Among all the reasons investors say they don't want to work with a property manager, there's one they usually leave out. They don't say it. But I'll say it.

How much reserve is the property management company requiring you to keep with them?

Some companies ask for $0. Some ask for $5,000.

And for a lot of investors, that number becomes the deciding factor.

How much reserve should you have?

Especially if you're buying rental properties in Cleveland where properties are about 100 years old.

What the manager requires you to keep with them is only part of what you really need to have available.

And if you're buying from an investor whose mindset is "we don't fix until it's broken," you're inheriting a property where the roof could go out, the plumbing may need upgrading, your electrical may be outdated, your furnace, and the list goes on.

You know what I'm talking about.

But let's say though your manifested wishes came true and none of that happens.

Say everything works.

You still have vacancy.

And vacancy doesn't come by itself. It comes with cleaning costs/repairs/utilities/leasing costs.

Sometimes vacancies come with vandalism and months of not being able to place the right tenant.

And here's another thing investors underestimate.

Just because people are applying doesn't mean they're qualified.

We're not putting somebody in a property just because they showed up.

That’s how you create bigger problems down the road. That’s how your property ends up becoming a “Tenant from Hell” story.

Now you'll hear investors throw around things like:

"You need three months of reserves."

Three months of what exactly?

Taxes/Insurance/Maintenance/Mortgage/Utilities?

That sounds good, but as a general reserve, it's not very practical.

The way I look at it, reserves fall into 4 different buckets: maintenance, vacancy, operating reserves, and CapEx.

The first bucket is maintenance reserves, and most investors account for it when they set 10% aside in their pro forma.

These are the everyday things.

The plumbing call/garage door repair/lock replacement.

That's what that number is supposed to cover.

Let's say the property generates $36,000 a year in rent.

Maybe you're allocating 10% for maintenance.

That's $3,600 per year.  That's not money you've already collected.

Here's the thing though.

You don't collect it upfront.

You build it over time from collected rent.

Which means you need money available before you've had time to collect it.

The second bucket is vacancy reserves. That allowance may be accounted for on the pro forma.

Again, that reserve usually gets built from rental income over time.

But what happens when the vacancy comes before you've accumulated enough reserve?

Then there's operating reserves.

The money that keeps the property running when income stops coming in.

Mortgage payments/Taxes/Insurance/Utilities/Property management fees/Landscaping/Snow removal/HOA/Lead certification/Rental registration.

Most of these costs, you’ll see in a pro forma analysis. You see how they apply when the property is in service. But they’re not necessarily accounted for in the context of reserves.

These expenses could be in your analysis, but have you set aside money in the form of reserves to cover them when the income stops?

Enough to cover everything required to keep the property functioning.

Vacancy and operating reserves can cover the same bills. These buckets describe what the money needs to cover, not four separate balances you automatically add together. So, don't count the same expense twice.

Now, add those numbers up. How long could you cover them if the tenant stopped paying? Three months, six months?

The fourth bucket is CapEx.

The roof/The furnace/The sewer line/The water line/The big-ticket items.

The things investors know are eventually coming but often pretend aren't.

That has way more to do with the actual condition of the property and what your future plans are for that property.

Maybe the roof is 20 years old. Maybe the furnace is nearing the end of its life. Maybe you already know you'll need to address something major in the next few years.

And today you also have to think about things like lead compliance.

A lot of investors buy a property and don't think about Cleveland's lead-safe requirements until the city puts the issue in front of them.

Then suddenly they're dealing with inspections.

Repairs/Contractors/Clearance testing/Deadlines.

And costs they never budgeted for.

And this is where I think a lot of investors drop the ball. They think reserve means the 10% maintenance allocation on a pro forma calculation. That's only one bucket, friends.

That's why you need reserves that cover the four buckets. They keep problems from turning into emergencies and help keep your investment solvent, so you don't become a distressed seller.

The safer bet though, is not to bet on the rent from the property to build the reserve. It's having that money upfront, from the onset.

So that brings me back to this.

A property management company asks for a $5,000 reserve.

Many investors immediately see that as a problem.

I get it. That money is tied up. You can't use it.

But that money should exist whether it's sitting in your bank account or sitting in the property management trust account.

Who holds it, how it's accounted for, and what they can spend without your approval still matters.

The point is to have it available so they can address things quickly if an emergency comes up, within the spending authority you've agreed to.

Now, does that automatically make them a good property manager?

Of course not.

There are plenty of other things you should evaluate.

Most investors think they're just in the real estate business.

They're also in the risk management business whether they realize it or not.

And that's where a lot of investors end up paying what I call the ignorance tax.

It is what you pay when you don't know what you don't know.

It's the cost and stress when vacancy lasts four months, you planned for four weeks, and you don't have enough cash to cover the shortfall.

It's the tenant you approved because you didn't want to wait for a better one.

It's the lead compliance issue you never budgeted for.

Because eventually every investor faces the same question:

Do you have enough cash to handle what's coming next?

And if you're buying 100-year-old houses in Cleveland, the answer better be yes.

Because Cleveland has a way of collecting the ignorance tax from investors who aren't prepared.