Cash Reserves/ Rainy Day Fund

17 Replies

In case you missed it, the online rent payment company eRentpayment has had  major issues when their payment processor filed Ch 7 bankruptcy and casued a lot of investors rent to not get deposited. This started quite the spirited debate about cash reserves in this thread: https://www.biggerpockets.com/forums/52/topics/499...

At the suggestion of Dima Kassim, I figured this topic deserved its own thread. 

How do you determine how much cash to keep in reserve for each property and do you change it as you buy more properties? 

There are a lot of great blog posts on this and here are just a few:

https://www.biggerpockets.com/renewsblog/2011/04/0...

https://www.biggerpockets.com/renewsblog/2012/12/1...

https://www.biggerpockets.com/renewsblog/2015/05/1...

I'll start the ball rolling: I use the very unscientific metric of three months of expenses and what the two most expensive repairs on the property would cost. I try to follow Warren Buffets rules of investing: " Rule Number 1: Never lose money. Rule Number 2: Never forget Rule Number 1."

What about everyone else?

I don't have anything legitimate to add to this discussion, but I thought it was worth discussing, so I figured I'd post to keep it active and hopefully draw attention to it.  :-)

I use a property management company and have a good bit "in reserve" that I keep in the stock market.  Okay, really, it's just my investments, but when I need something done, that's where I get my money.  So, either I have hundreds of thousands of dollars in reserve or nothing, depending on how you look at it.  lol

If you're interested, I've had a SFH for about 15 years and 2 sets of duplexes for about 8. So far, so good. But I have had to dip into my investments before for things like a new a/c and will be doing it again for new carpet as tenants move out of the duplexes. In some ways, how I do it isn't ideal because I might have to sell some stocks before I'm ready because I need to suddenly buy a big ticket item (like a new a/c). Not to mention, there is the risk of the market tanking and me losing a bunch of money, but in that scenario, my rentals aren't my primary concern as they typically don't have a lot of issues anyway. On the other hand, in the market, I'm making a lot more than I would if I kept it in a bank account, so for me, it's worth it. Not to mention, I don't always have to sell as when I sell, the money goes into my money market account automatically. If I'm lucky, when I suddenly need money, there's some in there already.

So, that's what I do...nothing.  lol

It's funny you bring up stocks. I'm a day-trader and I usually have my bank and brokerage siphon 10% of my earnings into an account with a credit union that I never use. My bank (Chase) has it where 10% comes out every month and, since I'm too lazy to go to the credit union, the money never gets touched. So whatever I have in my Chase Account is what I have to work with. It's good to know my laziness can actually work in my favor.

Generally speaking, though, I like to have about 3 months reserves, even though it's much more than that right now.

@Dima Kassim I like how you use your laziness to your benefit!  I always say, "Life isn't about being perfect, but about working around your imperfections."  You've found a perfect answer for one of your imperfections, not just working around it, but using it to benefit you...Genius!  Great job!

Thanks Jody! For once, being lazy works!

The good thing about keeping those reserves is that they send me a statement letting me know how much is in there, which helps when I'm going to buy a property and the mortgage company wants to see reserves for the property I'm about to purchase. 

Have you considered doing the same? There's a little bit of laziness in all of us...

Oh, Dima, there is a WHOLE LOT of laziness in me!  Hahaha! 

I recently got medically retired from the Army and am living on my disability check for the moment. But I hope to go back to school this fall to become a social worker and do discharge planning for the VA or something else so I can apply my 12+ years of Army service toward another government retirement. When I have another job, I think your idea is great...minus the part where I open the mail telling me how much I have set aside. That will just encourage me to spend it. ;-)

I would like to see this thread gain more traction as it is indeed an important topic! Many people do not have enough reserves--both for their rental property business or even for their own personal financial health--and it would be fantastic to see us as a population be better with our money.

For personal expenses, I ideally like to have 6 months of all my expenses (mortgage, utilities, food, misc, every single monthly bill, even the ones I don't *need* to be conservative). But I am still okay if I have 3 months of reserves.

Regarding properties, I generally break it down by the property even if some of them have 2 units in them. I've averaged out repairs from past years and again went conservative by rounding up. I then decide to save roughly 4 months' worth of expenses per property.

The rule of "pay yourself first" is a great one to remember.

I have started a few threads on reserves only to be met by crickets. For me, I want to have 6 months of PITI per property, no matter how many I own. I count my reserves as any cash/stock I own + 50% of my 401k (although some banks will count more). Then any additional "cash" I would have after those reserves are met, is the cash I can use to invest in more housing.

That thread about E-Rent only increased my suspicion that plenty of REIs swim naked. 

I know people can get excited from early success, but slow growth is key. I know another REI who is my age, he is racking up 4 plexes in a war zone area. When I asked him about reserves he rattled off LOCs and CCs as his "reserves". Completely ignoring that LOCs and CCs can be frozen.

@Dima Kassim @Jody Schnurrenberger @Peter T. @Nicole W. Thanks for responding with such great answers. 

It seems like most of us are in the ball park and have thought out some metric. 

I agree this topic does not get the attention it deserves in the forums or on the podcast and we have seen the effects with the ERP failure. It is fun to talk about creative financing strategies and doing deals. Telling folks you are saving 2x the down payment of your next property so you have reserves from the get go... that's kinda lame, I'll admit it. Though lame and boring keeps you from taking massive losses. I did appreciate the swimming naked analogy Peter, though the tide hasn't gone out in awhile so we don't know for sure who decided to forgo their swimsuit.Though when you look at the blog posts about reserves, it is mostly the serious investors who have authored them.

I agree 100% with Nicole's point that reserves help not only in REI, but life. I think people approach RE just like they do their personal finances and that comes back to bite them. Lots of folks start REI and don't treat it like a businesses in their mindset, preparation, or execution. Peter and I saw this in the ERP forum post with some of the very passionate responses to our posts.

Peter and Jody: you guys aren't worried about, in essence, cross collateralizing you reserves with your equities/retirement? My largest concern with holding reserves in high volatility assets would be the stock market having a flash crash or something similar at the same time I need a major repair and I've just undid years of gains in my equities investment.

@Bill F., am I worried about cross collateralizing?  Not a bit--mostly because I don't know that that means.  lol

I'm not too worried about suddenly needing money and the market just crashed.  There are several reasons for this.  

1.  I have a great/genius broker.  When the market fell several years ago, I was still okay.  I lost some, but nothing compared to what other people lost.

2.  I almost always have some cash in reserves for the market so if he sees something I need, he can buy it.  Or, perhaps because he's just sold something.  Either way, I almost always have several thousand waiting in the wings.  Admittedly, it's not getting the most interest at that time, but I prefer to have some gathering only a little interest so that when my broker sees something hot, we don't have to sell something else too early and lose some profits there.

3. My SFR is fully paid off, so I could take out a line of credit there if I needed to.

So, what is cross collateralizing?  lol

Originally posted by @Bill F.:

@Dima Kassim @Jody Schnurrenberger @Peter T. @Nicole W. Thanks for responding with such great answers. 

Peter and Jody: you guys aren't worried about, in essence, cross collateralizing you reserves with your equities/retirement? My largest concern with holding reserves in high volatility assets would be the stock market having a flash crash or something similar at the same time I need a major repair and I've just undid years of gains in my equities investment.

That's the risk I take with holding stock. I understand that risk. I had to sell stock when BREXIT happened...still made money in the long run, much better than having my reserves be in cash and earning diddly squat. The greater point, IMO is to have proper reservers..."credit" (CC, HELOC) is not a reserve...cash, equities, metals, bonds are.

@Jody Schnurrenberger   "Cross collateralization is the act of using an asset that is currently being used as collateral for a loan is also used as collateral for a second loan. If the debtor was unable make either loan's scheduled repayments in time, the affected lender(s) can eventually force the liquidation of the asset and use the proceeds for repayment." From Investopedia You aren't technically cross collateralizing since you don't have a loan secured by an asset, but you kind of are by designating your investments as a reserve. Now if you plan on using the cash in your investment account, I don't think that is any different than having the cash in a savings account as long as you know if your broker makes a purchase that you have increased your risk until you put up more cash. 

@Peter T. You nailed it, as long as you know the risks that is all that matters. Most people I get the feeling have never thought of the risks and that is where the real danger lies. You have a higher risk tolerance than I do, one of us isn't right and the other wrong; we operate differently.

I think we also need to make a distinction between holding your reserves in equities and using your investments as your reserves. The former is more risky than pure cash but can yield better results. The later is when you get the bleed over into cross collateralization and start to dilute any benefits that diversification between the stock market and REI you have. Some people spend a lot of time chasing yield and miss the fact that they have taken an more risk for lower return.

What always kept me from holding my reserves in equities is that there is no guarantee that a dollar of value today will be there tomorrow. I could have reserves of $10k on Monday and by Friday my reserves are at $8k with no change to my properties. What is the old saying "You don't make money until you sell"

The Erentspayment problem is a very unique situation, but has happened before. There have been countless stories where a property manager misspent funds or went bust. But, its an unknown, unknown. You don't know, to know, to plan for an event like that. Where as maintenance and capex are known issues at generally unexpected times. Erents issues is basically on the level of a catastrophic event or a once or twice in a lifetime event. Sort of like a flood, earthquake, or hurricane.

I really think one should have two categories of reserves, those being "Property Reserves" and then "High Liquidity or Credit".

General Property Reserves are there to help with vacancy, maintenance and capex. Items that you know are coming at some point. My rule of thumb has changed over the years. As I am now in all multifamily, and have more units, I am less worried about vacancy as I was when I had my first one or two units or was only invested in a SFR. Then also as my unit count has grown, I felt less of a need for larger reserves as I could easily absorb costs. As an example, if you have one unit with $1,000 in gross rents then get a $1,000 maintenance cost, its a big hit. Where if you have 10 units with $10,000 in gross rents, that $1,000 cost is easier to absorb.

High Liquidity - by having some other assets, not necessarily set as reserves, with higher liquidity, you can weather a storm like the Erents issue. An example would be money in CDs, or a brokerage account (non retirement). This is money that is invested in another means, but, in a tight spot you could pull it if needed. If you had an open, but unused HELOC, you could pull on it.

Diversity - by having a larger portfolio of units, with different property types (SFR, small multi, medium/large multi, retails, office, etc.) spread across different MSA you can help set yourself up to better absorb any catastrophic loss. As an example if you are invested in three MSA, and one MSA has an economic downturn from say a military base closing, you are better prepared. Or say you have mountain and coastal properties, and a hurricane hits, your mountain properties can help carry you while you coastal properties recover. But, with the Erents issue, if had all your diversified properties with Erents, you would still have a catastrophic loss. This is where High Liquidity comes in.

Insurance, Leverage & Living Below Your Means - lastly, I think these three topics play into reserves. If you have good insurance with rent loss coverage, are not over leveraged (low mortgage costs), and live below your means it’s easier to absorb hits. An example is if I generate a net of $5,000 a month, but only need $2,500 to live on, I can absorb higher maintenance costs and not affect my standard of living. Another example, I had a property fire in one unit of a quad a couple years ago. This fire, while caused some mental stress, financial didn’t even cause me a bump in the road. I had three other units in the building generating rent, my insurance covered all the repairs, I didn’t need to spend any money up front for repairs and in the end I was compensated for rental loss.

Lastly, I want to add as we have been in a very long bull market, to me it makes sense to deleverage a bit (get rid of that one problem property), build up higher reserves, and start to trim extra unneeded expenses to be ready for a downturn.

So that was long and drawn out. Here is my straight to the point example of what I have for target reserves:

2 months mortgage payments per property + prorated capex

I like to have at least two months of mortgage payments in the bank for each property.

$0 for general maintenance - I don't live off my rental income, its all extra, I divested last year of all my older properties, and with my unit count I can easily absorb general repairs from my monthly cashflow.

Prorated amount of Capex - as an example if a new roof will cost $5k and I need a new roof in 5 years, I want $1,000 in my reserves year 1, $2,000 for year 2, $3,000 for year 3, etc..

Then outside of my real estate investment business reserves, I have a personal emergency fund/reserves I could tap into if needed. I also have a non retirement brokerage account I could pull from if needed. Having other liquid assets is helpful and makes me sleep better at night.

Originally posted by @Andrew Kerr :

The Erentspayment problem is a very unique situation, but has happened before. There have been countless stories where a property manager misspent funds or went bust. But, its an unknown, unknown. You don't know, to know, to plan for an event like that. Where as maintenance and capex are known issues at generally unexpected times. Erents issues is basically on the level of a catastrophic event or a once or twice in a lifetime event. Sort of like a flood, earthquake, or hurricane.

I really think one should have two categories of reserves, those being "Property Reserves" and then "High Liquidity or Credit".

General Property Reserves are there to help with vacancy, maintenance and capex. Items that you know are coming at some point. My rule of thumb has changed over the years. As I am now in all multifamily, and have more units, I am less worried about vacancy as I was when I had my first one or two units or was only invested in a SFR. Then also as my unit count has grown, I felt less of a need for larger reserves as I could easily absorb costs. As an example, if you have one unit with $1,000 in gross rents then get a $1,000 maintenance cost, its a big hit. Where if you have 10 units with $10,000 in gross rents, that $1,000 cost is easier to absorb.

High Liquidity - by having some other assets, not necessarily set as reserves, with higher liquidity, you can weather a storm like the Erents issue. An example would be money in CDs, or a brokerage account (non retirement). This is money that is invested in another means, but, in a tight spot you could pull it if needed. If you had an open, but unused HELOC, you could pull on it.

Diversity - by having a larger portfolio of units, with different property types (SFR, small multi, medium/large multi, retails, office, etc.) spread across different MSA you can help set yourself up to better absorb any catastrophic loss. As an example if you are invested in three MSA, and one MSA has an economic downturn from say a military base closing, you are better prepared. Or say you have mountain and coastal properties, and a hurricane hits, your mountain properties can help carry you while you coastal properties recover. But, with the Erents issue, if had all your diversified properties with Erents, you would still have a catastrophic loss. This is where High Liquidity comes in.

Insurance, Leverage & Living Below Your Means - lastly, I think these three topics play into reserves. If you have good insurance with rent loss coverage, are not over leveraged (low mortgage costs), and live below your means it’s easier to absorb hits. An example is if I generate a net of $5,000 a month, but only need $2,500 to live on, I can absorb higher maintenance costs and not affect my standard of living. Another example, I had a property fire in one unit of a quad a couple years ago. This fire, while caused some mental stress, financial didn’t even cause me a bump in the road. I had three other units in the building generating rent, my insurance covered all the repairs, I didn’t need to spend any money up front for repairs and in the end I was compensated for rental loss.

Lastly, I want to add as we have been in a very long bull market, to me it makes sense to deleverage a bit (get rid of that one problem property), build up higher reserves, and start to trim extra unneeded expenses to be ready for a downturn.

Since I "only" lost $1600 with the ERentPayment situation, it didn't have a big financial impact on me since I have reserves in place for all my properties. The real pain was explaining to each tenant how to deposit into my Chase Business Account just to have the tellers tell them something completely different (and wrong). I think that, for people who didn't have reserves, the ERentPayment situation will make them smarter and have at least 2 months reserves in mortgage payments plus 3 months general maintenance from now on.

I like being a day trader specifically for the reasons that Bill F. described when talking about market crashes. My money is never in the market long enough to be affected by crashes, so I'm able to avoid that with the specific way I trade. 

I also like having reserves for when I go to buy a property. Banks are always looking for reserves, and it's always nice to satisfy a requirement without trying. 

@Andrew Kerr Great post that covers everything from reserves to risk mitigation. I like the idea of the tiered reserves and appreciate the Sec Rumsfeld quote. It all comes back to running your REI like a business and realizing that those "unknown unknowns" can occur. General Prop reserves as you call them won't solve the problem, but give you some time to find the optimum solution. Maybe @Dima Kassim can talk more about handling that.

Read an interesting article on Calculated Risk about long bull markets:

http://www.calculatedriskblog.com/2017/11/is-recession-imminent.html

A business! Yes! That's what alot of new real estate investors don't understand. 

When I started, I remember my dad talking to me about reserves. I told him that I have to buy the property first, and then build the reserves off the profits. After I bought the property, I had to make repairs and everything so there were no reserves.

Then came the second property. I bought it using the money I was saving as reserves, so I ended up with two properties with no money for emergencies. I kept making excuses for not having reserves, when the truth was I didn't delegate my money properly. Property purchase money has to be separate for reserve money, which has to be separate from general maintenance money. Thankfully I learned that lesson before anything major happened. It's a business, and should be run as such.

This is a great topic. Generally my husband and I shoot for 6 months of mortgage reserves for each property, and between our liquid accounts+retirement accounts we normally will have at least that much available. But it ebbs and flows; for example we're a bit cash low at the moment because of buying property and a business at the same time. So now we need to take some time to build our reserves back up, especially since I'm adamant about sticking to that 6 month figure!

Personally, I'm quite conservative so I like to have a year's worth of living expenses saved up outside of the property reserves. We've also made up a "bare bones budget", which is a budget that we could revert to if we needed to seriously cut back our expenses. I'm all about saving and planning when it comes to finances!

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