Hey BP,

I'm new to REI and just joined in early Dec. It's amazing the wealth of knowledge contained within these forums!

Here's my situation:

I just closed on my first investment property in San Diego two weeks ago and it went great! For my next deal, I plan to look out of state at SFH in the 100-150k range (exact area tbd), potentially using a turnkey company.

The problem is that I used up nearly all of my cash in the last deal. However, I do have a 130k HELOC on my own home. I'm debating between using that HELOC to finance my next SFH (either via traditional financing or an all-cash purchase) versus waiting a few months to save up the cash. What is a reasonable amount of cash reserves to build up before I dive back into purchasing? Thanks!

I think the cash reserves have to be enough to cover all unexpected items.  This includes prolonged vacancies, tenant trashing a place, severe maintenance/cap expense item, a prolonged drop in market rent, etc.  

my biggest single such expense was $60k but that was such a specific/unique situation that we will not count it.  My second biggest was a $28k foundation issue.  Eliminating those 2 items I have not had an item significantly over $10k.  

So I recommend having at least $10k cheap reserves (such as HELOC) and access to an additional $20k that could be more costly (I.e. credit cards or personal line of credit). Ideally you never need to access the more costly money.

Safest approach by far is to not heavily leverage your Home. I recommend saving some/most of the money necessary for the purchase and use the HELOC as the cash reserves if something goes wrong.

@Dan Heuschele thanks for the advice. It's tempting to use the heloc since interests rates are still low and I could close fast as if it were a cash buy. I considered using it to buy a prop, do rehab work, and then refinancing with a bank to pull my money out (assuming it appreciates). It's of course risky business but fun all the same with the right deal. Sounds like it may be wiser/safer to build up the war chest for now...

I have tried the BRRRR a few times but in my market it is difficult for 2 primary reasons: 1) the refi appraisals are conservative in this market and seem to trend lower than purchase appraisals 2) conventional refi seem to be capped at 70% LTV.

My last BRRRR had a purchase of $390k. We spent almost $50k on the rehab. So we are into it for $440k. It appraised at $580k so the refi at 70% LTV provided $406k. So we were still into it for $34k (not counting loan costs) but our equity position did increase. We would have needed an appraisal of $628.5k to have gotten all our money out. However I believe I know our market better than the appraiser and I would have put the value at $620k to $640k but as indicated I believe refi appraisals are more conservative than purchase appraisals.

So be leery of thinking it is easy to get all of your initial investment out via a BRRRR (it may be in some markets but in my market it is a challenging task).

Good luck

In most cases on biggerpockets, the amount of reserve you hold is entirely a personal choice. There are exceptions - especially in commercial - where the bank demands a reserve fund, but let’s say that you have 100% control of how much reserve you keep.

The choice is entirely a risk-reward trade off for you. Your heloc is a source of cheap cash, but it’s tied to your primary residence. You take a risk that if things really belly-up you will lose your house. The investments you make are somewhere on a risk spectrum which correlated to your risk of losing the house.

There are other sources of cash: bank of Mom and Dad, begging money from friends and family, asking for salary advance from your employer, getting a second job, getting a mortgage, getting a personal loan, getting a hard money loan... all of them come with different economic, time, and psychological/emotional costs. Which of those costs are worth it to you are based on your own situation, and likely will change over your investment career.

Personally, I don’t want to think about where my money will come from in the case of a catastrophe, so we are building to a year of PITI payments for each property. Almost certainly overkill, but I’m 100% happy to reduce our economic benefit thru lower return on equity for improved psychological benefit of reduced stress (“where will the money come from”) and more control over my free time (I don’t need to drop everything to hustle my butt to hard money lenders to get myself out of a ditch). Your time-and-stress value of money is guaranteed to be different than mine, though, so chart your own path.

In your situation I would also be considering the stressed environment case. In 2007-2009 a lot of banks reduced or closed unused lines of credit to minimize their exposure. A reserve fund is only as good as its availability during a real catastrophe, so I would (PERSONALLY) never rely on a heloc for reserves.

But as I said, unless the bank is telling you, your reserves are entirely based on your preferences.

@Dan Heuschele - Makes sense. I'm just starting out in building my portfolio so using your example, I'd rather get the 406k back to put toward the next house. It'll take me a lot less time to generate that 34k + loan difference vs using traditional financing from the start (390k purchase with 20% down would lock up 78k vs the 34k post appraisal). Not sure if this is the right way to look at it if my goal is to pull out equity and move onto the next deal with some speed...

@Jonathan West - Great post, Jonathan. I vaguely recall that some cash reserve is required for lenders (some % of unpaid principal needed to get the next loan) though I can't recall the exact details.

 You bring up a good point that in real downturns like '07-'09, a lot of things collapsed including the closing of lines of credit. I could see a perfect storm situation if only a few variables turn south. Any investments we make, we've got to be able to still sleep at night. There's also some wisdom there about where we are in our careers. You may be more in a place of capital protection, especially given how most of the market is likely closer to the top than the bottom. Since I'm starting out, I'm may be more inclined to take on a greater degree of risk.

Originally posted by @Dan F. :

@Dan Heuschele - Makes sense. I'm just starting out in building my portfolio so using your example, I'd rather get the 406k back to put toward the next house. It'll take me a lot less time to generate that 34k + loan difference vs using traditional financing from the start (390k purchase with 20% down would lock up 78k vs the 34k post appraisal). Not sure if this is the right way to look at it if my goal is to pull out equity and move onto the next deal with some speed...

.

I think you are looking at it correctly. Depending on your initial loan LTV the BRRRR can reduce your cash associated with RE as well as increase your equity via the sweat equity. Just do not expect in San Diego the BRRRR will be likely to get all of your initial investment out of the RE. It may not be as challenging where Brandon Turner does his BRRRR. I will also say that if my refi appraisals where more consistent with my purchase appraisals it may be more possible in San Diego but that has not been my experience so far.

Good luck