Rental Property Investor · Irvine, CA · Member since 2020 · 16 posts · 8 votes
Hi BP members,
I am currently saving some capital to finance my downpayment and closing cost on my first property. I'm planning to purchase a single-family house or small multifamily then househack it. My question is: How necessary it is to have cash reserves on getting my first deal? If it is necessary, should I have 6 months, 3 months cash reserves? What is the minimum amount that I should reserve on this?
It would take longer to get my first deal if I wait to have the full amount for a down payment, closing cost, and 6 months' cash reserves. Since I am planning to acquire an FHA 203k loan, the cash reserves are the most expensive part of my starting capital. What I am thinking is I can come up with at least 2months cash reserves then purchase my first deal. I can then save up more later to have enough money for 6 months' cash reserves.
I would appreciate your answers! Thank you in advance!
You need to have reserves. Not necessarily cash reserves.
If you have access to a HELOC ( or any line of credit) you can use that if needed.
But if you are acquiring a property with negative cash flow, then cash reserves becomes more important.
Also i do not like to use x months of rent. It depends very much of the state of the property and the monthly income. A 100 yrs old property might demand more reserves than a brand new one.
@Vince Espiritu It’s super important to have cash reserves. There’s always going to be unexpected expenses in this business, and you have to be prepared for them.
Here’s just one of the most recent posts (out of the many on here) where a new landlord is talking about all the expenses associated with owning rental properties:
I’ve had to replace a roof, re-pipe a house, and put in a new heater/AC - all across several properties - but all in the same year. Talk about an expensive year!
If it’s your own personal house, MAYBE you might have the option to delay some things. However, with rentals, the law generally requires you to keep them habitable and actually says the tenant doesn’t have to pay rent if they’re not.
So if the heater doesn’t work in the winter, or there’s a major plumbing issue or a serious roof leak in a tenant-occupied property, there’s usually no option not to fix it just because you don’t have the money. You must fix these types of things, which is why it’s so important to be properly capitalized.
ALWAYS!! I would have at least $20,000 in reserves to be safe. Murphy’s Law will raise its ugly head!! Not if, but when!! Been there and done that in the last nine years up to 230 front doors on my way to 500-1000 more in the next 3 years. You can NEVER have enough reserves!!!
Hi Michael! Thanks for the response! Do you advice to have that cash reserves early on before purchasing the deal? I wanted to get the ball rolling as soon as possible. I was thinking maybe I can have at least $10,000 cash reserves before purchasing my first deal then add more money to my cash reserves from my day-job salary to make it $20,000 after closing my first deal.
You need about $15,000 for your personal reserves, in case something bad happens or you lose your job and then $20,000 for your house hack project. One rental property is pretty risky. You don’t have economies of scale and we are still in a pandemic and the tenant has a lot of power etc... until we lift the eviction moratorium too!!
@Vince Espiritu I do not believe that you can assign an exact dollar amount to how much you should have in reserves. That amount should depend on the size, type, age, and condition of the property you are going to purchase, as you should also factor monthly savings for both Capex and repairs/maintenance based on those same factors. While you should most certainly have something in reserves when starting, don't let the fear of not having enough hold you back from getting started. While you are saving up to the point that you will be comfortable with, one of the most important things to do is evaluate potential investments and run calculations on as many as possible. The more you do that, the more accurate your numbers will be and the more confidence you will have in your numbers. Hope this helps! =)
You need to have reserves. Not necessarily cash reserves.
If you have access to a HELOC ( or any line of credit) you can use that if needed.
But if you are acquiring a property with negative cash flow, then cash reserves becomes more important.
Also i do not like to use x months of rent. It depends very much of the state of the property and the monthly income. A 100 yrs old property might demand more reserves than a brand new one.
To me it is like having one stock, pretty risky. He talked about maybe getting a duplex. I usually say $15,000 in reserves for one single family for safety. I have had a roof blow off, major sewer line collapse, tenants die of old age or in the hospital or found dead in the units upon well checks etc... It is par for the course. Murphy will rear his ugly head, sooner or later. My conservative reserves has really saved me time and time again!!
Again, you can NEVER have too much in reserves. ONLY too little in reserves.
Also Quentin, I am originally from Glen Ellyn. I graduated elementary school at Benjamin Franklin and went to Hadley Jr. High and then moved out to San Diego in 1978. I lived on Duane St. until 1st Grade and then moved to Hillside until 8th grade.
I always like to run conservative numbers on deals with a 5% vacancy rate to help give me a buffer but there should always be costs that you expect when taking on a new property even if it is pretty turn key (ie. change locks, be prepared for something to break like a lighting or toilet issue etc. so you do want to have a bit of extra cash budgeted). In your deal analysis, you should also be taking into account maintenance fees that your rent will have to cover in the future (ie. replacing appliances)
In regular times, having over 3 month of reserves should be enough IMO but being able to access a couple months more in the event of an emergency is helpful. However with COVID, I'd like to be closer to the 5-6 month range if I didn't have other rentals to prop up my income - I've got 5 rentals now so if one goes down, I'm still getting income from the others which can help cover the mortgage & expenses.
Having too much in your cash reserves is also bad as it's money that is not working for you.
Always, 6 months min on a single property. But the needs go down as you build a portfolio. If you have 10 properties you don't need 60 months reserves as all are not going vacant or have big repairs at the same time.
@Vince Espiritu people lose property primarily not because of using leverage but being undercapitalized in their portfolio, so just be careful and keep that in mind as you grow. Being well capitalized allows you to hold the property for some length of time, which for a lot of investors is the name of the game, ie longterm wealth creation.
"FHA 203k loan" -------------------------------------------- What repairs/replacements are encompassed in your 203k loan? I ask because they MIGHT allow you to cheat down your capital repairs/replacement fund down some. New stuff is less likely to fail than old.
That said, others have mentioned the need for personal reserves and for business reserves. If you have a relatively new house (all the 203k repairs here), initial CapEx demands should be lower than normal, so you might be able to lower those reserves somewhat. Your business reserves will have to increase, on the other hand, to account for vacancies, non-paying tenants under moratoria, and your inevitable rookie mistakes. So all in all, it's probably a wash.
It does tell you, however, to look at your market. If your CapEx is likely to be low for a few years, then your probable hits are vacancies and deadbeats. What's the rental market like (vacancy rates), and how is the labor market/wages in the neighborhood (deadbeats)? That will affect your vacancy percentage and probable turnip losses. Make sure you have strong, consistent, conservative, WRITTEN, tenant screening criteria, that you use religiously. The best problem to have is the one you avoid.
As the building ages CapEx requirements will increase, and with any luck, vacancy and deadbeat reserves will go down. You would like the vacancy/deadbeat side to go down faster than the CapEx increases.
So look at your market and figure out carrying costs for vacancies and deadbeats, ASSUMING you have an extensive 203k loan rehab in the works.
@Vince Espiritu it's extremely important. You need to keep a reserve for vacancies, tenant turnover repairs and general maintenance which are inevitable.