Anything with the potential to detract from a rental property’s bottomline warrants the undivided attention of passive income investors. There are two potentially devastating “losses,” however, that stand above the rest: credit losses and vacancies. Each of these variables have been responsible for devastating consequences in the rental property community, but that’s neither here nor there to the inexperienced investor. While harmful to one’s bottomline, even new investors can mitigate their exposure to credit loss and vacancies. If for nothing else, a proactive approach can reduce your risk and even tip the scales in your favor.
Credit losses are essentially detractions from a passive income investor’s bottomline. It is worth noting, however, that credit losses are the result of a proactive decision on behalf of the landlord to compensate the renter for any number of reasons. While credit losses hurt a landlord’s ability to make money, they are often a conscious decision to keep the tenant happy. Credit losses are, therefore a good business move for the most part; they are often a costly expense, but nonetheless a necessary one. Either way you look at it, credit losses hurt your bottomline.
Credit losses are exactly what their name implies: credits extended to tenants that reduce profit margins. You see, sometimes it is beneficial to “credit” tenants for any inconveniences they may incur as a result of living in a property. A happy tenant is a paying tenant, are they not?
It is reasonable to assume that landlords will need to make concessions for their tenants every now and then. As a landlord, you may need to credit your tenants for one reason or another. Perhaps they were the unfortunate recipients of some unexpected construction work or a malfunctioning water heater. Whatever the case may be, there are scenarios that call for landlords to credit their tenants, and each of those credits can eat away at profit margins — hence the name credit losses.
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Vacancies are often used to describe unoccupied rental properties, but they represent something much more parlous to landlords: a significant threat that must be avoided at all costs. Generally speaking, vacancies are the single most threatening aspect of investing in rental properties; they are one of the few things that can single handedly derail an investor’s entire exit strategy. An unoccupied property is a non-performing asset; it’s a drain on your savings and a detriment to your overall investing strategy.
The threat of vacancies are compounded when debt obligations are accounted for. You see, it’s bad enough vacancies neglect to result in cash flow, but they simultaneously detract from the bottom line of investors. Lenders don’t care that a property is vacant; they will still expect their loan to be paid in full each month. As a result, landlords are expected to pay the mortgage on their rental property out of their own pocket if they don’t have renters. So not only is the vacancy costing them money, it’s not making them any money either.
Investing in real estate, especially passively over long periods of time, requires an acute attention to detail and a mind for due diligence. Of particular importance, however, is the inherent ability to mitigate risk. Today’s greatest investors already know it, and you should, too: those that can mitigate the highest degree of risk stand to realize the most success as a real estate entrepreneur. Subsequently, proactively accounting for vacancies and credit losses will prepare investors for two of the biggest obstacles associated with rental property investing. After all, what is a great investor, if not a prepared investor?
It is important to note, however, that it’s not only beneficial to avoid both credit losses and vacancies, but also to account for them. In their simplest form, credit losses and vacancies are expenses — expenses that need to be factored into a budget. Credit losses and vacancies are variables of one’s net operating income that are estimated not to be realized. Investors need to factor these things into their budget, at least if they want a realistic picture of what to expect moving forward.
The most accurate way to calculate vacancy and credit losses is to reference historical data. It is possible to uncover vacancy rates for a particular home, but it’s more likely that you’ll find vacancy rates for the neighborhood, in general. In other words, you may not be able to find the historical data on your own home, but there’s a better than good chance data exists for similar homes in the area, otherwise known as comparables.
If, however, you can’t find the information on your own, try calling a local property manager for some insight. Don’t hesitate to ask them the numbers they are seeing for vacancies and credit losses in the surrounding neighborhoods. That’s not to say their information should be taken as gospel, but it should give you a better idea of what to expect. And, as always, be sure to cross-reference the information you receive. Do some research of your own to confirm your findings.
You could also inquire with the local real estate investment club. You would be surprised to learn that many investors are willing and able to share said information without expecting anything in return. Again, confirm your findings with your own research, but their data should give you a good idea about what to expect from vacancies and credit losses in your area.
Vacancies and credit losses are a passive income investor’s worst nightmare. Both of them have the very real possibility of detracting from the bottom line of even great investors; there’s almost no avoiding them. That said, the best thing you can do is counteract them with a proactive action plan. That’s not to say they will impact your own property, but it never hurts to be prepared. It’s those investors, after all, that expect the unexpected who will find their rental properties producing positive cash flow more often than not.