Why you need reserves

Question

I see a lot of people analyzing deals and they do a nice job of assigning a certain percentage of monthly rent for different expenses, maybe 5% repairs/maintenance, 5% Cap Ex, 4% Vacancy, and 8-10% Property Management. I think this is a great way to underwrite a deal, but in reality these expenses don't happen all nice and spread out like the budget; they can and do happen thousands of dollars at a time, sometimes tens of thousands. In the past 3 months I replaced the HVAC in two of my rental SFH, one was $9k and the other was a little bigger, so it was $10k, this wasn't a big deal because I had the reserves. My point is, for anyone starting out wanting to live on the cash flow from rental properties, do yourself a favor and add a little extra to your reserves, it will help you make better decisions. Lenders usually require 6 months of PITI payments as reserves, but I like to have a little more, I like to have 6 months plus $10k per property for SFH. How much do you like to keep in reserves?

Chris Seveney · Answer

@Josh Young

Agreed. I have never been a fan of keeping a percentage when you own a few rentals. You can do this when you own 100 or 1000 rentals.

What I recommend is review what the property has and what is it’s life expectancy. For example if the roof is $10k and has ten years left - well you need $1000/yr and tack on 5% inflation so I would probably wants $100-$150/mo just for the roof

Those on a $1000 rental holding 10% can cover the roof but no appliances, hvac, plumbing…. Exterior repairs, windows, driveway….

Nathan Gesner · Answer

How much you hold in reserve depends on a lot of factors. I have a strong income, I hold all my cashflow from rentals until I'm ready for the next investment, I have some big credit cards, and I have a large line of credit. If my bank accounts are low and I'm faced with a big expense, I can charge it and then pay it off the following month with cash flow.

Ray Hage · Answer

I don't have a particular number that I need to keep in reserves for each of my properties but I keep plenty on hand because big expenses or vacancies can happen any time. I had to renovate one property this year for 15k and had 2 months vacancy. I had to do some work on another property and due to issues with the HOA, I had 3 months of vacancy.

I wasn't happy but I also wasn't overly stressed due to keeping a ton of reserves knowing any time that there could be an issue even if everything (roof, appliances, AC, etc) are brand new.

Bjorn Ahlblad · Answer

All of our properties are local, so I set aside one hundred k that can be used across any of our properties. It gets replenished as needed.

Becca F. · Answer

@Josh Young

I like your 6 months PITI reserves and an extra $10k per property in reserves. I have just over that amount in reserves. I'm anticipating a property tax increase on my California SFH rental since I did a major renovation, just waiting for the county assessor to send me that letter. I have a stable W2 job. I'm risk averse, which results in analysis paralysis, and probably have a bit too much sitting in a savings account when I could put the money to work getting a better return than 4.8%.

John Morgan · Answer

It all depends on the investor. Do they have a W2? Do they have rental income from other properties? Can they tap capital from other means if needed?

I have 18 rentals and hardly have any reserves. Less than 20k right now. I’d rather spend my saved up cash to use for 20% down payments on my next investment property. However, I can tap 50k from two different credit cards with 0% interest for a year (Citi and Capital One) if necessary. I can borrow 50k from my 401k which I’ve done 3 times for real estate (to purchase two homes and rehab one). And my bank gives me a 25k line of credit if needed. So I’m ok not having much reserves since I can tap 125k quickly for random cap ex things that may pop up.

Jaron Walling · Answer

@Jay Hinrichs That's exactly what we want to achieve. The problem we have is capital and retaining it after refinancing the property. We have trapped good amount of money in our rentals. The last one we left $18k... we got the investment ball rolling but it's slow. I've added about one property per year with $100-200 per month cash-flow. It feels safe given this market but I'd rather do REI full time. I could retire in 4 years with a pension at my current 9-5 if I stay around that long.

Did you partner or syndicate with people early on to scale to 300 units? Or buy most with your own capital?

Why you need reserves

Why you need reserves

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