Why Have Reserves? How much do you keep on hand?

7 Replies

I have seen multiple threads and discussions on BP surrounding the questions of reserves. SO, I won't ask the same question again but pose it from a different angle. If all of the following happened to you, do you feel comfortable with your current level of reserves. 

Here is what has happened in the past 60 days:

-Sewage backup in a quad. The result was needing a clean out installed which required the front yard to be dug up and the lines then hydrojetted. 

-two different quads had upstairs bathrooms have plumbing issues that caused water to leak through the floor into the units below.

-two property fires - One of the fires was in a quad and was thankfully contained to the one unit. I have great coverage that included rental income loss, but I still had to come up with the unit in a quad. The second fire was in a condo, while the fire was fairly small, it set off the sprinkler system and two sprinkler heads doused the entire unit. The HOA master policy was recently changed and the deductible was increased from $5k to $25k. This left me with a gap in coverage in my personal policy. The tenants also cancelled their renter's insurance. I am now fronting the repair costs while my attorney works with the insurance companies, HOA, and pursues legal action against the tenants for damages.

-two tenants each gave their 30 day notice, they were each tenants that I inherited when I bought the buildings they are in. The units have not been updated in 20 plus years so each will need a full turn (paint, flooring, etc..)

Then lastly, while this isn't a maintenance issue, it has caused a drain in my cash on hand. I just purchased a new quad and the loan I got included funds for renovations, but the construction draw is paid out after work is done and verified by an inspection and invoices. I not only had put up money for the down payment but have been cover the renovation costs in between draw periods.

This summer has been the perfect storm of maintenance issues and has tested not only my level of reserves but my resolve of how bad I want to be a real estate investor. Every property I own has had a $1,000 plus issue come up on it. 

With all of this in mind, do you feel you and the level of reserves you have are enough for a perfect storm of maintenance issues?

Hi Andrew,

Based on what you are telling me you bought wrong and now unfortunately are paying the consequences.

The fire thing may or may not be related to the condition of the property. The plumbing issues before buying did you have a plumber scope the sewer lines?? They take off the toilets and run cameras to the streets main.

Inheriting crappy tenants you should plan for vacancy and major repairs and loss of rents.

The type of reserves depends on asset type and condition of the property going in. Reserves are subjective and for loan purposes a lender might feel you need more and you feel you need less or vice versa. You can always carry reserves over the lender minimum.

I hope this situation works out better for you.

No legal advice. 

Hi Joel,

 Some good comments. I don't think I bought wrong, I paid quite a bit under market price for most of the properties. But it is a thought.

With the sewage backup issue - no I didn't have the lines scoped while I was doing my due diligence. With the inspector we tested all the plumbing, all the drains ran fine but didn't scope them. I am sure they were not in the best of conditions, but I am assuming they got more backed up over time. The plumber also said it looked like the lines have never been cleaned out. 

The plumbing leaks - to me it seems a like a bit of a fluke. One happened in a newer building and the other in an older building. 

With the tenant vacancy issues, I don't look at them as crappy tenants, they always paid on time and keep the units quite clean. One had been in there just over two years and the other had been in their for almost 5 years. They both just decided to move at the same time. I also had been building reserves and planning for the units to need major updates when they left. 

For the fires, I don't know if there is anything I could have done differently as it wasn't the result of any electrical issues or building malfunctions. One was a with a grandmother that  developed dementia and put out a cigarette inside which caused a fire. The other was when a tenant was cooking, they were not paying attention and the oil in the pan caught on fire, they panicked and threw the pan in sink, the water caused the grease fire to spread. The actual fire damage was minimal, but the smoke caused two different sprinklers to go off, and a majority of the damage came from the gallons of water poured out of the sprinkler system.

Part of it is you just never expect for multiple major issues to happen at multiple properties all at once. Thankfully I had reserved and had been building them.

@Andrew Kerr  wow have never heard of so much in the way of disasters. Hopefully these problems are freak accidents and not par for the course.

I would take a close look at your tenants. Any more accidents and they need to leave. 

Some places are just a lot of problems and when mine go in that direction they get sold.

As far as reserves go you are pretty young to have much in credit and/or back-up funds. At my age there are no worries because time has been good to us with appreciating properties and good credit. When starting out though there were no reserves and no room for vacancies. Good luck.

@Andrew Kerr  

 your experiences are more common than people want to admit.. we just never get people posting this part of the investing experiences... there was a thread with a young lady out of state or country that had the same issue she had to put her tenants up in hotels. Or another lady in Memphis whos house kept getting broke into while she was trying to renovate... These are the risks.  you can mitigate risks by buying the nicest property you can and do some basic due diligence up front like Joel said.  Sewer is a main issue. When we bought houses for our portfolio we just matter of course changed out the sewer line to the street during rehab unless it was obvious there was a new PVC pipe.

having owned hundreds of these types of rentals you can get lucky and things go smoothly for a while but at the end of the day your going to be fixing something all the time as you grow your portfolio and deal with tenants just what the bizz is.

undercapitalized investors are not as common as the were pre 08  with so many paying cash or large downs.

@Jeff S.   Yeah, I hope this is a freak streak of accidents. It got me thinking, I feel I have had a pretty good run, the last major maintenance expense I had was probably 2 to 2 1/2 plus years ago. Guess it was time it came around. 

I was already considering selling the condo cash out the equity. You make a good point to just sell something if problems persist. 

As far as reserves, I build into my acquisition cost a small start reserve and then since I haven't needed the cash flow each month I have been trying aggressively build reserves. But still with it all hitting at once, it drained me quite a bit. I am also lucky to have good credit and two citi cards with pretty high limits so I have been putting the renovation expenses on the credit card and then paying it off each time I get a draw from the bank.

@Jay Hinrichs I agree with you that some of the experiences I have are more common than a lot of people admit. That is a big part of why I wanted to put it out there. Let people see it as an example of what can happen and use it partly as a lesson learned and also to let someone that is going through something similar they are not alone.

I will definitely keep plugging along and learned a while back that this business has ups and downs.

@Andrew Kerr  

  agreed and that when these investor look to buy out of area with TK and west coast marketing folks they need to understand the proforma's these companies create are very best case scenarios and your actual results may vary  ( that sounds like disclosure).. I have seen all manner of sales material over the years and many do not put any maintenance in or vacancy in the proforma.. they rationalize that a fresh rehab and fresh tenant you won't have that .. well MAYBE in year one then the reality sets in and your 12% preforma becomes a 6% reality.. and then maybe investing in fixed debt looks better and better all the time.. NO emotional roller coasters if you buy the right debt.

@Jay Hinrichs  - Hope we post our lessons learned and not paint only the bright side of the story

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