How Much Liquidity To Carry In Your Portfolio
Investor · Round Rock, TX · Member since 2010 · 8k+ posts · 4k+ votes
For those of you with sizable rental portfolios with debt on them I was wondering how much cash you keep as an overall percentage of your long-term debt. We have been targeting 10% liquid for every dollar of long-term debt. With this constraint we have limited our debt burden and kept ourselves from being overleveraged.
Does anyone else use metrics like this or something else to determine how to prudently grow a long-term portfolio? We also use debt to equity ratios, but I find those less reliable than analyzing cash as a percentage of debt.
I tend to do things a little different than most people. I own 7 properties, of which I have mortgages on all. I always have enough reserve to cover all the mortgages for 1 year. That is the rule I use. My mortgage guy tells me most people are not in that position, and that my be an error on my part, as I know in order to make money in this business you have to leverage alot, but I have also seen alot of guys think nothing is going to go wrong, or everything will just work out. I am more conservative, and that my be the reason I only own 7 properties verse other friends of mine owning 100+. I also have small children, so that is in the back of my mind always.
I plan on building a single house later thin year or early next year. I got the final approval this week. In a deal like that, most people would borrow the money, but I am going to do the deal 100% cash out of pocket because I am not sure how long it will take to sell, and I don't want to pay the bank all the interest. I figure I will only be losing a small amout if interest having the money in a CD. Just my take on things.
I tend to do things a little different than most people. I own 7 properties, of which I have mortgages on all. I always have enough reserve to cover all the mortgages for 1 year. That is the rule I use. My mortgage guy tells me most people are not in that position, and that my be an error on my part, as I know in order to make money in this business you have to leverage alot, but I have also seen alot of guys think nothing is going to go wrong, or everything will just work out. I am more conservative, and that my be the reason I only own 7 properties verse other friends of mine owning 100+. I also have small children, so that is in the back of my mind always.
I plan on building a single house later thin year or early next year. I got the final approval this week. In a deal like that, most people would borrow the money, but I am going to do the deal 100% cash out of pocket because I am not sure how long it will take to sell, and I don't want to pay the bank all the interest. I figure I will only be losing a small amout if interest having the money in a CD. Just my take on things.
Any other takers on this? I am doing some planning for next year and some helpful comments are appreciated.
I only have 2 rental units, so my response probably doesn't carry much weight, but I'm in the 'keep more in reserve than you could ever possibly need".
My reserve is in my personal accounts, my rental accounts have very little excess since I've not been at it that long.
Regardless of where the funds are, if I don't have enough liquid assets to carry me for a year at the very minimum (business and personal) then I'm not fun to be around.
I err on the overly cautious side.
I keep a reserve based on 6 months of costs and debt service for my rental, assuming it is vacant. This would also cover any major repair that might occur.
For multiple properties, I believe you should establish a similar replacement reserve for each. On commercial properties, many lenders require an escrow for such replacement reserves based on age and condition of the property. This actually is a good way to save for that rainy day.
My cash varies. I keep anywhere from 4-6 months of expenses along with cash for new purchases. It is very rare that I would only have 4 months of expense money set aside though.
I own 22 properties with a total of 28 units. All 22 properties have debt but the cash flow on them covers all of my expenses which include vacancies, turnover repairs, ongoing repairs & maintenance and the taxes and insurance on non escrowed properties. I still have enough cash reserves to cover my mortgages for at least 6 months. For me that is a little bit less than 10% for every dollar of long term debt.
It would be unlikely to have all of my properties go vacant and stay vacant for that long. Things would look very different for this country should that occur!
Thanks Jonathan....I am thinking 6 months' worth of cash to service all of my debt and living standard expenses. That is likely a better metric than a percentage of long-term debt.
Ideas? I hate tying up assets in cash if I can keep them working, but I recognize that cash or access to it are good for jumping on opportunities too.
Bryan, I feel like I'm familiar with your business (not saying I am, just that I kinda fell it, if ya know what I mean).
Private investors that you may have or seek to have will prefer doing business if they know you can take them out of a deal. Doesn't mean it's a reserve requirement, it means having others ready to step into thier shoes. OTH, having assessed the risk of default from your borrowers, I suggest 6 months coverage in addition to 15 to 20% to make up any difference in liquidity. Meaning, you can borrow money to take out a private lender at 80% from another investor and acquire 20% in short term financing from your reserves or other assets that can be moved in 30 days...most private investors will be happy getting out in 30 days. If you do have non-recourse debt, I would not consider that as an alternative to walk out on anyone or a strategy, cover the debt as any other, IMO.
6 months debt service should be sufficient for conventional financing. This depends to on the size of your portfolio, what's the chance of something happening that hits every loan? So, I looked at 25% of the total
at 6 months and that can flutuate some, like over a thirty day period arisng from float and maturities. it should not just be setting there.
While most probably are not there, one year for reserves for your personal life is really the goal, your personal financial security should not be milked by a poor quarter, IMO.
Liquid assets, cash, should be utilized in short term uses. You should implement a maturity distribution for funds. Easiest way to explain this is having say 25% in CDs maturing in three months, so that every three months money is readily available. Timing your obligations to scheduled maturities is a trick but will allow you to reduce reserves providing options.
Assessing what reserves should be is really born out of assisng various risks.
Maturity of obligations and events that reuire payoff before they are contractually due is a management decision and should lean toward meeting demands, even if you are not required to do so....your reputation is your most valued asset. Some 80 year old lady does not care what your contract says if she really wants he money for an operation!
Risks such as vacancy, really stand on the market, worst case, what's the vacancy going to be and are you properly insured so that an insurable loss does not put you behind, check and make sure you have loss of rent coverages. Otherwise, your market should reflect the risk and stagering your leases will reduce larger vacancy rates at one time. 20% of the portfolio debt service should be allocated as a minimum.
Rehabing, reserves are really on a case by case basis at the time and I don't see you actually participating in such matters, but to the extent as a financing conduit, so refer back to the 80% refi thoughts.
I might be rambling now.....but reserves should be assessed to the risk assumed less amounts that can be transferred, to an insurance company or to other investors of by selling of refing the deal.
Each aspect or portfolio represents a risk where reserves should be set. From this total risk, look to ways of financing or leveraging that contingent liability at that 80/20 ratio, in other words, you don't need 8,000 reserves for rentals, 12,000 for loans, 30,000 for investors, since the likelyhood of all of these aspects would not be due at the same time. Be able to borrow and move reserves to manage 80% (40K in the example) of the total and have 20% in you cash, on hand reserves or 10K.
As this grows, say over 100K, you can begin reducing the per centage, from 20% down, but I would never dip below 15%.
Compare this too, as you said, in your debt/income ratio to command reasonably expected earnings to cover unforseen expectations. As you earnings increase and cash flow becomes large enough, reserves can then be palced in other uses or invested for longer terms. Moving such funds out to a three year and five year schedule might be something to look at.
OK, good luck.....
Any words of wisdom from our new members on this subject?
Bryan,
Very good question. IMHO, the answer to this question will vary for each member depending on their personal situation. Someone, who has a family to support will be more conservative and will tend to have more cash in reserves. OTOH, someone who is just out of school will be willing to put more on the line to make it big.
As for me, I consider BP as my mentor, so I tend to follow advise given by experienced members on this forum. For the most part, members on this forum consider 50% rule as reasonable one. So, my goal is to right away put 50% of the gross monthly rent into a separate account and pay all the expenses from that account. The other 50% will account for mortgage payment and my cash flow.
Everyone seems to be approaching this question from strictly a real estate standpoint....for good reason! This is a real estate site.
What are your thoughts/comments if you have a mix/blend of other investments? Basing the liquidity threshold on strictly real estate and ignoring the rest of your portfolio may ignore other leverated positions. An overall D/E ratio or global cash flow that demonstrates margin for downside risk may be in order...right? Can you think of other things to measure?
This thread was really great and a question that everyone needs to ask themselves.
So if you own 20mm in apartment buildings you are going to keep 2mm in cash sitting around (not working hard). I am not sure this is realistic. I think you can have a line of credit and some cash reserves in your business account.
I think if you are on the hook for all of these loans that you should evaluate the liquidity of your personal non rei portfolio and be ready to make up some slack if needed.
I have several buildings so the chance that something is going to go wrong at all of the buildings is rare.
Last month I had two furnaces, a kitchen remodel, a new entry door, an electrical problem, a gas repair, and a roof. This is in addition to all of the normal small stuff. This probably cost me 20k. This is not a good month for anyone, but if your business is big enough you understand you are going to have months like this. The chances that you are going to have this at every building in a short period of time is not realistic if you are keeping up with things. I keep an extra 50k around and have a line of credit if I need it. I also dont have mortgages on all of my buildings so that helps.
Yeah...our portfolios are (I think) similar Jeffrey. I can't see myself keeping $2M in cash with a $20M portfolio either....but I could if I had $20M of DEBT...or at least $1M.
I always have erred on the side of keeping the money working and making up the difference on lines in cash crunches too. As I get older and the recession drags on I find myself wanting to keep more cash though.
This is a psychological thing and not necessarily what is optimal for my portfolio.
For those with lines...do you have debt covenants on your lines?
I have started looking at much bigger buildings these days and the roofs, big boilers, and the copper risers can be very expensive to replace.
Playing in the big leagues can be fun and you can make money, but when you have a major system problem is it major money. It isnt like you can hire a guy from infront of homedepot or have an HVAC guy do it as a side job (not that I know anything about using this type of labor).
Yeah...I think you need to build in more margin for the larger projects. Mistakes are also magnified much more if you miss something.
I was really hoping to get more commentary about liquidity if your portfolio consists of things that include real estate and other assets. Assume a small businessman that wants to retain his ability to borrow going forward for things that include real estate or purchasing small businesses.
Bryan,
A reserve of 6 months is what most everyone is saying. Now that could be a large amount of NON-WORKING cash. I would put them on a CD and if you need the cash before the CD matures, then borrow against it. You will have to calculate how much interest you're getting from the CD investment and how much will the loan cost you. I mean ....are the possibilities of you needing that cash pretty high? If not...a 1 or 2% difference between interest earned and interest paid might be worth it.
I'm nearly all cash with reference to the equity portion of my "portfolio" because i think we'll see pullback and I want to jump on some higher yield opportunities.
I think it best to view your RE portfolio as its own entity instead of in the context of your overall portfolio including other assets classes. Other assets classes are not as closlely run like a business with revenues, expenses, debt service, unpredictable maintenance/repairs, etc. Equities for example, you buy and hold and they go up or down - no thought needed for operating capital or the like.
Therefore I think you should view real estate as its own business rather than as an asset class of your overall portfolio.
In that light i think 6 months of debt service and expenses is reasonable, but I would also develop some sort of metric beyond that to keep cash for potential acquisitions and to be able to jump on new opportunities. This market can present unique opportunities everyday. I think its best to follow the 6 month operating capital rule and have a good chunk of cash set aside to pursue new opportunities as well.
Interesting comments...I prefer to think of the equity in my real estate portfolio as a component of my overall PFS though.
Thoughts from others?
Any new thoughts on this? I have seen this question in different forms on threads recently.
I used to be of the mindset that 1 or 2 months of cash was sufficient, if you had the credit lines that could take you for 6-12 months. I preferred to have the money working. Then the recession hit and those credit lines disappeared. So I guess I'm still of the same mindset, but w/o the credit, so I'm working on getting my cash reserves up.
I think it also depends on how much you want to make vs how much you are making. Eg, if you want to make $100,000/year in cashflow, you're have less reserves as you work up to that, and more after you cross "the finish line" :)
It also depends on cashflow. If you have big cashflow which will remain positive even if some apts take a hit, you don't need as much in reserve. OTOH, if you're walking the line, then you need a much large reserve.
Agreed Roy...I am pretty cash light right now due to some projects I am developing with some partners so the issue is something I think about daily.