Real estate assets offer investors several class-specific advantages, including arguably unmatched tax benefits, the potential for a countercyclical resistance to economic downturns, and regular income from tenant rents. This is in addition to the potential appreciation gains offered by real property investment. However, as Uncle Ben so wisely declared in the excellent 2000s-era Tobey McGuire Spider-Man films: “With great power comes great responsibility.”
When investors choose to deploy capital in real estate assets, and especially when those assets are under their direct management- like with a self-managed rental property, the need for adequate financial reserves is unquestionable. It’s your responsibility to account for the unknowns-Acts of God-even if those rainy days never come. This is in stark contrast to your traditional equities or mutual fund investor, whose initial due diligence duties end the moment they decide to purchase a security-aside from high-level activist investors, guys like Bill Ackman, Michael Burry, etc.
Areas of Focus When Maintaining and Protecting Your Single Family Residential Assets
Like we mentioned above, most equity investments are “set it and forget it.” Your great-grandmother could have bought some Coca-Cola stock early in the last century, and your family’s only responsibility would be cashing the annual dividend checks and keeping track of which broker is holding the stock. Compare that to inheriting a portfolio of single-family rental homes, where you’re legally and financially responsible for several different areas of focus in keeping that asset running smoothly and generating income. Some of these areas include:
Regular maintenance is less an Act of God than a fact of life in the property business. Still, as a property owner, you will see situations where you might be tempted to dip into reserves for regular maintenance or maintenance above and beyond typical line items. For instance, if a tenant gets an unsanctioned pet that destroys a property can cause unforeseen financial headaches. If you own a share of General Electric stock and they have a plant failure somewhere in the Midwest, you’re not going to be liable past your potential losses from share values dropping. This is not the case with directly managed real estate.
Another area of concern where reserves may need to be utilized is with vacancy issues. Imagine you own a portfolio of 30 single-family properties, and you’ve got one or two homes that are just unrentable for whatever reason- poor lighting, loud noises, traffic, or just plain bad luck are causing those properties to remain empty. Regardless of the reason for the vacancy, you’re on the hook financially. Your fixed costs remain the same. You’ll still have to pay utilities, lenders, staff, etc. While most financial models take a less than 100% vacancy rate into consideration as a matter of course, you’ll want to have reserves handy.
Natural and Man Made Disasters
Even if you’ve got an uncanny ability to pick the perfect tenants and the world-class marketing proficiency to ensure your properties remain fully leased up, you’ll always have to contend with events beyond your control. This includes financial burdens caused by natural disasters like earthquakes, hurricanes, tornadoes, etc., as well as man made crises like a global recession or other similarly stormy economic waters. Take our current COVID-19 issues, for example. Government assistance is spotty at best, and property owners and landlords without sufficient capital reserves are feeling a pretty pronounced pinch right now. Conversely, well-capitalized outfits with the ability to ride out this storm may find themselves in an incredibly favorable position after things calm down. Just ask any of the firms who realized incredible gains in the years following The Great Recession and the property market crash in ’08.
The Break Down
The Roman philosopher Seneca once remarked: “Luck is what happens when preparation meets opportunity.” Part of your preparation as a real estate investor includes taking steps to defend your wealth against all eventualities and account for the unknown. It’s also a fact that tenants have lives, and they live their lives in your properties. Issues are likely to occur even in the best of times. Like single-family or multifamily properties, residential real estate offers more stability than many other real estate classes and sectors. This is demonstrated by the current troubles in retail, real estate, and other commercial properties, which are suffering mightily from the ongoing Covid-19 pandemic and related economic effects. People can live without going to the movie theater or out to eat, but they’ve always got to have a place to live, pandemic or no pandemic.