Real Estate – Where Does All The Money Go?
By Amanda Cruise
If you’ve ever heard a would-be real estate investor talking about real estate investing, it might sound something like this: “I should buy a rental property. The mortgage on a nearby house would be $2000 per month and the rent is $2200 per month so I’d be making $200 each month.”
Most of the time when I hear this I try to (compassionately) let them down easy on how real estate investing cash flow really works. Speaking of the way cash flow works, here’s a rundown of where the cash goes and in what priority.
1. Mortgage/Debt
The bank gets paid first. They are always in first position. That means if everything goes south, the bank will take any money, the asset itself, etc. to recoup their money.
In our case, we personally guarantee bank loans, so if things went terribly wrong, the bank would take our retirement accounts, other assets, etc. This is one of the many reasons we have to REALLY believe in the real estate deals we take down!
After the bank, any other loans such as to debt investors are paid.
2. Expenses
While land generally has no ongoing expenses except taxes, the real estate on that land certainly has expenses. Repairs such as roofs and leaking water lines, manager salary, insurance, taxes, ongoing maintenance, electrical for street lights, turnover costs in between tenants, etc. You get the picture. These are all part of the cost of doing business.
3. Reserves
Some expenses don’t occur predictably each month such as repaving a road, replacing a roof, repairing/replacing an HVAC, and repairing a septic system that broke. Money has to be set aside to account for the expenses that, while they haven’t happened yet, we know will come.
4. Equity Investors
Once debt is paid, expenses are paid, and the reserves are accounted for, the next money goes to any equity investors.
I’ve written a handful of times about the difference between debt investors and equity investors. There are certainly merits to each. One of the positives for debt investors is they are paid first (up there in position #1 with debt) whereas equity investors are paid here in position #4.
5. Managing Partners
With any money remaining after positions 1-4 are paid, the managing partners of the asset then get paid. There is a reason we as managing partners are paid last. It’s one of the incentives to ensure the asset is managed well.
As always, I love talking about this stuff. Please reach out if you have any questions. Amanda@VoyageInvesting.com and if you’re looking for ways to put your money to work passively, make sure you join our Investor Circle.