Get Your Finances in Order
This is Part 4 of a series on how to get started in real estate. Each new installment will be a bite-sized tutorial gleaned from 30 years of investing experience. The goal is to remove as much doubt and fear as possible, so you’ll begin, or continue, the process of creating enough passive income to change your life. If you missed previous posts, you may access them at www.richdoctor.com
Now you’ve nailed down your strategy, picked a market and assembled a team.
You’re ready to find deal and buy something!
One of the first things you should do before you make that first offer is to make sure you have what it takes to buy it!
You either need the cash to make the purchase, or the balance sheet to support the loan. It’s not likely, that you will use cash, nor is it recommended. So, you will want to make sure your own financial house is in order before you make an offer on a property.
Know Your Own Finances
If you’ve followed time-honored success principals, you likely have goals that you wish to reach. One or more of those goals are usually financial.
The crazy thing about chasing goals is, to get where you’re going, you must know where you’re starting. You must determine your financial starting point.
You must know your personal and business finances.
The first reason to get a handle on your finances is to plug leaks and create as much investment capital as possible. This is “Success 101.”
While not required, I suggest software such as Quicken or a double-entry program like Quickbooks. Either program will help you track your income and expenses and will allow you to break them into categories of your choice.
This allows you to see the real numbers, which is important, because numbers don’t lie. You must be honest with yourself during this process to give you a true financial starting point. Once you know where your money is coming from, and where it is going, you can adjust as needed.
Create a budget
This is often boring and very “Dave Ramsey.” However, Dave teaches this for a reason. Your empire building will stall if you don’t complete this step. You must know where you need capital and where it comes from. A budget will help you do that.
Based on what your spending habits are, try to map out what it will cost to pay for your basic living expenses. This includes mortgage, utilities, taxes, insurance, food, kids’ school, clothing, travel, etc.
Once you total those numbers, you can compare them to your income. Any funds not needed for the budget can be used for investment.
If there is too little left over, (or if there is a negative number), you can look for places to decrease expenses or increase revenue. The numbers will tell you where the holes are.
The goal is to increase the investment capital.
Financial Statement
Once you’ve created income and expense categories, and that has been aggregated into a budget, I suggest you create a personal financial statement (PFS).
The components of the financial statement are the Income Statement and the Balance Sheet. The Income Statement tracks your income and expenses, and the Balance Sheet tracks your Net Worth. The PFS will tell you in black and white if you’re making progress or losing ground financially.
Sometimes an add-on to the PFS is the Statement of Cash Flows. This document is specific to income and expenses. Though it mirrors to some degree the Income Statement, it is a bare bones version of “what I make and what I must spend to live.” Many lenders like to see a Statement of Cash Flows.
The PFS can be created by you, your bookkeeper, or your CPA, though I suggest you understand the components before passing the duties on to someone else. There is a user-friendly PFS available at www.richdoctor.com/tools.
Be a Good Borrower
The reason you go to the trouble to create a budget and a financial statement is primarily to know your financial situation, but it also helps you look good to your lenders. You want them to like you as a borrower.
The first thing to know is that bankers are not entrepreneurs. (That’s why they’re bankers!)
While the rare one will loosely understand what you do, most will have no clue. What they want is surety of payback when they give you a loan. They use several parameters, and they want you to fit in their box.
Now that you’ve painstakingly created your PFS, much of the information they need is at your fingertips.
If you are buying a property, they often want to make sure you have the Net Worth equal to, or greater than the value of the property. If you have a Net Worth of $1 million and you want to buy a $5 million property, you might have trouble qualifying without some partners. The bank wants collateral.
They also want to make sure you have the liquidity (cash) to handle problems with the property. This sometimes equates to 10% of the loan they are giving you. That $5 million property might require a $4 million loan. They might want to see $400,000 of cash or cash equivalents in your name.
Banks look at credit scores. In general, you need a credit score over 680 to qualify for a conventional loan. Over 740 will get you better interest rates and terms.
Keep an eye on your credit score. I had a great credit score until I co-signed a student loan for a relative. He missed one payment and I got hit on my credit report. It took seven years for it to recover! Keep that in mind if someone asks you to co-sign a loan!
Lenders like to see a track record. However, everybody starts somewhere. If it is your first real estate purchase, they might give you your first loan, or you might need to enlist some experienced partners. Options are there.
Be prepared to provide at least two years of personal and business tax returns. They always ask. I produce mine multiple times per year and it’s currently about 30 tax returns. It helps to have a system to access those files!
Summary
It’s much more exciting to source deals and tour properties than it is to tighten up your finances.
It’s also more fun to play than it is to practice, but the best athletes spend more time practicing than they do playing. This gives them the foundation to perform when it’s game time.
Buying a property is “game time” for you. If you get your finances in order before you find a property, you will be ahead of the competition, and ready to win the game.
Every deal you do will require most of what was discussed above. It’s boring and must be updated, but if you have your house in order, you will know what you can buy, it will be easier to get loans, and you might get better terms.
Getting your finances in order eliminates one hurdle and allows you to concentrate on purchasing cash flowing assets, which is what will get you to your goal!
To your success!
Tom
