Back to the Fundamentals
This fall, I’ve been teaching the Personal Finance course at Longwood University. I want to equip these 22 undergraduate students with the knowledge, tools, principles, and perspective to win with their finances. To prepare for class, I’ve been going back to the fundamentals and rereading classic books on personal finance, which has had the added bonus of sharpening my own thinking and attitudes about money.
So, what does this have to do with real estate? Well, I’ve often been struck by how closely the essentials of personal finance match what it takes to succeed in real estate investing. Let me walk you through these few, simple principles.
1. Know your numbers. How can you know if you are financially healthy or unhealthy if you don’t actually track and measure those numbers? It is so critical to take ownership over this area of your life. In personal finance, ignorance is not bliss. You can’t bury your head in the sand and hope your finances work themselves out. Use a balance sheet to track your liabilities (what you owe), your assets (what you own), and your net worth (assets minus liabilities). Produce income statements to detail money coming in and money going out over time. In real estate investing, you’d be amazed at how many people really don’t know their numbers. They may have a shoebox of receipts for the accountant and a vague sense of whether they’re making money or losing it, but there’s no tracking or measurement of their numbers to really analyze how their properties are performing. Positive or negative, you must know your cash flow.
2. Set goals and make a plan to achieve them. Once you know your numbers and have an idea of where you want to go, an essential part of the planning process is creating and following a budget. As John Maxwell says, “A budget is telling your money where to go instead of wondering where it went.” In life and in real estate, a thoughtful budget will set you up for success by helping you spend less than you make and save for the future.
3. Avoid excessive debt. Financial guru Dave Ramsey constantly quotes Proverbs 22:7, “The borrower is slave to the lender,” and strongly advises against credit cards, consumer loans, and other forms of debt. To win with money, you want to keep borrowing to a minimum rather than making it a way of life. You can’t borrow your way to true wealth in life or in real estate. While some people use leverage to increase their returns on profitable investments, the problem with excessive debt in real estate is that it gives you almost no room for error or margin of safety and then magnifies your losses on unprofitable investments.
4. Save up for those predictable expenses on the horizon. If you have young kids, you don’t wait and start a college fund the day they turn 18. You can see it coming from far away, so you start to save as early as you can. Real estate is full of far-off but predictable expenses such as replacing a heat pump or repaving a parking lot. Smart investors set up a replacement reserve account to save up for these items. Having the discipline to save along the way prevents a daughter’s wedding or the need for a new roof from becoming a financial crisis.
5. Life happens, so prepare in advance for the unpredictable. Protect yourself from catastrophic losses with insurance, but make sure you know what it does and doesn’t cover. Record rainfall may lead to flooding damage not typically covered by insurance, which many property owners have learned the hard way this year. Create an emergency fund or a rainy-day fund for unexpected expenses, those things insurance doesn’t cover, and disruptions in income. In real estate, that great tenant may go out of business and leave you with a vacant property producing zero income.
6. Assemble a team of trusted advisors to assist you. It’s difficult to go it alone, especially when dealing with the complex areas of investing, legal issues, and taxes. While we’re here, make sure you always consider the impact of taxes on your money. In personal finance, 401ks, IRAs, and Roths are examples of tax-advantaged plans available to individuals. Real estate owners and investors also need to consider the tax implications of their real estate decisions and be informed about strategies that can defer or minimize the impact of taxes.
7. Read the fine print. Don’t sign anything you don’t understand. As Warren Buffett advises, “Never invest in a business you cannot understand.” In real estate, that advice may keep you out of a potentially great investment from time to time, but it will help you more often than it hurts you. If you don’t fully understand both the risks and opportunities of a potential investment, pass.
8. Live within your means. Many people get caught up in the comparison game and lose the ability to decipher want from need. They spend more than they make, run up credit cards, buy more house than they need, and end up in a difficult place financially by trying to keep up with other people. In real estate, you will be tempted to keep up with other investors, which may force you to take on excessive debt, accept more risk than you are comfortable with, and operate outside of your area of expertise. Study the market and learn from others, but let everyone else play their own game while you focus on playing yours. As Jon Acuff once wrote, “Don’t compare your beginning to someone else’s middle.” Run your own race. Invest within your means.
Success in both personal finances and in real estate requires more than just a one-time decision made with a “set it and forget it” attitude. They both require careful attention, wise decision-making, and disciplined action over the long run. Money certainly isn’t everything, but having a good handle on your finances enables you to live and give the way you desire.
About the Author: Billy Hansen, MAI is a commercial real estate appraiser, broker, writer, and teacher serving the Lynchburg and Central Virginia area.
(Originally Published in Lynchburg Business Magazine - December 2018/January 2019)