How much reserves should I keep?

Question

I am looking at purchasing 3 duplexes, but the 20% downpayment is going to eat up all of my current capital. These will be my first deals.  My wife and I are currently employed and have large savings. Should I pass on one of the duplexes to save some capital or purchase all 3 to capitalize on these deals? All 3 have been recently renovated and would cash flow almost 2k a month according to the bigger pockets calculator.

Nathan Gesner · Answer

This is not an exact science. It depends on your financial strength, the quality of the property, how many properties you own, etc.

I like to start with one major expense and three months of vacancy. Imagine if you had one single-family home. The tenant fails to pay their last month's rent and leaves the place needing new flooring and paint. It will take two months to turn it around and get it rented. That's three months of mortgage and utilities, the cost of flooring, and the cost of painting. That's a pretty common scenario and could cost you $10,000 - $15,000 so that would be a good starting point for your reserve.

But there's more!

What if you're a cardiologist with no debt and making $250,000 a year? You could probably afford $20,000 without much impact on your personal budget. If you're a single mom with student loans, a car payment, and living paycheck-to-paycheck, then $20,000 would be devastating and a reserve is critical.

What if you have an apartment complex with 20 units? Do you save three months of vacancy for each unit and $50,000 for the roof replacement? That would be around $90,000 sitting in a savings account! At this point, I would recommend having a line of credit to cover these things so you don't have money sitting in the bank doing nothing when it could be put to work.

I have 33 units, no debt except for mortgages, and excellent income. I can pay for all my problems using the cashflow from my current rentals. I also have a $175,000 line of credit at the ready if something catastrophic happened. A reserve is unnecessary, but I still keep around $15,000 - $20,000 in my account.

The point is, you should sit down and assess your personal finances to determine what the worst-case scenario may look like, how much you would need to cover it without impacting your life, and whether you will need to build a reserve.

Frank Avallone II · Answer

Hi JonPaul, this usually comes down to personal preference. I know some bigger investors that will say they prefer to deploy all their money as doing so makes more money quickly. Personally just for peace of mind I like to actually keep a 6 month reserve for each multi family I buy (I know this is the slower way to scale). Now doing this for the past 5 years, there has definitely been times that unexpected costs or vacancies come up. If these occur and you have no money to fix them.. it may cause problems. Now another factor is income outside of the investing. If you and your wife have jobs with good, almost "guaranteed" income, then maybe you can get away with it and quickly save up after the initial investments. Another factor is truthfully your network and family. If one of these unexpected costs or even vacancies come up could you turn to someone for help? I'm very curious to see other investors opinions as well!

Andrew Garcia · Answer

@JonPaul Kessinger, I would talk to them about the other two as well. That way, they can tell you if you have enough reserves for their guidelines.

Frank Avallone II · Answer

and these are all in West Virginia? I would speak to the lender about the entire plan.

JonPaul Kessinger · Answer

I am talking with a local lender from a community bank about the first one. But I haven't spoken to him about the other two because I wasn't sure if I wanted to be in a spot where I did not have any reserves. I have added closing costs into my total cash needed for the down payment. @Andrew Garcia

JonPaul Kessinger · Answer

I haven't gotten the letter let, the first duplex I am working on getting is a pocket listing. My old boss is selling his house and it has an additional unit on it. But he isn't moving out until mid-July or August. So after talking to my lender he thought it would be best to wait a month until I get it so it doesn't expire halfway through the deal. @Frank Avallone II

Frank Avallone II · Answer

ahh darn. Might not make too much sense to do that then. Have you gotten some sort of pre-approval from a lender yet for these deals? I am a lender myself but I am not currently licensed in WV where I believe your profile says. Is this where the properties are located?

Andrew Garcia · Answer

Hi @JonPaul Kessinger, you also have to factor in closing costs. Most lenders will require 6 months of reserves + closing costs in order to give you a loan. Check with the lender and see if you have enough assets to buy all 3.

Let me know if I can be of any assistance.

Frank Avallone II · Answer

Glad to hear that you guys have the support in place! This should definitely make things a little less risky. I'm assuming you meant lower the down payment right? What is your current living situation if you don't mine me asking? Only reason I ask is because if you guys were living with family or renting for example then maybe you can temporarily live in one of these properties as an owner occupier. Then from a lending perspective, the one you guys move into wouldn't be considered an investment property and you can put as little as 3.5% down. You probably have heard of this as "house hacking" in other forums. It's a great way to get started and lessen the cash exposure initially.

How much reserves should I keep?

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