Investing in rental properties can be a smart way to build long-term wealth, but it’s not a decision to make lightly. Buying an investment property is a major financial commitment that requires careful planning and preparation.

41-year-old Isaiah was thinking about purchasing his first investment property and wanted to assess his financial readiness. Here are some of the key factors to consider, based on Isaiah’s situation:

Aim to Have 1-2 Years of Liquid Savings

Isaiah has an Lt score of 1.2, which is over one year’s worth of living expenses saved in accessible cash and investments. This is a great starting point, but aiming to get the Lt score closer to a 2 will allow you to have more flexibility after the real estate is purchased.

Note that the bulk of Isiah’s liquid assets (80%) are held in the cash value of a whole life insurance policy. While this provides some accessible funds, it’s not the most efficient way to build liquidity for real estate investing.

Whole life insurance policies blend life insurance with an investment component, but often come with high fees and commissions that eat into returns. The cash value can be borrowed against, but it’s not as readily accessible as a savings or brokerage account.

Building up liquid reserves in a high-yield savings account or after-tax investment account is typically recommended. That way, you have penalty-free access to your funds for a downpayment and any unexpected costs like emergency repairs or prolonged vacancies.

Make Sure You’re on Track with Retirement Savings

In addition to his liquid funds, Isaiah has at Qt score of 1.2 (which is 1.2 years of expenses saved in retirement accounts). Ideally, the money in this account is to be used for retirement, not real estate, so you want to balance how much you build up in the Qt bucket with how much you put into liquid and even real estate assets.

An Emergency Fund Only for Rental Properties

There are a ton of unexpected costs when it comes to real estate investing; a market downturn, a myriad of maintenance and repair costs, or even finding good renters. Because of the unexpected costs, aim to have at least 3-6 months of property expenses saved up in addition to your personal emergency fund. That bigger cash buffer makes it less likely an emergency or market shift will derail your investing plans.

It’s also important to remember that tying up a large chunk of money in a down payment means you lose liquidity and flexibility with those funds. It is not easy to sell your rental to get the cash back out of it, which means you need to be ready to not have that cash on hand after you’ve made your purchase.

If you have ample liquid reserves both personally and for your real estate ventures, you won’t be forced to make short-sighted decisions if unexpected expenses arise with the property or in your personal life.

Don’t Forget to Factor in Time and Energy

Many new real estate investors underestimate the significant time and energy it takes to manage rental properties. Being a landlord is not passive income – it can be a part-time job.

You’ll need to market your property, thoroughly screen prospective tenants, and deal with any issues that arise, from clogged toilets to broken leases. If a tenant stops paying rent, the eviction process can be lengthy and expensive. You’re on call 24/7 for emergencies.

While you can hire a property management company to handle the day-to-day operations, that will cut into your profits. Expect to put in plenty of sweat equity, especially in the beginning. Make sure you have the availability and bandwidth to take on this new side hustle before moving forward.

The keys to smart real estate investing are preparation and patience. Focus first on making sure you’re in a solid position with retirement savings and on building up several years’ worth of expenses in accessible accounts. Then start learning the ropes of how to evaluate and finance investment properties as well as maintain the properties over time.

When you build your investing strategy on a foundation of financial stability, you’re much more likely to weather the ups and downs and come out ahead over the long term.

Considering an investment property purchase and wondering if you’re ready? Book a free 30-minute consultation to review your numbers with an expert and get personalized advice.