Reserves - How much cushion do you need?
Rental Property Investor · Andover, MA · Member since 2017 · 126 posts · 67 votes
Hi All,
My goal is to purchase a multi family rental in 2018 and house hack it. I'm curious to know how much you all budgeted for reserves when you purchased your first deal? Would you take your 401k into consideration?
Dan
Your reserves should be 6 months of PITI per investment property. Reserves can be stock, bonds, cash and yes up to 50% of your 401k in most cases.
Reserves is not your HELOC or Credit Cards like several foolish investors tell me. Those things are "credit" and credit can be frozen when markets get messy re: 2007-2008.
Good luck.
Daniel Ortiz
I’d figure $10k for immediate reserves. Rent should be deposited in same account and mortgage/expenses paid from same account.
Maybe your 401k would count as a backup but it is significantly less liquid and obviously would incur penalties and taxes if you liquidate it. Banks, however, do consider your 401k as reserves, which can help you qualify for a loan.
Hey Kyle,
Are you suggesting that when you open a new bank account for your property, you transfer all of your reserves for that property to that account, and then use that same account to accumulate rent deposits and to pay mortgage/expenses?
Dan
Yes, pretty much. Just make sure the balance stays at $10K (or ideally above $10K if you are cash flowing positive). Ideally this account would kind of operate on it's own...meaning it shouldn't require more capital from your "personal" account (i.e. shouldn't require more money from your "real job") and also when you're starting out I'd recommend just letting the cash flow build up for awhile (don't use it to go buy a car or something).
$10k would be a nice reserve, however, if you buy the right property, and account for reoccurring cost in your rent, their shouldn’t be any surprises that would require that size reserve . The buffer on my first property was $2k. With that said, I also put $500/month into the rental property account so that At the end of the year I will have that much more for a down payment on my next property.
Your reserves should be 6 months of PITI per investment property. Reserves can be stock, bonds, cash and yes up to 50% of your 401k in most cases.
Reserves is not your HELOC or Credit Cards like several foolish investors tell me. Those things are "credit" and credit can be frozen when markets get messy re: 2007-2008.
Good luck.
I would suggest that 10k to maybe 15k is the right amount when you're first starting out (say between 1 to 3 properties). The biggest thing is that you need to be able to cover a large expense like a roof or a sewer/water line from the street, etc.
Do you have a credit card? You can use that towards your reserves as well as you can usually pay for materials by credit card and most companies (hvac, roofing, plumbing) take credit cards.
I would not suggest you go with 2k as your reserves. If the roof goes out, you have to fix it and fix it fast. And I don't see a new roof getting done for 2k or 3k. :-)
Yes, pretty much. Just make sure the balance stays at $10K (or ideally above $10K if you are cash flowing positive). Ideally this account would kind of operate on it's own...meaning it shouldn't require more capital from your "personal" account (i.e. shouldn't require more money from your "real job") and also when you're starting out I'd recommend just letting the cash flow build up for awhile (don't use it to go buy a car or something).
Makes sense, just wanted to make sure I interpreted your advice correctly. Appreciate the feedback, sounds like a great best practice for every investment in a portfolio!
$10k would be a nice reserve, however, if you buy the right property, and account for reoccurring cost in your rent, their shouldn’t be any surprises that would require that size reserve . The buffer on my first property was $2k. With that said, I also put $500/month into the rental property account so that At the end of the year I will have that much more for a down payment on my next property.
That's great feedback James! I feel like I'd be a bit nervous of finding unexpected issues with a property and only having $2k to cover myself with. I agree that doing your due diligence upfront should allow you to account for majority of the costs to ensure your going to make money the second you buy, but what about some of the hidden unexpected costs that you can't always predict?
Your reserves should be 6 months of PITI per investment property. Reserves can be stock, bonds, cash and yes up to 50% of your 401k in most cases.
Reserves is not your HELOC or Credit Cards like several foolish investors tell me. Those things are "credit" and credit can be frozen when markets get messy re: 2007-2008.
Good luck.
Hi Peter,
Appreciate the feedback! Quick hypothetical example/question for you. Lets say your PITI is $1k/month. You have a 401k with $12k in it, so therefore you have access to $6k or 6 months of PITI if you need it (50% of your 401k). You have $30k saved up for a down payment on a home and would need that entire $30k to finance the deal.
1) Do you make the deal and feel comfortable enough knowing you have the $6k in your 401k if you really need it?
2) If no to question 1, how much of your $30k saved would you feel comfortable putting down in order to complete a deal?
I would suggest that 10k to maybe 15k is the right amount when you're first starting out (say between 1 to 3 properties). The biggest thing is that you need to be able to cover a large expense like a roof or a sewer/water line from the street, etc.
Do you have a credit card? You can use that towards your reserves as well as you can usually pay for materials by credit card and most companies (hvac, roofing, plumbing) take credit cards.
I would not suggest you go with 2k as your reserves. If the roof goes out, you have to fix it and fix it fast. And I don't see a new roof getting done for 2k or 3k. :-)
Hi Mike,
If I won't be able to accumulate $10k-$15k in reserves, do you suggest I continue to wait and save until I do have that much saved in reserves?
I do have a credit card, but I never hold credit card debt. I only charge what I know I can pay off.
Dan
If you're buying a multifamily property and you don't have at least 10k that you can access, then I would say you should wait to buy. And I'm probably one of the more aggressive people in here when it comes to that kind of stuff.
But here's the thing. If you have a credit card with zero balance then I'm guessing you have 5k to 10k in available credit that you can access. Ultimately, you can count that towards your reserve.
The reason I suggest needing 10k for reserves is that you need to be able to account for a major repair/replacement. A sewer line that gets clogged under the foundation or that has to be replaced outside might cost you 8k. A new roof might cost you 7 to 10k depending on the size of the building. You can't push off a sewer repair when the thing caves in.
You have to have the money to fix it right then and there. And thats where you simply need available funds to cover it.
If you had 6 or 7k in cash and 5 or more grand in credit card available balance, I would feel comfortable with that as well. That should easily get you through any doomsday scenarios - assuming the building's mechanicals are in relative decent shape.
If everything looks like its on its last legs, then maybe not.
But you just need to be prepared that you may get hit with two things in a month (i.e. new ac and roof or sewer and furnace, etc) and have the money to be able to replace them. And whether you pay by cash, credit card or taking out a loan from your 401k, as long as you can get it done and still have some cushion left, then you have enough.
The key is understanding that your reserves have to cover more than just vacancies. And that the big ticket repairs will eventually popup.
I like the 10k number that was thrown out. We had about 6k in the bank when we got our first house hack and I was suprised when a few months later we were down to 4K. Suprise repairs on the first few months were prevalent.
We quickly got our reserves back up to 10k and have not gone below that since.
Once we hit 8 units this past summer and averaging 2 flips per year, we bumped that number up to 25k just to be safe.
That money don’t get touched. It just chills there for bad days. It’s funny how even when we have bad days now we just cashflow the problems and we hardly ever have to touch the fund.
I think it is a vital piece to the puzzle.
If your 401K plan allows it, you can take a loan for up to 50% or $50k, whichever is smaller. You have to repay it over 5 years or less. This would be nice to have for an emergency.
Most of my properties were not profitable the first year. They were always for sale for a reason.
Hey Jason,
I 100% agree with you that everyone’s risk tolerance is different. I also agree that it’s important to ensure you are factoring in things like maintenance, CapEc, vacancy, etc. I was mainly interested in what people have typically held in reserves when purchasing a property as it pertains to “backup” funds in case you need budget to support unexpected events for example. Just not sure whether or not I need to be thinking about postponing jumping into real estate investing if I don’t have enough in reserves.
Dan
I am not a fan of them generally, but keep in mind that a home warranty could help you hedge your repair costs in the early stages of investing. We put one on our first rental and it saved us some cash when the AC died in the Texas summer heat - but dealing with the warranty company was a major headache. Once we picked up a few more properties we felt we had enough cash flow that we could do without.
Andy
If you're buying a multifamily property and you don't have at least 10k that you can access, then I would say you should wait to buy. And I'm probably one of the more aggressive people in here when it comes to that kind of stuff.
But here's the thing. If you have a credit card with zero balance then I'm guessing you have 5k to 10k in available credit that you can access. Ultimately, you can count that towards your reserve.
The reason I suggest needing 10k for reserves is that you need to be able to account for a major repair/replacement. A sewer line that gets clogged under the foundation or that has to be replaced outside might cost you 8k. A new roof might cost you 7 to 10k depending on the size of the building. You can't push off a sewer repair when the thing caves in.
You have to have the money to fix it right then and there. And thats where you simply need available funds to cover it.
If you had 6 or 7k in cash and 5 or more grand in credit card available balance, I would feel comfortable with that as well. That should easily get you through any doomsday scenarios - assuming the building's mechanicals are in relative decent shape.
If everything looks like its on its last legs, then maybe not.
But you just need to be prepared that you may get hit with two things in a month (i.e. new ac and roof or sewer and furnace, etc) and have the money to be able to replace them. And whether you pay by cash, credit card or taking out a loan from your 401k, as long as you can get it done and still have some cushion left, then you have enough.
The key is understanding that your reserves have to cover more than just vacancies. And that the big ticket repairs will eventually popup.
Hey Mike,
This was an excellent response, thank you. Few things I’d like to comment on here:
1) I have a credit card with a limit of $10k. I have not asked for a limit increase yet so it’s likely that I can make this larger. I never carry credit card debt.
2) Sounds like the main things I'd need to budget for reserves is big ticket CapEx items and holding costs. Would you agree, or do you think I'm missing anything else?
3) to give you some perspective, I am forecasting having $30k saved up by mid next year. I have $10k in my $401k, and then my credit card. I was planning to look at homes in the price range of $300-$350k, so let’s take the worst case and go with $350k. If I pursued a multi family for $350k, I’m looking at roughly $27.5k down (down payment and closing). That would leave me with $2.5k in cash, up to $5k that I can borrow against my $401k, and my $10k limit credit card. Do you think this is enough of a safety net? Or do you think I should postpone jumping in for say another year until I can save up that $10k in cash.
Dan
We have 10 SFR's. Mostly class B/C, purchased at 50-65k each. We have about 25k in our maintenance/capex/vacancy account and we deposit 1k per month into it. It's a separate account than our normal rental account. We use that account to pay the mortgages, taxes and insurance, and it's balance goes up and down as rents are deposited and bills are paid.
I like the 10k number that was thrown out. We had about 6k in the bank when we got our first house hack and I was suprised when a few months later we were down to 4K. Suprise repairs on the first few months were prevalent.
We quickly got our reserves back up to 10k and have not gone below that since.
Once we hit 8 units this past summer and averaging 2 flips per year, we bumped that number up to 25k just to be safe.
That money don’t get touched. It just chills there for bad days. It’s funny how even when we have bad days now we just cashflow the problems and we hardly ever have to touch the fund.
I think it is a vital piece to the puzzle.
Hey Joshua,
First off, just want to say I really enjoyed listening to your podcast. I like how determined you and your wife were right out of college. My girlfriend and I share in that same passion.
It sounds like $10k seems to be what I am hearing more and more. Do you think that $10k needs to be in cold hard cash? Or do you think that I just need to have $10k accessible in some way whether it be borrowed against my 401k or through use of a credit card?
Leaving your reserves as an untouched nest egg sounds like a great idea. Almost like when you sit down at the blackjack table and find yourself up quickly. I’d put my original investment right back in my pocket and only play with the house (no pun intended) money until I either win more and walk away or lose it all. In this case, sounds like you’re using your cash flow as the “house money”.
If your 401K plan allows it, you can take a loan for up to 50% or $50k, whichever is smaller. You have to repay it over 5 years or less. This would be nice to have for an emergency.
Most of my properties were not profitable the first year. They were always for sale for a reason.
Hi Amy,
This is great info. I definitely don’t have $50k in my 401k, so I’d be looking at 50%. Do you know if this differs from 401k to 401k? Same for the 5 year repayment...is that standard or does it depend who your 401k is through? Putting this one down as an action to contact my 401k holder to find out the details, but would love to hear your feedback regardless.
Dan
I am not a fan of them generally, but keep in mind that a home warranty could help you hedge your repair costs in the early stages of investing. We put one on our first rental and it saved us some cash when the AC died in the Texas summer heat - but dealing with the warranty company was a major headache. Once we picked up a few more properties we felt we had enough cash flow that we could do without.
Andy
Hi Andy,
Interesting, I never thought of that before. Did you factor the warranty costs into your deal analysis to ensure the deal still cash flowed even with the additional warranty costs?
Dan
We have 10 SFR's. Mostly class B/C, purchased at 50-65k each. We have about 25k in our maintenance/capex/vacancy account and we deposit 1k per month into it. It's a separate account than our normal rental account. We use that account to pay the mortgages, taxes and insurance, and it's balance goes up and down as rents are deposited and bills are paid.
Hi Roger,
What did that account start out with when you approached purchasing property #1?
Dan
@Daniel Ortiz, Yeah, sorry, I answered too soon and didn't read your clarification of your question. We had zero in that account, but had substantial available reserves in 401k and IRA accounts.
@Daniel Ortiz, Yeah, sorry, I answered too soon and didn't read your clarification of your question. We had zero in that account, but had substantial available reserves in 401k and IRA accounts.
Hi Roger,
No worries! Sounds like you had plenty available in readily accessible funds in the event things turned south.
Dan
The warranty cost around $450 or so (annual premium) at the time, and $60 per visit when we called out the trades for repairs. We did not purchase it when we bought the house, but sometime after renovations since we decided not to replace the HVAC, oven and cooktop. I did not actively include it in my budget up front since it is a relatively low cost and honestly something we decided on after the fact. After the first year we did not renew.