How do you pay for items on a rental if no rental segregated savings yet?

Question

Let's say I'm looking to start renting primary residence in April. Driveway needs redone. Renters move in. Rent covers mortgage + $1000/month. Driveway cost $6k. I wouldnt have enough in my rental designated bank account to cover driveway project until 6 months from start of renting. How do you pay for things like this earlier than waiting for cash flow accumulation in a way that is most advantageous for tax/write off items?

Also - let's say the tenant doesn't pay rent in time prior to when mortgage is due and you dont have enough in the rental designated bank account, how would you cover? Everything I read says not to co-mingle personal funds with it, but you cant wait until rent hits...

Thanks!

Nathan Gesner · Answer

Welcome to the BiggerPockets forums!

It is common for new investors to spend their last dime to buy a property, which is a big mistake. Any time you buy real estate, you should have funds in reserve to handle surprises. How much? That's a good question and I appreciate you asking! ;)

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.

Eliott Elias · Answer

Do the driveway when you build the cash up, or don't do it at all. Will it inhibit your ability to rent the property out?

Alex L. · Answer

Typically I BRRRR any property that I purchase, but if I were in your situation, I'd simply use whatever cashflow is available to take care of any immediate needs, or to pay myself back for paying out-of-pocket for them prior to renting the place (i.e. leaking plumbing, damaged stairs). Things like the driveway, or old aluminum windows, I'd simply deal with once the maintenance fund has enough in it to warrant it. So, that might mean living with a not-so-great driveway or ugly outdated windows for a while, but oh well. If it works, and isn't causing a potential risk/hazard, then it's cosmetic and can wait.

Theresa Harris · Answer

Use money from your regular bank account.  You need to have money set aside before starting to cover unexpected expenses.  Even with inspections, surprises happen (plumbing, vacancy, etc).

Any regular expenses (current expenses-repair leaky faucet) get claimed on your taxes.  If you do improvements (ie replace carpet with wooden floors-capital expenses), they get claimed when you sell.  I think the rules are similar in the US (I'm in Canada).