For many investors getting into property a driving goal is to replace income from a job, either for retirement or to get out of the “rat race”. To do this, many courses teach delegates to identify their “financial freedom” figure, in other words, the amount of money needed to cover basic living expenses. The idea being that once this figure is achieved through rental income, the delegate is free to leave their job, and focus full time on property, benefitting from a “passive income” from rental payments.
Structured properly this can be a great way of achieving long term financial security. I would add a caveat though. Before rushing to leave a job, it’s important to build up a contingency fund to cover any unforeseen costs that may come up. With property, costs can be considerable, so a contingency is vital. Without a decent reserve of funds you run the risk of not being able to carry out an essential repair. This can then mean that the property is not rentable and ends up costing money, as the mortgage and running costs still need to be paid.
If the property is not in rentable condition, it’s then the condition can quickly deteriorate further, as an empty property is more prone to damage through damp, mould or break-ins. Without the contingency funds to bring it back to rentable condition, it’s easy to become a distressed seller. If the condition has deteriorated, then the property may also be worth less than it was previously valued at, meaning that it would sell at a loss.
So how to avoid these loss making scenarios? One thing we do to ensure that funds are always available for essential repairs is to ringfence 10% of the rental income every month in a separate bank account, earmarked for property repairs. This should usually suffice, however on lower value properties with a low rental income it is a good idea to have a larger backup savings pot. When something major comes up, like a roof repair there have to be the resources available to cover it.
Income from a job can be helpful while building up the contingency pot. It can also be a vital backup if there is an issue with a tenancy, and the tenant stops paying rent. It can take a long time to end the tenancy, and in addition to covering court costs or lost rent, funds may be needed for rubbish removal and redecoration to get the property back onto the rental market. In the early stages of investing, that earned income is a safety net.
None of this is meant to scare any novice or would-be investors. If you plan for the worst, most likely it will never happen, and then a surplus from a contingency pot can be used for a well deserved holiday!
(Please note, this is not meant as financial advice, simply sharing tips based on my personal experience.)