How Much Money Should Be in Your Reserve Fund? Expert Investors Weigh In
“I’m not worried about a recession—people will ALWAYS need a place to live!”
How many times have we heard some variation of this phrase? Frankly, how many times have we said it ourselves?
Real estate is supposed to be the “safe” investment because people will always need a place to live. Yes, but will people always have a way to pay?
In these unprecedented times, we’re learning that no, they may NOT always have the ability to pay their rent, due to circumstances far outside their control—and yours.
You need to protect your investment the only way you can—with very healthy reserves.
You NEED a Reserve Fund
As the Community Manager for BiggerPockets, I’m in the Forums all day, every day. I see comments from people with all points of view. Mostly these comments are encouraging. Other times, they’re a little too much.
On the BiggerPockets Money Podcast, I preach the importance of caution, frugality, and savings. These are especially true in real estate investing.
As we are now seeing, reserve funds are important.
Tenants are losing their jobs, and some will be unable to pay their rent. Some tenants who resent their landlords are organizing rent strikes—even when they do have the ability to pay.
While mortgages backed by the federal government have a moratorium on foreclosures, your credit score still takes a hit if you don’t make a payment. And not making payments now will have a HUGE effect on your ability to obtain future mortgages.
How Much Do You REALLY Need in Your Reserve Fund?
Banks will typically require six months of reserves for investment purchases. This is what Brandon Turner recommends, as well as most everyone else I know.
When Scott Trench, my co-host on the BiggerPockets Money Podcast, first purchased his duplex, he put $10,000 into a reserve fund that he never touched—ever. He had a good-paying job with excellent prospects, was living in half of the property while renting out the other half, AND rented out a bedroom in his half of the duplex on top of that.
Scott qualified for the entire mortgage payment on his own, meaning he didn't use any potential rents received to help him get approved for the loan.
His monthly mortgage payment was $1,550. He rented each half out for $1,100. On his half, he rented a room to his friend for $550 and paid an additional $550 himself, plus all utilities.
Every month he was basically banking the portion he personally paid, adding to his reserves.
How Many Months of Reserves Do You Have?
I posted a poll in the Forums late last week, asking BiggerPockets members how many months of reserves they have set aside. I qualified reserves as “the total dollar amount you would have to pay out of pocket if your tenant paid nothing.”
So not accounting for vacancy and CapEx, how many months can you cover 100 percent of expenses?
I was quite surprised by the answers.
When divided up into 0-3 months, 4-6 months, 7-9 months and 9+ months of reserves, respondents were fairly evenly divided across the board.
While this is fantastic news, I’m wondering if those with less-than-adequate reserve funds are simply not responding?
Anthony Wick shared my concern—and offered up some comforting words, too!
“I will be curious if people that are strapped will respond. While this is a great reminder to have reserves, we must remember to support those that are just starting out, like we once did. I certainly didn’t always have months and months of reserves, and the idea of 50% vacancy or tenants not paying would have been quite nerve racking.
“So, if you don’t have months of reserves, you can still get through the hard times! Things like self-managing and YouTube fixit videos are your friends!”
Anish Tolia suggested that the size of your portfolio and your breakeven point should dictate your reserves, too.
“I think it depends on the size of the portfolio. If you only have one or two, then 6 months for each is reasonable. If you have 50, I don’t think you would need 6 months for each unit, because the chances of all being vacant for 6 months at the same time is vanishingly small… at least before the coronavirus hit! Another way to look at a bigger portfolio is your breakeven occupancy rate. If say your breakeven occupancy is 50%, you are pretty safe. If it’s 95%, you need a lot of reserves.”
Whitney Hutten goes even further and also recommends having insurance deductibles in that reserve fund.
“I keep 6 months all hard costs (PITI) + all of my insurance deductibles in an account (then additional reserves as well). The odds of all my properties going vacant and having an insurance claim against them is astronomically high… I know.
“I know what it is like to live paycheck to paycheck and have a disaster hit. It’s scary times! When it happened to us in 2008, we actually were too ‘naive’ to be scared crapless (when we should have been). Now, my reserves might be a little on the heavy side, however, I sleep very well at night.”
Re-evaluating After Coronavirus
Sean McDonnell thought he had a good plan with 3 months of reserves—but is now re-evaluating his position.
“With no rental income, we have enough reserves to cover ourselves for 3 months. Before this epidemic, I thought that would be good enough and was comfortable with that. This has definitely changed my mindset and made me re-evaluate my business structure. After the dust settles, I will be saving hard and will try to not ever go below 6 months’ worth of payments in my reserves.”
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The Bottom Line
This article isn’t meant to make you panic, it’s aimed to get you to think about your reserve fund. Having deep reserves will help you through these uncharted times. If you haven’t started investing yet, now is a GREAT time to be building up your reserve fund.
But if you already own property and have low reserves, start thinking about how you can cut expenses without cutting services and provisions to your tenants, so you can grow your reserve fund and help weather these tough times.
What do you think is an appropriate amount to set aside in a reserve fund?
Join the discussion in the comment section below.