How do you manage your maintenance reserves

18 Replies

Across the forum, we talk about ensuring that you maintain your reserves... but how do you actually manage them on you own the properties? This question is for the properties you plan on holding. If you are flipping, reserves are a different topic I think. 

Do you maintain a separate reserve per property, by class or location, or across your portfolio?

Where and how do you hold these funds? do you physically shift $X to a separate fund on a monthly basis? What is the amount based on - rent or property value, so much per door?

Do you keep the funds in cash or money markets or some other type of account? Or do you rely on lines of credit if funds are needed?

How do you determine if you have enough set aside (ie. perhaps you can invest some of them or need to set aside more). Do you use a percent value of your portfolio? or do you look at what might be needed for each property individually? what is the time frame you use

Your advice and thoughts are greatly appreciated

@Julie Macd

Here is how i self manage my rentals:

1.  Bank account for Rent deposits (you never use any money out of this account) and one for Operating funds.  Keep deposits separate from your operating funds always.  When renting you will have to give the account info where the deposit is held.

2.  I use quicken (you can use excel, mgmt software etc. Just need to be able to label and categorize expenses and income) and when I get paid on the unit i just deposit in operating account and label it by the unit and rent received.  If i have to make a repair I just label property, repair and expense to that unit.  I can pull detailed reports and see what i have spent on each property by the unit and labels.

When i purchase my property i put in the budget of what it will take to get to my standards before i put a renter in.  This way i can keep a low 5% per month repair reserve (you can put what you like) since it will be "Rent Ready" in my eyes,  also i don't get calls on things that I know are not correct from the renter and have to go fix something in the middle of the night and drive up repair costs and my time.  I also keep a 7% vacancy and 8% property management fee monthly (pay myself always even though i don't use any money from my rentals to live).  This way if the property has any unforeseen repairs there hopefully will be enough to cover it.  As far as cashflow left over i just leave in the operating account also.  From the report i Know what i have and I can pull if i needed.

Hope this helps!

Julie, two quick rules of thumb lenders consider, at application for purchase money they want to see 6 months PITI and 10% of the home value in reserves or enough consumer borrowing power to borrow for emergencies, to get them at that 10% level......that has room for +/- and isn't a "requirement" but a "like to see". They won't do a loan where it takes all the borrower's cash and is so thin they can't obtain other small loans.

Maintenance reserves are always a guesstimate because there is just plain luck involved. 

Who knows when the blower motor in the HVAC will burn up or if a kid mowing the lawn hit the condenser hard enough to crack a joint in the line, pressure drops and causes damage? Possibilities for damages are endless.

Investors need to do an assessment of the property condition when they buy and annually. The age of mechanical items, roof, appliances, structure and interior is where you need to begin consideration for the reserves for each property. 

You can look to the IRS tables for depreciation, classes of property will have different periods to depreciate an item. Depreciation is an expense, not a cash expenditure but applies to taxable income. Treat it as an expense for your "use of cash" projections and savings or retained earnings. This should apply to all those who buy and hold.

For those getting into the business, their first or first few properties, then;

I suggest you consider MY Target Goal of 4,3,2,1 done approach to reserves. First year withhold 4% of the long term depreciation, a 75,000 property/27.5 years = 2,727.27. 75,000 X 4% is 3,000. 3% the next year is 2,225, the next year 2% will be 1,500 and year 4 is 750.00 in year 5 you're done saving so long as you don'y use those funds, if you do, "2% will do" normally to replace funds. At year 5 you have set aside 4,475 or 6% as a cash reserve.

Now, you say, gosh, I bought the place to get $150 a month out of it! That's only $1,800, I can't make up that 4% in the first year!       

4,3,2,1 doesn't necessarily have to come out of income, it's a target of the balance of cash on hand for each period. That will mean that when you buy the place, you should already have funds to make up that difference, so in year one to hit $3,000, you can minus out the reserve requirement from income, say $50.00 a month and you should then have $2,400 to start with. 

Don't forget your ability to borrow either. What you don't have in cash needs to be available to you from other sources. The ability to raise cash quickly, let's say 3 to 5 days, most anyone doing work for you or supplying materials can bill you and paid within the week. Accounts with suppliers should be set up, many give 30 days same as cash terms. 

Two major concerns initially are the mechanicals (HVAC) and the roof. Larger or well established vendors in these areas usually have financing available, so know where to shop and deal with.

So, your ability to borrow also plays on that 4,3,2,1 approach. By year 5 you should be in a better cash position but for small investors the ability to borrow will always be a consideration for your use of funds.

As your portfolio grows, beyond 3 properties, you begin to start building a business, not just as an occasional landlord. Your use of cash begins to take on an all inclusive approach rather than a per property view. You can begin by weighting factors of each property condition to a whole rather than individually. This is because 2 or more properties can begin to "subsidize" expenses of an additional property. 

What are the chances that 4 HVAC units will all explode in the same year?  Slim and none!

Concentration of units risks, having 5 properties along one street, additional risks are assumed. While many perils are insured, wind storm, fire, hail, etc. something like a railroad gas car overturning or an oil pipeline breaks, might cause a loss of tenants and that will take time to sort out, all the while, you'll have clean up, repairs and leasing duties to get back into the business.  There are advantages of not having all your eggs in one basket. 

Reserves are not just for maintenance, they are for when stuff hits the fan. 

We call the account "maintenance reserves" that's accurate for a few properties, but as you grow into a business I prefer "Operation Expenses/Reserves" taking in a broader definition for what if the stuff hits the fan. An example of expenses that can be tagged to the business and not so much to a single property are legal fees, compliance costs, office expenses, auto expenses, tools and equipment expenses including replacements.

Initially as a small individual investor, your reserves will be higher per door simply because you can't spread the costs over a larger operation. As you grow, the total of your reserves may be higher in a dollar balance but per door they can decrease as other properties subsidize the "what if" factors. Your expenses become better identified and determinable as well. 

Where you keep cash simply comes under cash management. Reserves should be readily available, so you don't want to hold cash initially in "timed deposits" like CDs. Liquidity is most important to any business. 

When investors suggest using separate checking accounts for each property, that is an obvious admission that they can't manage money and lack basic business aspects to finance. When you go to a lender with a sack full of checkbook statements, it tells them the same thing. ONE operational account. ONE escrow account. A money market is what I used. 

There are four types of financial statements:

1.Statement of Financial Position or your Balance Sheet. Assets-Liabilities=Equity 

2.Income Statement showing income and expenses to obtain net income or loss.

3. Cash Flow Statement or Use of Cash, this shows cash income from operation, investments, the sale of assets other than inventory and financing activities, costs associated with raising capital, interest, principal repayments and timing of the movement of cash can be ascertained.

4. Statement of Changes in Equity or Financial Position or Statement of Retained Earnings.  This measures the owner's equity and cash flow over a period of time, during an accounting period. It shows the movement  of net profits, capital repaid  and dividends or drawing to owners as the take out profits. You can also recognize revaluations of assets (appreciation of properties) and changes in accounting policies or corrections of accounting methods.

As to your management of accounts, you have a "Chart of Accounts" this is a simple road map of  your accounting system. Your Operations Account holds all the money of your business operation and from that general account you have sub-accounts on your books, not as separate bank accounts. You will show income, expenses and retained earnings as they are allocated or assigned to appropriate categories, such as 2336 S. Kings Ave income, expenses and retained earnings. Each property is a sub-account.

A chart of accounts are usually noted by a numeric key, 100's as assets, 200's as liabilities/expenses, 300's as equity. Rent from the Kings property could be account 105, the mortgage payment for that property could be 205, what net can be shown as account 305. You can make up the chart of accounts anyway you like, just so long as how you identify funds is consistent throughout the accounting system. 

The above are the basics of accounting, you don't need to be an accountant, but accounting is the language of business, if you can't speak to these basic accounting functions, you can't talk business. 

If you're running different checking accounts, it's time to speak to a bookkeeper or an accountant, you don't need a CPA unless you're a publicly traded or non-profit company, but they certainly have demonstrated a greater knowledge, that might be important to you, but usually not just setting up your books. BTW, if you believe plain English will get you through Quicken or some accounting program, you're wrong, you need to understand those 4 main areas of accounting to properly input data.    

If you sell a pair of boots at a garage sale, you don't need an accounting system, you do if you're trying to run a shoe store. Your system should be appropriate for the size and scope of the business operation, nothing more. 

So, assess each property as to its economic life and use the depreciation tables to set reserve standards. As you grow, identify the risks assumed and plan for the unknown to be covered. Use your cash on hand as well as your ability to fill in any financial gap for emergencies to meet your target reserve requirements. Keep with the requirement for liquidity, quick cash available. Understand the basic accounting statements, what and how funds are to be allocated, this will guide you in your use of cash and the types of accounts you may use to keep cash on hand and other liquid investments. 

My gosh, I hope that covered your questions Julie! LOL :)

Edited: BTW, I think the above post meant to say keep personal and business accounts separate. You certainly deposit rents as income to your operating account. 

A helpful hint as to understanding basic accounting will be to study "T Accounts" and double entry accounting, it isn't hard. Good luck :)

Updated about 2 years ago

Notice: NEW RULES I mentioned accounting for publicly traded companies being required to follow GAAP, in 16, all businesses will need to follow GAAP due to depreciation and asset recognition rules, no more shoe box full of receipts and a note pad. :(

Hi Juli,

Thanks for asking this question. I have struggled with the reserve question for sometime so I am looking forward to the responses. I will need to read through Bill's response a few times to better understand it.  My approach is to have two accounts one for annual maintenance both planned an emergency funded at the beginning of the year at $50 per month per property and a second for reserves funded at 4% net asset 

Originally posted by @David Chwaszczewski :

@Julie Macd

...

1.  Bank account for Rent deposits (you never use any money out of this account) and one for Operating funds.  Keep deposits separate from your operating funds always.  When renting you will have to give the account info where the deposit is held.

...

Terminology being used in this snippet is confusing. I believe that instead of "rent deposits" it was intended to be worded "security deposits". Some of us have rent deposits every month that belongs to the landlord but only get a security deposit one time that belongs to the tenant in the end. 

I try to keep it as simple as possible. I have 7 rentals. I use quick books to "manage" my operation funds which I keep in one cash account. Very easy to track income and expenses for each door. I keep 3 months of the total PITI for all properties as my minimum for the operating account. For me that has covered any vacancies and all repairs. I reset it every month and use any leftover money for upgrades to the properties or transfer to another investment account. If I have a large repair bill it may take a few months to recoup.

@Steve Babiak  you are correct.  I meant to say Security Deposit.  I was writing this before the coffee kicked in. :-)

Thanks for the correction.

That clears that up, LOL, @Alison Robinson

 Sorry it's thick reading. 2 Accounts, an operating account; this is the main business account, it's your treasury department. The treasury sends checks out through different departments of your overall business operations, each department has it's mission, one pays mortgage payments, another pays taxes, another buys office supplies yet another pays for maintenance. These departments have names, they are listed to be identified as to their function and the functions may have multiple activities so we number the activities to better identify where the money goes.

The other account is an "escrow account" deposits are not income, they belong to others, not you, you are in some states required to hold funds held in trust in an escrow account. The only funds that may go into an escrow account are the amounts necessary to maintain the account, paying bank fees and funds held in trust. If you deposit any other funds other than funds held in trust, you violate your duty to hold funds in trust and most likely, state law as laws pertain to escrow deposits, withdraws and the maintenance of such accounts. 

Having other checking accounts would be redundant, additional bookkeeping, more costly and isn't good money management. Let your treasury department account for all income and expenses, that system will give you your net operating income anytime you ask for it. Good luck :)     

@Bill Gulley thank you for the very detailed response. This is incredibly helpful to put in perspective how to start out to crate and maintain reserve balances, but also how to manage as you grow. While I only have one door now, I am very much hoping to expand into larger portfolio. As my assets grow, I want to ensure I have sufficient reserves on one side, but not overdoing it and slowing down my ability to invest in new properties.

As for the accounting lessons, I am an accountant by training, though I am still managing my accounts in excel....

@David Chwaszczewski @Brad Griffith

 @Alison Robinson

Thanks as well. All the responses help to find an easy way to track the reserves. Sounds like overall you leave the 'maintenance' type reserves by ensuring you have enough in your operation accounts.

Security deposits are always kept in a separate account in any case.

Originally posted by @Julie Macd :

Across the forum, we talk about ensuring that you maintain your reserves... but how do you actually manage them on you own the properties? This question is for the properties you plan on holding. If you are flipping, reserves are a different topic I think. 

Do you maintain a separate reserve per property, by class or location, or across your portfolio?

Where and how do you hold these funds? do you physically shift $X to a separate fund on a monthly basis? What is the amount based on - rent or property value, so much per door?

Do you keep the funds in cash or money markets or some other type of account? Or do you rely on lines of credit if funds are needed?

How do you determine if you have enough set aside (ie. perhaps you can invest some of them or need to set aside more). Do you use a percent value of your portfolio? or do you look at what might be needed for each property individually? what is the time frame you use

Your advice and thoughts are greatly appreciated

I have a single reserve account for all of my properties. I don't have partners or use an LLC, so this is acceptable. I keep the money in a savings account, it is 100% necessary to be able to access these funds quickly and easily. I keep all the money in cash. I do not rely on credit for reserves as I hate using short term unsecured debt for anything.

In terms of the amount, I keep 6 months worth of mortgage/insurance/tax payments for each building in reserves, or about $18,000 for my three 4-plex properties. I use that amount as a reserve to pay for maintenance that costs too much to be covered by monthly rents.

In honest truth, I do not know if I have enough set aside, but I will say that my monthly cash flow has been able to cover a lot of the maintenance and repairs, and I only had to go into my reserve account once in the last 1.5 years, when I completely rehabbed a unit.

402-965-1853

@Julie Macd

I should read profiles before posting, I'd save a lot of time! LOL, I would not have gone into the Accounting 101 stuff. 

Then, heck, we can have fun with this!

(Note FASB #5 to reserve contingencies with losses being recognized at the time of the loss as you formalize your accounting system into a business mode.) 

 I use a MIRR approach to the present value of expected losses for major repairs. That keeps reserves lower over time to the remaining economic life of an asset or in real estate, a part thereof.  

I mentioned all that 4,3,2,1 done primarily for newbies getting in the business, as a guideline to a goal.

As time goes on, experience will kick in. Many keep too much in reserves lessening the ability to operate, but that's better than being short! 

My buy and hold strategy has never been long term, 7 to 12 years as the rate of depreciation decreases, then inventory is turned over. Inventory is then replaced, rinse and repeat. This also directly impacts reserve requirements, let the new buyer replace the roof in 5 more years!

Identify your strategy first, holding inventory increases holding costs, expenses go up in time, tax benefits decrease but rents can go up long term. Being mortgage free means the cash flow can take care of many of the maintenance issues too. 

With your experience, I think you'll do great! Good luck :) 

Just recently created a new account for CapEx funds that will cover all properties. After calculating how much should be set aside each month, I set that amount up to auto-deposit from my general checking account (where rents are deposited and bills are paid).

By grouping the CapEx funds for all properties together the balance in that account will grow much more quickly (and hopefully in time for when something big breaks down) than if I had a separate CapEx account for each property.

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@Bill Gulley Will you be taxed on any money you set aside for emergency repairs or CapEx?

@Lauren Norman

you will not be taxed on money set aside per se.. you are taxed based on income less expenses including depreciation.

having a reserve is to ensure that you have the funds to cover yourself when something unexpected happens whether vacancies, repairs, etc.

good info here! Ive been wondering the same!

Originally posted by @Lauren Norman :

@Bill Gulley Will you be taxed on any money you set aside for emergency repairs or CapEx?

 The tax hit depends on the entity you use, take it as income and yes, you will owe taxes. You can avoid taxation if your retirement account earns the income at least it's deferred.

I never had an issue with making money and paying the taxes, it's the joy of making money in our capitalistic system! Give unto Cesar what is Cesar's. But no more! :) 

@Bill Gulley

You mention using a money market account.  I was under the impression that you cannot use an interest bearing account for business.

Is an escrow account looked at differently?

Originally posted by @Hugh Ayles :

@Bill Gulley

You mention using a money market account.  I was under the impression that you cannot use an interest bearing account for business.

Is an escrow account looked at differently?

 Escrow and business accounts are state specific and if a bank is under a national or state charter, the types of accounts and what they offer can vary, but a depository can pay interest on funds held by a business and they may index an account to most anything they like, their prime, WSJ prime, bonds, or a published rate.

A bank may also have a minimum balance required, I had money market rates with my mortgage company operations account and as I recall the minimum was 50K. 

You can find MMA rates here:

 http://www.bankrate.com/partners/sem/savings-accou...

Escows can be very complicated, funds held in trust are subject to state law first but may have federal  laws applicable to the types of business or industry, if the depositor (like your tenant) is required to be paid interest, if any is paid. Usually, it is not an interest bearing account and you really don't want interest as it requires more accounting and rebating interest at some point, best just not to go there, IMO. Funds in escrow isn't your money and the interest isn't yours, but if interest is paid, a fee may be allowed for the maintenance of that account.

There are also commercial accounts with mutual funds and bond or stock indexes, Vanguard and other brokerages may offer a depository relationship. :)

   

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