First property- budget/cushion for unexpected repairs?

Question

Hi all,

I'm looking at getting my first property, but a big concern for me is unexpected expenses in the short term. What would you recommend as a cash cushion for unexpected expenses/repairs in the first year or so of owning a rental property (3/2 SFR)? I know that often maintenance/repair costs are baked into ongoing cashflow analyses and proceeds from rent should go to an expected maintenance fund. Playing the percentages/estimates likely works out well once you've got some momentum and have some cash flow, but getting off the ground is a different beast. Say you've just purchased your first home-- you've drained a good chunk of your cash reserves and have yet to collect much in the way of rent. You're maintenance fund from rent might be a couple hundred bucks 3 months in. But problems don't happen linearly, they happen when they happen. Worst case scenario (and I've read enough stories to know it happens) you just bought a house and Murphy strikes with his best shot to bankrupt you....what's a reasonable emergency fund to cover most of what he'll throw at me without rendering me illiquid? Obviously there comes a point where you can't cover all possible contingencies, but what amount would you recommend having set aside before getting in the game to play it safe?

I ask because I don't have experience yet and don't know what surprises may or may not lay in wait for me, and some of you might have experienced some of the unlikely but horrible situations I'm worried about.

I appreciate whatever insight you have to offer.

Scott Thompson · Answer

Justin,

Right, but my point is that this works as an ongoing strategy, but not as a liftoff strategy. If you save 53.33/mo and your HVAC breaks in month two, you've got ~$100 in your maintenance fund and are facing a $3200 repair cost. For liftoff, as I say, or for getting your first property, having an already built up emergency fund in place up front is surely essential to maintaining liquidity in the short term until these monthly contributions to a maintenance fund amounts to anything. So I'm trying to learn from experienced investors what you think is a reasonable cash cushion for liftoff to prevent a quick crash due to untimely repair needs before monthly cash flow builds up a maint fund. Is $3000 enough? Nowhere close? Assuming for a 3br/2b SFR.

Thoughts?

Gary Wong · Answer

Personally, I would have $3000 to $5000 save up but have credit reserve up to $10k. Just a new credit card with 0% interest for 18 months should give me a peace of mind if anything big happens.

Scott Thompson · Answer

Michael,

Thanks for the input. Obviously getting a thorough inspection should uncover the likelihood of some repairs and provide somewhat of an estimate of the timeline for the major ones (HVAC, roofing, etc.). But you hit the nail on the head with the running toilet/stuck window/failed appliance examples. The small things that might get missed in inspections/walkthroughs but become an issue shortly after closing. I don't plan on starting with a shoestring budget necessarily, which is why I'm posing this question. I want to be reasonably prepared. However, I'm still pretty young and don't have a ton of cash reserves built up yet. I don't want to stretch myself to thin and end up over a barrel shortly after closing on my first property. I'd rather wait a little bit longer and be reasonably prepared. But I'm trying to get a better picture of what that should look like. Just trying to read through the text, it sounds like you are saying $3-5k is probably ballpark, but maybe a little on the low side. So maybe shoot for more like $5-7k?

Michael Boyer · Answer

Scott, I think you are on track about the short term acquisition expenses and what you might think of as initial costs associated with occupancy stabilization of the property. It is not on a scale you would have with an apartment complex and trying to get it rented up and all cap ex addressed, but it can still exists on for sf rental..

That is, you understand there will be more predictable income and expenses once you are a going concern ( your expected occupancy rate and associated monthly set asides for maintenance and repairs, and CAP EX) but you want to know about how much you may pay to "get the ball rolling".

I think it depends.

If you buy a distressed property, even a SF, you are going to have to tend to deferred maintenance and CAP EX. So you have up front costs. Your inspection report can help get you an idea about these and a contractor visit and estimates up front might be prudent if you are buying a fixxer. Here I would have reserves in place to cover even major issues related to HVAC, plumbing, etc. Probably more of a 10K-20K reserves scenario if you buy a fixxer or much older property.

But even a rental with just cosmetic problems will have odds and ends to tend to , be it a running toilet, failed appliance, stuck window, etc. Then I would look even renewing some common wear points, like you would in any turn over if the items are aged, before renting it out.

Ideally, you can get the seller to fix as many things as possible, but it depends on the market...

With a 3/2 in Dallas that is in fairly good condition (no structural issues) and well maintained, I think your 3-5K reserves could get you going provided your roof, HVAC ( key in TX) plumbing, appliances and major systems have some useful life left. That said, just in case, if you are starting on a shoestring, having access to emergency credit or personal funds that can keep you rental afloat in a worst case scenario can help you sleep at night...... Best of luck

Justin Fox · Answer

All you can do is just take the end of life term of each system and subtract the current age.  Price out the cost of replacement, do the math and save accordingly.

So if you have a 5 year old HVAC and you think it will need heavy repairs or even replacement year 10 and costs ~3200 bucks.  Save 53.33/mo for down the road.  Same for roof, water heater, applicances and etc.  When stuff is repaired or replaced, you can adjust your numbers if you want to.

In reality all these funds are going to do is soften the blow.  Like you said, nothing happens when you want/expect it to.