. Rules of thumb are just a starting point.
What I think is a bigger issue for you than your monthly personal expenses is the fact that you are self-employed.

What is the absolute worst-case scenario for your business? Is it possible that you could face a temporary, extended period of time where your business would be LOSING money (money you bring in is not enough to meet your overhead)? I'm not talking about a situation where your business has become a bottomless pit (then you'd want to close it and move on), but a temporary bad situation you felt would turn around as long as you could hang in there financially.

How much would you need to not only cover your personal expenses but keep your business afloat, if that worst case scenario were to occur??

My personal belief is that the average small business owner needs to have much MORE of an EF than the average Joe. Not only is the income irregular (granted some business are more irregular than others & I don't know about yours), but there are no unemployment benefits to fall back on, and the businesses need to be protected. Your business IS an investment, and as long as it is profitable (or you believe it will return to profitability), it should be protected at all costs.

I think I understand your desire to invest in a property ... you are an entrepreneur & maybe you like your investments to be something you can see, touch, be involved in, and completely understand (unlike putting money in some stock fund where people who are thinking about their own personal best interests are making all the decisions).

But if the business you already have is successful and you plan to keep it going, make sure you've got it well protected before you plan on starting your next venture.

P.S. - What about investing in your current business instead of buying an investment property? Is there someplace you could spend some money and get potentially great returns on that "investment"? Again, I have no idea what that would be in the case of your business, but for some businesses it might be advertising, updating equipment or technology, getting an additional certification, hiring an employee, networking for new business, etc, etc.

**disneysteve** · 01-12-2011, 08:26 AM

Originally posted by Scanner View Post

When I punch the #'s, the property would be "self-sustaining" with my downpayment + partner's downpayment and that' factoring in a 3% home value = cost of repairs per year. In fact, that is what I am saying - mortgage rates and properties are getting so low, you can put 20% down and immediately be turing a profit in rent ( a small one, which is rolled in)

So, no. . .why would I invest in a property with a negative cash flow proposition? And I am estimating a 1 month per year vacancy rate (8.125%?).

How much do you trust the partner? What if he decides he wants out of the deal at some point?

What if your vacancy rate is higher than you estimate? What if a renter trashes the place and it takes a couple of months to do all of the repairs needed to rent it out again?

I'm not saying not to do it - just making sure you are considering all of the "what ifs".

**Scanner** · 01-12-2011, 08:40 AM

How much do you trust the partner?

Very much - good patient of mine and a solid reputation.

What if he decides he wants out of the deal at some point?

We would put exit clauses in our contract - one partner must buy out other within 90 days or the house proceeds to sale.

What if your vacancy rate is higher than you estimate?

Well, that's why we do have a revolving LOC on the house along with rollling extra equity into the mortgage. We would have to of course cover all losses after that.

What if a renter trashes the place and it takes a couple of months to do all of the repairs needed to rent it out again?

The home I believe can be inspected on a monthly basis to see signs of damage, along with prescreening candidates with credit scores and linking the security deposit and credit score to their rent (in other words - charge a premium to someone let's say with a 620 credit score)

SCFR:

You actually probably hit me the most with your post. . .is it really wise to "diversify" my enterpreneural efforts and yes, self-employed needing larger EF's than other people? On one hand, I have amazing security sometimes with my 2 endeavors. . .on the other hand, my business isn't immune to market forces.

I realize the other posters are trying to account for every risk and match it with the reward. . there is no such thing as a riskless venture. . .that's for sure. . .but you raise a good point - would the upside potential of putting 15K into my practice marketing be money better spent?

I am not sure. . .sometimes I just see money being thrown at marketing with no tangible rewards.

Nonetheless, your post deserves meditation on my part.

**littleroc02us** · 01-12-2011, 11:35 AM

Originally posted by Scanner View Post

Okay, I have my monthly expenses on another computer. . .I'll post the breakdown. Yes, I clear $700/month, which I invest in a SEP-IRA now.

Um. . .let's see. . .I know. . .zillow is just a ballpark. Actually, beleive it or not, I think it's worth more since I've done improvements to it (electrical - restored hardwood floors) but I try to estimate conservatively. I think zillow is actually conservative (in this case). But I'll know more when I get an appraisal for a refinance in a month or two. Then I'll have two sources.

I would also keep a HELOC revolving before the emergency yes. . .

Well, the "action plan" is that I don't beleive in just waiting out emergencies and tapping $50,000 of cash like some pundits seem to pundit. IN other words, if I was totally disabled let's say. . .as bitter as a pill it is to swallow, I wouldn't need a 3/4 bedroom house to co-parent kids and I would "retreat" to an efficieny apt. (knock on wood) and either sell or rent it out. I estimate I could rent it for more than the mortgage + taxes + insurance.

I am not sure I agree with just siphoning gobs of cash away, even if I have it.

I am still compiling hte "business plan" for LLC on the property rental but the cash flow should immediately be positive with a 15 year mortgage, by about $200-500/month but I wouldn't see it - it would be rolled into the home equity, especially if we borrowed through an ARM.

I'll see if I can post my monthly breakdown later.

Sounds like a lot of risk. Good luck with that.

**Scanner** · 01-12-2011, 11:57 AM

A lot of what kind of risk?

**bjl584** · 01-12-2011, 12:15 PM

I currently have about 7 months worth of expenses in my EF, and it makes me uneasy. I'm thinking about beefing it up to 1 year's worth. I would say that you should probably have about the same saved up being self employed. It depends on your appetite for risk.

**kork13** · 01-12-2011, 03:16 PM

Scanner, my concern would be in the unknown of vacancy. If you buy the house and can't find renters for 3-6 months, how would you pay the mortgage, HOA (if any), taxes, insurance, and so on? BTW, have you factored insurance into your estimates? I haven't seen mention of it...

Having the partner you trust reduces your risk somewhat, but you can't plan to rely on him if something goes sour. Bottom line: I don't think you have the money YET to go for it. I wouldn't recommend doing it until you can cover AT LEAST 6 months of vacancy without impacting your personal finances--your finances (EF, Roth, home) should be completely separate from the investment property. In fact, since you're looking to use an LLC, it's REQUIRED by law that the LLC (the investment property) stand on its own. If you were to co-mingle your finances with the LLC, if anything ever happened (someone sues the LLC), you would lose the protections of the LLC. (I believe it's called "piercing the veil")

I considered doing the exact same thing a few months ago, and these are all the questions I worked through myself back then. I didn't do it because I didn't quite have the capital to do it without an unacceptable level of risk. Accumulate some more capital for yourself, and plan for the worst. Enter with enough capital to cover your portion of the DP plus at least 6 months' worth of the property's expenses. The LLC needs an EF just as much as you do, in order to cover vacancy, repairs, natural disaster, etc.

**Slug** · 01-13-2011, 06:59 AM

Scanner,

I'm in a similar position to you, and I think it's a risk worth taking. I've been passively looking for about 2 months now. If my 2010 bonus is solid, I'll use it as a down payment IF I can find the right deal. As I noted in a previous thread, I'm only looking in the graduate housing category because of the high occupancy rate and quality of tenant and only looking at condos/townhomes because houses tend to have higher carrying costs. There is definitely risk here, but even with the rise in mortgage rates, you're still in a great position to be cashflow positive and get a decent ROI once the real estate market moves off the bottom.

**littleroc02us** · 01-13-2011, 07:07 AM

Originally posted by Scanner View Post

A lot of what kind of risk?

Vacancy of apartment, no cash reserves set aside specifically for this investment. Heloc is not a viable option. Dumb idea. Home equity isn't real money, it's borrowed upon your house increasing your mortgage. Bad idea. Do I just keep saying it over and over until someone listens. Quit borrowing... Roth IRA's aren't for borrowing except in an emergency.

Enough of an EF for me?