Investor · Phoenix, AZ · Member since 2018 · 420 posts · 388 votes
Ok here goes.... I’ve finally put some of the useful knowledge I’ve acquired over the years on BP into action. My strategy is buy and hold and I’ve just acquired my third deal. I now have approx $1M in rentals but am 90% leveraged. My properties barely cash flow because I’ve only put 5% down on each. Rents in my market (Phoenix) are improving drastically at the moment and appreciation has been EXTREMELY healthy over the last 5 years. Normally if I read a post like this from anyone else I’d advise caution but bear with me....
My strategy is based around maximum leverage to acquire as many rentals as I can right now. My safety net is that I carry a hefty reserve. My question to the group is, given this set of circumstances.....what kind of cash reserve would you be comfortable with?
@Account Closed I would suggest you keep 10% of what you owe in debt up to 1 million (100k in reserves). Then 5% of your debt past that (50k in reserves for each addition million you are in debt). Part of the reason for having so much in cash is if you want to really scale banks are going to require you to keep reserves in their bank in order for them to lend you millions of dollars. They call it the relationship. I have a about 4 million in loans with one of the banks I use and that bank want me to have about 250k in my accounts with just their bank.
As I started to scale, I leaned toward leveraging as much as I could in order to grow. But as I grew my portfolio more and more, the banks started looking more at my ratios for my global financial situation. In other words they started looking at all of my debts, both personal and business, and they needed it to be at a 1.2 - 1.25 ratio. That means for ever 100k that I had in expenses, I had to bring in 120k -125k in income.
So leverage is a double edge sword. On the one hand, it helps you to grow and scale, and on the other hand, it prevents you from growing and scaling if your cash flow isn’t high enough for the banks (risk managers) to feel comfortable enough to continue to lend to you. We have had good relationships with certain banks that have given us millions of dollars in loans that all of a sudden stopped lending to us because they hired a new risk manager.
So just keep in mind that leverage can help you grow and leverage can keep you from growing.
@Shiloh Lundahl @Account Closed I agree with Shiloh. I keep plenty in reserves not because I think I'll need float my portfolio, rather every time I need new financing the banks require I need a ton of cash for them to feel safe. There is no correct answer on your question, it will differ based on risk tolerance and strategy of each investor.
@Account Closed I don’t know your exact numbers, but if you have 3 properties valued together at about 1 million with around 900k in debt on them with 5% of your own money down and they are not cash flowing a lot, you may not have gotten great deals on the properties. It will be hard to scale buying properties this way even if you are able to put only 5% down.
The way a lot of people scale is they buy properties well under market value and force appreciation through fixing the property or adding value to it some way. After the forced appreciation, they will either refinance the property or get a Heloc on it because it is now worth a lot more and they can suck their rehab costs back out of it and it still has about 20% equity left into it.
The price points that you are buying at may be hard for you to get cash flow with. You may consider buying cheaper properties. C class and B- classes tend to produce higher cash flow. If you are looking for appreciation, then the play would be to sell some of the properties as they appreciate and get money that way to roll into more properties. Try playing the updated version of Robert Kiyosaki’s Cash Flow 101 game to get the feel of this concept.
@Caleb Heimsoth $6k per month or $72k per year. I agree, it's chalk full of risk but with Class A- SFR in my market the best you can expect on a $300k house in $2k per month. I have to stick to the market I understand best to get started so I am hedging with cash reserves. It's not as dangerous when your cash reserves can carry PITI for 24 months. Appreciate the well wishes!
@Shiloh Lundahl great suggestion, I will have a listen. I'm trading class A type renters for cash flow at the moment. As rents increase my expectation is that they will outrun PITI. I've considered doing a recast on my mortgage to generate more cash flow for my ratios, but that doesn't make sense until I run into lenders who won't lend anymore IMHO.
I expect the appreciation to generate better ROI in Phoenix for the immediate future. It's one strategy and I understand the criticism. My theory though is that 3% appreciation on $1M in assets plus the principle pay down nets me roughly $45-50k per year before transaction costs (in the event of a sale) and taxes. I can't logically trade that for $100 per door right now, not when I'm sitting on the cash that I need to be comfortable.
@Shiloh Lundahl I'm VERY new real estate but I'm reading reading reading reading as fast as I can to ramp up. I'm still a little fuzzy on how neighborhoods get classified as A/B/C and why some people use a +/- or five-letter scale instead of three though?
I've lived in my current city for about ten years but I've lived in one general area the whole time. Now that I'm looking across the whole MSA for investment I'm having to re-learn the city all over again. I guess this is why it's crucial that I partner with a good agent?
@Syed H. Leverage always matters. History is filled with failures/bankruptcies from those that had the same mentality.
You take one of part of what I said without taking into the account the next part.
Leverage means nothing. DSCR and other metrics are way more important. If you don't understand why, that's fine. Most people don't jump into the weeds of RE finance like I do.
@Theresa Harris I have 3 Class A- homes that are fairly new/well maintained. I expect capex of $6k per year for the next 5 years. Purchased at $300k, $300k, $400k respectively. Any thoughts on reserves to carry the existing portfolio safely?
@Phil Denton having someone in the market who knows its inner workings inside and out is CRITICAL. I can’t stress this enough when you are getting started. I have practiced extreme humility as I’ve gotten things going and asked for help/suggestions from anyone and everyone...with the understanding that I weigh more heavily the opinions of those who have successfully done what they are proposing.
@Theresa Harris I have 3 Class A- homes that are fairly new/well maintained. I expect capex of $6k per year for the next 5 years. Purchased at $300k, $300k, $400k respectively. Any thoughts on reserves to carry the existing portfolio safely?
I'd have enough that you can cover a few months' rent and make sure there is room elsewhere (eg credit card that you can pay down quickly) for any emergencies.
@Andrew Syrios that was my thinking as well, $100k at minimum. My next step (hopefully 6 month from now) will be to buy a $600k quadplex with 5% down and live in one of the units for a year. Any thoughts on where I should be in reserves before making that leap? Keep in mind that my target property would be one where once I leave after that 1st year I’m able to cash flow $100/door fully leased up.
Yikes. A few of you recommend 12 months PITI?! For each property? That seems super conservative. Is that what you guys are doing?
How many here even keep 6 months PITI for every property? Where do you keep those funds? A simple savings account? Money market? Brokerage (that's me)?
I’m just a small time local guy, and we actually do not take a profit at the moment, so we do technically keep 100% of profits as reserves/down payment for the next acquisition.
Btw; the OP’s properties seem fairly new so I wouldn’t expect capex to be very high for a period of 5-10 years.
@Whitney Bowling. Looks like you are betting on appreciation to bring your goals. Appreciation in this Market now is long term but the good thing about your game plan is low money in for appreciation on higher end properties. If you can go 10-15 years without any major setbacks I think you will get a great return I like to roll my properties every 5 years or so with 30-40% down. Sell one buy 2 that needs TLC. Get cash flow To live on and forced equity to reinvest plus makes my retirement not so boring and still have time to fish This is a tight market with a lot of flippers and wholesalers. I think the class A properties are great investments for youngsters like yourself as long as you have protection of equity as part of your backup plan You are not going to get any cash flow because 1 month empty is probably a years cash flow and one fridge is probably 4 months of negative income. Don’t give up your day job just yet. Best of luck.
@Fred Cannon 😂 thanks Fred. I won’t be giving up my day job any time soon. If I were headed that direction I’d be MUCH more concerned with immediate cash flow. Always great to hear how others approach it. Dependent on appreciation I certainly hope to be trading up to MF in the next 5-10 years. For now I’m just trying to gauge what kind of reserves others carry to absorb the ebs and flows.
@Andrew Syrios that was my thinking as well, $100k at minimum. My next step (hopefully 6 month from now) will be to buy a $600k quadplex with 5% down and live in one of the units for a year. Any thoughts on where I should be in reserves before making that leap? Keep in mind that my target property would be one where once I leave after that 1st year I’m able to cash flow $100/door fully leased up.
Are you certain that you can put down 5% for your next 4-plex househack, since you already have 3 houses? I wanted to do the same but don't think any lenders would allow that.
@Mohammad Nur to the best of my knowledge as long as my debt to income ratios are in line I'm still eligible for one FHA loan as my primary residence which would allow me to put down even less. Keep in mind all my current loans are conventional.
@Mohammad Nur to the best of my knowledge as long as my debt to income ratios are in line I'm still eligible for one FHA loan as my primary residence which would allow me to put down even less. Keep in mind all my current loans are conventional.
You are right about FHA loan as your primary residence. However, I think I was told that I can't identify a Multi Family as my primary residence when I already own single family homes. There may be some conditions (like moving to a different place for job) that would allow to use Multi Family as primary residence, but it would probably be best for you to talk with your lender first. This will also dictate how much of reserve you may need.
@Mohammad Nur interesting. I’ve never heard of that for a primary, but have encountered it for a secondary home. Have you looked into private lending or seller carryback to finance yours? Just curious to see what kind of experience people are having in those markets.
@Mohammad Nur interesting. I’ve never heard of that for a primary, but have encountered it for a secondary home. Have you looked into private lending or seller carryback to finance yours? Just curious to see what kind of experience people are having in those markets.
I have found portfolio lending ( rate close to 7%, 30 year fixed). Didn't look into private lending just yet. I am somewhat like you - I plan to slowly acquire few properties and keep them as retirement investments.
@Whitney Bowling You have had some good advice here, but let me chime in as a fellow local Realtor investor.
Banks will require you to have 6% of the loan balances + 3-6 months reserves on the subject property for any refinance or new purchase. There is a range of reserves based on the number of properties you hold. Right now, you hold 3, so you would need 3 months reserves on subject property plus the 6% balance of the remaining properties. Down the road as you go over 4 properties held, it will increase steadily to the 6% mark. So, that is your BOTTOM cash reserve figure to keep in mind.
Since you are a Realtor in the market you hold your investments, I worry less about you knowing when the market shifts. You should be able to set up MLS searches for each community and have any new status changes emailed to you as they happen so you can keep your pulse on the comps and sales trends within that community. If you see a downward trend, it 's time to evaluate your equity position and make some decisions. You may want to set up a search for rental comps as well.
I set "triggers" for each of my properties, whether up or down in price, increases in HOA fees, days on market for rental, and so forth. These help to force you to sit down and do those re-evaluations. Sometimes something will "trigger" on one of your properties, but after sitting down and evaluating it, it still makes sense to hold it. So, then you set another trigger. For example, I picked up a condo in 85254 for $67K in 2012. I don't normally buy condos, but it was a good deal, so I set triggers. A price trigger of $150K, and an HOA trigger of $200 (the HOA at the time was $155). Several years later, my $150K trigger hit and I sat down and determined that it was still a money maker, and so I set a new price Trigger to $200K. Then a year and a half later, both the HOA trigger and the price trigger were set off. I sat down and evaluated the property, and determined that it was time to sell, and so I did.
Rental rates are awesome right now in our market. They have vastly improved over the course of the past few years. However, the rental market also can spike up or down. I held a nicer home in North Scottsdale that fetched rent in the $3600 per month range in 2005. However, by 2008, I could barely get $1850 for it. NOW, I know that in 2008 we were in the middle of a housing crisis, but I just give you this example to share the risks of leveraging yourself too close to your bottom line, and not having a healthy cash flow amount. Ask yourself, could you carry a property , or at least cover the difference for 6 months? A Year? It's worth considering when you look at properties to convert to rentals.
What you decide ultimately is up to you and your comfort level, but now you know the lender's requirements. Anything you set above that is up to you.
During the housing downturn, I had ample access to credit lines and cards. Once Lehman Brothers cratered, Amex sent me a letter stating my $25,000 credit card limit was being reduced to $500. I was like, what’s the point?
Banks quit lending during downturns. It doesn’t matter how much equity you have to pursue a refi and roll strategy. No loan, no leverage.
Do you have 30 year fixed loans on these properties? If so, you will be fine as long as you make the PITI. 30 year conventional loans are not callable.
As others have mentioned, you need to get your debt coverage ratio to 1.25 or higher if you wish to expand and quit owner occupying properties. The FHA program was never designed for investors and you will run into issues with this strategy soon.
In terms of reserves, 6 months PITI would be ideal as you scale. Worse case, if the market turns, you only have 5% skin in the game. Hand the properties to the banks and learn a valuable lesson.
If market advances, refi into a better debt coverage ratio or into properties that cash flow. At this point, you are building a house of cards where I'm assuming you don't cash flow after PITI, CAPEX, maintence and management fees.