How much do you set for reserves??

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J ScottPro Member
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Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
15y

I don't hold many rentals, but my general strategy is to keep a separate account for each, deposit all rent into that account, use that account to pay for expenses and mortgage, and then once that account reaches 6 full months of rent, start diverting payments for other business uses.

So, basically, I build to 6 full months worth of reserves, and then maintain that level.

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  • Brad Z.
    Investor · Member since 2009 · 132 posts · 30 votes
    15y

    I currently have 14 units (6 unit, 3 duplex's, 2 single families) and try not to go below 8k-10k in reserves just for the unexpected. I think you probably have a minimum needed for properties 1 through 3, then $$ held per door can probably decrease.

    1Reply
  • Phil C.
    Accountant · MN · Member since 2008 · 142 posts · 25 votes
    15y

    I have argued this with my partner many times. He says we need at least one years worth of reserves. I say 6 months is enough. We are currently at on year however I have at least convinced him that much of this can be invested in lower risk, highly liquid investments.

    This isnt just for repairs. This would cover vacancies and other expenses that come up.

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  • J ScottPro Member
    Moderator
    Investor · Sarasota, FL · Member since 2008 · 18k+ posts · 17k+ votes
    15y

    I don't hold many rentals, but my general strategy is to keep a separate account for each, deposit all rent into that account, use that account to pay for expenses and mortgage, and then once that account reaches 6 full months of rent, start diverting payments for other business uses.

    So, basically, I build to 6 full months worth of reserves, and then maintain that level.

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  • Account Closed
    Full-Time Investor · Charlotte, NC · Member since 2009 · 2k+ posts · 1k+ votes
    15y

    i have reserves to cover me for 6 months should all my tenants leave...but there's a bigger problem if they all get up and go at the same time!!

    1Reply
  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    15y

    You'll need at least 3 months PITI in reserve for each property. This becomes a hefty balance as the number of properties goes up. That three months can be reduced considering that your vacancy should never approach 50% of the units. Any lender will want to see at least this 3 month coverage when you ask for a loan on a new property as well.

    As to maintenance and improvements, having an estimate of when costs will be incurred, say for a roof, you need to have a sinking fund set out to that time line. Each property will be different. I have had properties that booked only about 20% of net cash flow for the first year.

    You should have seperate accounts on the books for each property, but it's not necessary to have seperate bank accounts, but it has advantages. I used a sweep account, to keep money earning the highest rate and accounted for each property (and deals) on it's own book.

    IMO, it really depends on your financial position. If you can write a check for a new roof, there is little reason to put good funds aside in a non-earning account or small seperate accounts. The interest you receive will often be deterimend by the balance of the account.

    It's a balancing act. IMO, there is no right or wrong answer, beyond that 3 months that really stems from lending requirements. Your availabilty to money, either on depoist or borrowed from some source (to some degree) should be considered as well as how long you intend to hold a property. For example, if you roll properties over at 5 to 7 years and you have a 15 year roof on it, I wouldn't set funds aside thinking I'd have to replace it.

    Insurance deductables is another reserve issue. I held a 1,000 ear marked for every 5 policies which I felt was conservative starting off. It depends on how many you have. You should be in a position to pay or deal with the deductable on your very first property.

    Fixed expenses, business license on a property, sewer assessments and other overhead are simply "escrowed" as real estate taxes would be.

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  • Joel OwensBusiness Member
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    OP
    Real Estate Broker · Canton, GA · Member since 2010 · 15k+ posts · 11k+ votes
    15y

    Great answers everyone and interesting to see how everyone does it.

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  • Account Closed
    Landlord · Seattle, WA · Member since 2010 · 3k+ posts · 1k+ votes
    15y

    When initially looking at a property I will build a table of anticipated repairs over the next 10 years or so. I look at the roof, windows, appliances, heating system, AC if there is one, windows, flooring and other large ticket items.

    I also build a list of repairs that I would like to make over time.

    I put together estimates then for when these repairs may need to be made and estimate the cost of the repairs. I usually will estimate on the high sidfe to insure that I am setting a sufficent amount aside for reserves.

    For my single family residences I have had no trouble with reserves because I have very good cash flow.

    It is for multi-family properties that I have developed this reserve schedule to help insure that I always have sufficent reserves on hand. Repairs in this situation can be far more substantial and I have worked with property owners that have been hit with expensive repairs or assessments that only thought they had sufficient reserves.

    1Reply
  • Philip B
    Appraiser · Memphis, TN · Member since 2011 · 10 posts · 2 votes
    15y

    A lot of market participants I've previously worked with use around 5% of the EGI. There is a big debate among some commercial lenders and investors as to the validity of using reserves as an expense item. Some say that a "mom and pop" or non-institutional owner doesn't set aside reserves because they merely make repairs on an as-needed basis. Others say it's a critical component not only in valuations but also perceived risk. I personally think accepting reserves as an expense item is realistic and should be employed. Unless you can estimate the remaining economic life of short and long lived items, forecast accurate replacement costs and dates, I would think using 5% after V&C would be safe.

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  • Rob Gillespie
    Specialist · Cleveland, OH · Member since 2011 · 1k+ posts · 852 votes
    15y

    Depends on the area. In the ghetto, I would have a lot more than the burbs! More turnover and repairs.

    0Reply
  • Brian LevredgePro Member
    Investor · Chattanooga, TN · Member since 2009 · 1k+ posts · 903 votes
    15y

    I try to do 15% for both maintenance and capital expenses combined. What doesn't get used at the end of the year gets rolled over into the next. Imo, this money should not be used to cover PITI reserves, which are completely different. In that department, I think 6 months per property is the target. I don't want to live off my rentals at this time so the more cash I can amass, the better.

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    There are some good answers already. We try to keep about 10% of our long-term debt in cash, which is more than enough to fund periodic repairs or capex. This is primarily because the bank wants us to keep this much in cash. If I didn't require debt financing to grow we would probably keep less.

    A lot depends on how stable your cash flow is each month. We have very stable cash flow month to month so I am comfortable keeping less cash. If we had to stretch some in a given time period we could use our line of credit and hoard cash to get things in line. I don't think anyone is going to be able to give you a great answer to what you are seeking without a lot more information about your personal finances.

    0Reply
  • Account Closed
    Real Estate Investor · San Antonio, TX · Member since 2010 · 122 posts · 17 votes
    15y

    Bryan,

    Is that a covenant in the loan? How many payments are your banks looking for in the bank account?

    0Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    15y

    We don't have formal covenants for the line cited. They are signature lines and that is fine to cover one-time expenses for the size of our portfolio in the unlikely event we take a big dip in cash at any given time.

    As things grow I could see the lender getting more concerned about these things. I generally don't like having a banker tell me how to run my business so I try to finance new growth through equity raises and FTD private money instruments. Banks are a real PITA to deal with right now.

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  • Bill Gulley
    Investor, Entrepreneur, Educator · Springfield, MO · Member since 2009 · 21k+ posts · 12k+ votes
    15y

    Good point Brian, reserves depends largely on the circumsatnces of the properties and your ability tocover the expenses.

    For those who can qualify for bank financing and utilize the best rates in decades, keep in mind that three months PITI is not that soft of a cushion.

    0Reply
  • Andrew Jones
    Investor · Los Angeles, CA · Member since 2011 · 242 posts · 61 votes
    14y
    Originally posted by Rob Gillespie:
    Depends on the area. In the ghetto, I would have a lot more than the burbs! More turnover and repairs.

    Couldn't agree more. In D class properties you need more reserves.

    0Reply
  • Nathan Emmert
    Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes
    14y

    I'm surprised more people don't use Brian's approach with Credit Limits or Credit Lines in lieu of cash. Is having a Credit Card with a $10,000 limit that much different than $10,000 sitting in a bank?

    1Reply
  • Rich Weese
    Real Estate Investor · the villages, FL · Member since 2008 · 5k+ posts · 3k+ votes
    14y

    My religion has always counseled its members to have a minimum of six months reserve in food, water, and cash. I follow that same suggestion on my real estate properties. When I started in real estate, I made sure that I had at least a six months reserve. I've continued that throughout my career, but now as I am older I want to feel even more safe and secure. I'm sure my reserve is considerably more than that now but I am not as interested in creating wealth as I am in maintaining what I have. Rich

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  • James H.
    Investor · Fort Worth, TX · Member since 2011 · 1k+ posts · 450 votes
    14y
    Originally posted by Nathan Emmert:
    I'm surprised more people don't use Brian's approach with Credit Limits or Credit Lines in lieu of cash. Is having a Credit Card with a $10,000 limit that much different than $10,000 sitting in a bank?

    Its not ideal, but my CC is my main reserve right now. I do have enough cash to cover about 3 months of rent, but I don't have a mortgage. I would definitely want more cash if I had a mortgage as I personally don't like the idea of paying credit with credit. As little as I am (in regards to investments), it would be pretty tough to not use anything past 3 months of rents in cash toward a DP on the next property, especially considering I could use my CC in an emergency.

    It is a little paradoxal that the big guys typically hold a smaller percentage of there liablity toward reserves whereas the little guy holds a higher percentage. Yet at the same time, the little guy needs about every penny he has just to play the game.

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  • Rusty Thompson
    Real Estate Investor · Salem, OR · Member since 2011 · 422 posts · 149 votes
    14y

    The wider you spread your risk, the easier it is to recover from a setback. 100% vacancy is likely if you 3 SFR's, but not so much if you have 100.

    1Reply
  • Nathan Emmert
    Investor · San Ramon, CA · Member since 2011 · 1k+ posts · 569 votes
    14y
    Originally posted by Brian Hoyt:
    Originally posted by Nathan Emmert:
    I'm surprised more people don't use Brian's approach with Credit Limits or Credit Lines in lieu of cash. Is having a Credit Card with a $10,000 limit that much different than $10,000 sitting in a bank?

    Its not ideal, but my CC is my main reserve right now. I do have enough cash to cover about 3 months of rent, but I don't have a mortgage. I would definitely want more cash if I had a mortgage as I personally don't like the idea of paying credit with credit. As little as I am (in regards to investments), it would be pretty tough to not use anything past 3 months of rents in cash toward a DP on the next property, especially considering I could use my CC in an emergency.

    It is a little paradoxal that the big guys typically hold a smaller percentage of there liablity toward reserves whereas the little guy holds a higher percentage. Yet at the same time, the little guy needs about every penny he has just to play the game.

    I think this gets into your Debt to Income... the idea of having to make the mortgage payment. If your month to month bills are less than 1/3 of your projected gross rent... in theory, you could make ends meet even at 67% vacancy. You may have to put off some repairs/upgrades/maintenance (or use a credit card) but you wouldn't need your card to make your mortgage payment.

    At the end of the day, it's all your risk tolerance. Mine is pretty high but this is also a long term investment. I don't need month to month cash flow and could even divert cash from my day job to my investments in the care of dire emergency.

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  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    14y

    Great thread.

    I just wanted to point out that cash hoarded is really "investing in dollars." The inflation-adjusted yield on investing in dollars is likely negative. So there is a real cost to keeping reserves. Credit lines are excellent for funding large expenses.

    Of course all of this needs to be balanced with keeping the banks happy and the discount achievable by writing your contracts as all-cash with no financing contingencies. If you start a private equity fund you essentially have inefficient access to the capital markets and can officially tune your balance sheet like a bigger company would. This also allows one to trim how much money they invest in cash.

    1Reply
  • Bill Mauldin
    Real Estate Investor · El Reno, OK · Member since 2009 · 17 posts · 5 votes
    14y

    I generally don't keep a whole lot of cash. Usually when my reserves get large enough I'll buy another property. However, I've got a large LOC extended off a free and clear property to satisfy any unforeseen expenses.

    1Reply
  • Bryan Hancock
    Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
    14y

    I am considering setting up a LOC on a free and clear property too Bill by moving some money around on my balance sheet. Have you explored selling the property with financing and pledging the cash flows for a hypothecation loan? If so, do you know who may loan on these cash flows?

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  • Bill Mauldin
    Real Estate Investor · El Reno, OK · Member since 2009 · 17 posts · 5 votes
    14y

    Bryan I haven't even considered taking that route. Our rental market is so strong with quality tenants I'm not even considering selling with financing. Currently I'm carrying 1 note and I really wish it was just another rental.

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  • Levi Gale
    Real Estate Investor · Tempe, AZ · Member since 2011 · 102 posts · 27 votes
    14y

    What if you own your portfolio free and clear? Would you decrease the amount of reserves you keep, or refi and readjust your reserves to your preference?
    I'm surprised so many on here have such a large DTI, and am intrigued by the use of credit for reserves. I like the info this thread has put out thanks to all that have contributed.

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