Where do you keep your reserves?

Question

I'm working on buying my first buy and hold and am trying to figure out the best way to work bank the accounts. I plan on creating a checking and a linked savings account specifically for RE. I was figuring I'd have rent checks deposited into the checking account, and then take out 15% for vacancies/repairs and put it into the savings, repeating the 15% into the savings for each subsequent property. I'll be financing my first 10 or so properties, so I'd just set up an automatic payment for the mortgage out of the checking account.

Does anyone have any suggestions for other ways to do this?

Jerry W. · Answer

Hey @Frankie Woods, good to see you again.  Keep in mind I have income coming in every month.  It is not like I don't have income I can devote to paying a huge expense.  I could easily take a $20K hit and pay the credit card off in less than a year.  I have seen some pretty hard times throughout my career.  If you pay your credit card every month I have never seen them reduce your credit.  It is possible the bank could reduce my line of credit, but unlikely.  The only likely scenario would be if I lost my income.  That is always possible, but even if that happens I have retirement account money as well.  It is not intended for real estate investing, but I could get to it.  I try to keep at least one or 2 properties paid off, that is what I have he line of credit on.  The bank 5 year ARMs are not balloon loans, the interest rate adjusts every 5 years.  That is different than balloons.  Here is my logic.  If the money sits my savings account, say $25K like Nathan does, then I only earn .25% interest on it.  If I put $20K of that money down on my property to make it pay off sooner and reduce my interest expense.  I save $1,200 per year if I have a 6% loan that I pay an extra $20K on each year I leave that money in there.  I could refinance the money out if I really needed it, or I could just use the credit card for short term as well.  I can save $6K over a 5 year period if I just pay down on a loan instead of having it in savings.  That is a lot of money to save.  The biggest hit at one times was a auto accident where a ball broke off my hitch and severely damaged a trailer I had borrowed, and dumped about $5K of shingles on the interstate.  I paid about $8K out of my line of credit to just buy my friend a new trailer to replace the one I wrecked, and a little over $3K for towing from the wreck site, and towing it home, and don't forget $5K of shingles.  I eventually sold off a problem property that year to help offset all the expenses and restore full cash flow.  I also had enough left over to buy a nicer rental than the one I sold.  Everything but the $8K for the trailer I simply put on the credit card and I paid that off in about 4 months.  I never even tapped into the $5K I keep for emergencies.

Nathan Gesner · Answer

It depends on what works for you and your organizational/financial skills.

I use a checking and savings for all rentals.

Checking account is for income and expenses.

Savings account is for security deposits and reserves.

Let's say I have 10 units renting for $1,000 each and with expenses of $750 each. On January 1st, I receive $10,000 in rent. I pay $7,500 towards my mortgage, utilities, taxes, insurance, etc. This leaves $2,500 in the checking account, which I leave there as a buffer.

On February 1st, this repeats. Since I already have a buffer of $2,500 in the checking account, I take the $2,500 left over from this month and transfer it to savings.

I repeat this until my reserve is built up to the level I want. Let's say I want a reserve of $25,000. I would put $2,500 a month into the savings account for ten months and save up $25,000.

Now I have my reserve built up and don't need to keep adding to it. I can start saving the $2,500 a month to put towards another investment. I leave it in the checking account where it is available for use. I have to stay disciplined and ensure I don't spend money designated for the mortgage or other expenses. If this is too difficult for you then I recommend setting  up a third account that is strictly for holding funds until you are ready to invest them.

Frankie Woods · Answer

Fantastic advice!  Thank you!  This was just the thought process I needed.

Steve Vaughan · Answer

Jerry, I really like this. Right now I have a large dry powder / opportunity fund in a money market acct earning 1.25%. Not horrible in today's dismal savings rate environment, but I also have a 2 loans at 6%+. (Seller-financed apartment loans going back 6 and 13 years).

I think I'll establish a line of credit on a free and clear so I have access to money if an opportunity comes up, then slap a nice chunk against these mortgages and earn 6%+ risk-free, hassle-free and tax-free.  Thanks for a great idea!

Jerry W. · Answer

I tried to do like @Nathan G. listed above, but found that I had trouble being disciplined enough.  Now I put all deposits, and some money each month for taxes at the end of the year into savings.( Those can be a huge hit)  I also keep at least $5K back for emergencies, but I no longer keep larger amounts for repairs.  The extra is used to do preventive maintenance like putting new roofs on a schedule, or paying down balloon notes coming due in the future.  I have a few credit cards with large lines of credit I can use if needed for a big repair and have a line of credit for big emergencies.  I think it is smart starting out to have a lot of money saved up, but despite having a lot of units now I just rely on credit cards and the line of credit.

Frankie Woods · Answer

@Jerry W.  Do you ever worry that your Lines of Credit and Credit Limit will be reduced during an evitable crisis?  What if your balloons come due during one of these periods?  How would you manage that situation?

Where do you keep your reserves?

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