The Sominex Account
Posted @ 6:08 pm - Filed under Cool Info, Financial Planning, Purposeful Planning, Real Estate Investing
Investing in real estate without significant cash reserves is, shall we say, not recommended. An investor without reserves might as well send an engraved invitation to Murphy to come over and party. You’d think real estate investors would include this ingredient in their plans. The paradox I’ve observed so many times is that investors love that I insist upon it, but they’ve never incorporated it in their own planning.
The importance of a generous cash reserve cannot be overstated. I simply will not work with an investor who won’t set aside adequate reserves. It’s only happens rarely, but if they’re not willing to do so, I won’t take them on as clients. Period.
I’m talking about real reserves. CASH reserves. Enough to allow child-like sleep nightly. The rare exception to this rule in fact isn’t an exception. If your day job income is so abundant that your after tax savings are mind boggling, reserves might not matter in your case. I currently have a client who is a good example. He earns $3-400,000 after tax yearly. Since his investments up until now number only two properties, the worst case scenario would be to have both of them vacant for say three months. This would result in a negative cash flow equiailent of about 8-10 days of take home pay. In other words, he an handle this in stride.
The rule of thumb — have enough cash in your Sominex account to sleep like a kitten no matter what happens.
However, he’s about to pull the trigger on a tax deferred exchange, using both properties. This will result in the acquisition of roughly 6-8 properties. Though the numbers will show each property will break even or better, he’ll hear from me that relying on a break even analysis is folly. Murphy is alive and knows where he lives. Have you ever heard O’Toole’s corolarry to Murphy’s Law? He said, “Murphy was an optimist.”
Before we even begin the exchange process he and I will discuss in depth what could go wrong during his holding period. Having 6-8 properties now begins to have a real affect on your sleep patterns even if you’re making the money he is. Using the worst case scenario again, Murphy could cost him nearly a month’s take home pay. I will insist he set aside a cash reserve account of no less than $35-50,000 BEFORE we even begin selling his properties. This account will be used for the expressed purpose of securing those investments when Murphy decides it’s his turn in the barrel. And make no mistake — at some point in your investment life, it will be your turn.
My time in the business has allowed me to weather the ‘74-75 recession, the terrible runaway inflation which immediately followed, which resulted in interest rates sounding more like shoe sizes for NBA players. That was followed by the late ‘79 through ‘83 so-called recovery. I still remember being grateful that a client who was in love with a seven unit building was able to secure an 11.75% loan! Nirvana was just around the corner. 
Then after the late ’80’s run-up came the double-barreled shotgun-ambush of the early ’90’s. Not only did San Diego get hit by the S & L crisis, but simultaneously lost a couple of the largest employers in the entire region.
In over 30 years I’ve only had two clients have serious problems with their investments. Both dipped into their reserves for non-emergency items. (One was for the new kitchen the wife ‘had to have’.) In both instances I was kept out of the loop until it was too late. They knew what my response would be.
A generous reserve account is not merely an option. In no way is it a luxury. How long can you go without sleep?
This entry was posted on Wednesday, December 27th, 2006 at 6:08 pm and is filed under Cool Info, Financial Planning, Purposeful Planning, Real Estate Investing. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
(I’m pretty sure his employer doesn’t just give him the money for showing up)