Reserves are almost an absolute necessity!

44 Replies

They would be an absolute except a few people get lucky and put everything they have into a rental property and nothing goes wrong for a year or two, giving them time to build up cash reserves.  Then again a few people win the lottery.   

However, most people are going to see vacancies, your PM turns out to be a major disappointment,  major unexpected repair work, a tenant who destroys a property and moves out in the middle of the night (especially when starting out), or sudden tax or insurance hike.  There is a  high probability something is going to go wrong within the first couple of years of owning a property, particularly when you don't know either how to inspect a property and/or you don't know how to properly screen tenants.

Remember, the majority of people out there can't come up with $2,000 within 30 days.  If you are one of those people  you need to think long and hard about becoming a landlord.  Yes you might get lucky, but then again you might get lucky in Vegas.  

I strongly believe that having reserves are extremely important to a buy and hold investor. Preferably, those reserves would be in a liquid bank account or other forms of liquid assets (stocks), then a CD, then a credit card with cash available on it, then pulling out of your IRA or borrowing it from someone you know who has the cash and is willing to lend you money when needed. That is a list I put together quickly and will likely tweak, but you get the idea. I'm certain there are other ways to raise some cash that you can count on as your reserves, but I very strongly believe you have to have some way available to quickly raise some cash.

I think investing in buy and hold property is an excellent idea, but it can easily be a terrible idea if you don't have reserves.  I certainly hope the investors in oil dependent parts of the country have some reserves, because I believe they are in for some tough times ahead.  

@Cal C.  just listen to the guru you dont need money. Thats why they want it all. LOL I couldn't agree more.

You absolutely need money or at the very least access to money.  If you have high credit limits or access to semi-liquid funds like a 401k you can borrow against those work in a pinch too.

There will be storms... especially if you're buying distressed properties... takes cash to weather those storms!

Cash is great, but if you are in a pinch, a 0% APR credit card is also helpful, especially if it's tied to cashback rewards or travel points. Just to be sure to pay it off before the interest-free period ends, and never be late!

And yes, you can borrow from an IRA (and 401K) but an IRA requires repayment within 60 days to avoid penalties and interest.

Updated over 1 year ago

New tax guidelines from 2015 (or maybe '14) state you can only borrow from your IRA once a year.

I recently bought a property that within 3 months requires:

A new roof: 16K-25K (not entirely a surprise I knew it's near the end of life span but didn't expect immediately leaks)

Subterrainean termite termicide perimeter treatment: 1K (a surprise)

Drywood termite tenting: 1.2K (not a surprise but didn't know the extent of damages)

Power line weatherhead cracked: 1.3K (a big surprise)

Interior doors and closet shelving from sub termite damages: $500 (a surprise)

New water heater: $650 (not a surprise)

So yes, you need cash reserves.

A mentor of mine that had grown children out of college told me this several years ago.  Basically I asked him how he put his kids through college.  He had started saving and investing for college when they were children.  When they became age for college he put them through school without touching the funds he invested the 18+ years.   That diligent practice of investing and preparing created far more wealth that was used to fund college.

In a nut shell we all should be preparing for the future expenses of problems and desires.  When the time comes to use the cash we will have created other sources of funds from the mental preparation.

Yeah you thing that is Crazy talk...


Frank

Frank Romine, Real Estate Agent in CA (#01957844)

Great post and sage advise. For those of us, though, without the benefit of hindsight and experience in the industry, and without existing wealth or rental portfolios to build reserves to cover future unseen costs - can some of you please expound a little more on the following:

  1. 1. how much is enough to get started? 
  2. 2. what did you  do to build these reserves?
  3. 3. for those out there who are getting by paycheck to paycheck, but wanting to get started, do you really recommend not just jumping in at the first opportunity, but instead waiting until you have a pot of "reserves" at whatever level you recommend (see answer to question 1.).

Thanks all.

Fannie and Freddie want six months PITI as reserves, so that's one starting point. I think six months rent is a safer number. More realistically, you want enough to cover some big expense. I replaced a sewer line on one of my rentals for a $6200 total bill. That's more than six months rent. When you have those kind of issues, its essential to have cash or credit readily available to deal with such a bill.

IMHO you need some amount of reserves in place the day you buy the first rental.  As @Sam Leon points out, things can happen right away.  For that matter, when you buy a property you should just bank on having several thousand dollars in expenses you did not foresee.  Its just the nature of the business.

Personally I stash away 5k in my savings account before I buy each property. It becomes easier once you have a few properties to diversify your risk a little bit. 

I used to feel that 3 months rent in reserves was good enough.  Over the years I have decided that number is a little low for me personally.  6 months is what I am building up now.   That is enough to cover anything I can think of and still have some cash in the bank.  

I think the "Key" is to have liquid cash to be accessed too. Personally while I have alot of money on hand as I save for the next house. If something ever happened during the 2ish months when I was "low" I have access to credit cards and other "harder to access" funds. This allows me to be liquid enough to be successful and continue to invest. While at the same time take advantage of great deals.

Originally posted by @Alex M. :

Great post and sage advise. For those of us, though, without the benefit of hindsight and experience in the industry, and without existing wealth or rental portfolios to build reserves to cover future unseen costs - can some of you please expound a little more on the following:

  1. 1. how much is enough to get started? 
  2. 2. what did you  do to build these reserves?
  3. 3. for those out there who are getting by paycheck to paycheck, but wanting to get started, do you really recommend not just jumping in at the first opportunity, but instead waiting until you have a pot of "reserves" at whatever level you recommend (see answer to question 1.).

Thanks all.

Great post, Cal.

Alex, in answer to your questions:

1) It will never feel like enough, honestly.  However, I'd recommend at least five grand, preferably ten, as a reserve.  That should at least cover most of the possible surprises you might face.

2) My husband and I simply lived below our means.  Well below.  Pretty spartan, actually.  We still do, to be honest.  We are both engineers, so yes, we have good-paying jobs, but we also live in Orange County CA, which is quite expensive.  I set up a budget spreadsheet in Excel so we could see how much we could live on, then we stayed focused on being cheap.  We didn't have cable tv (still don't), I clipped coupons (still do), pretty much didn't spend money on anything unless we had to.  We also put off having kids, for 2 reasons: first, kids are expensive, and second, I plan to be a stay at home mom, and doing that wouldn't allow us to save up money.  That's how we saved up the down payment and reserves to buy our first rental, and it's how we've continued to buy rentals and grow our reserves.  We are now finally at the point where we're ready to start a family.

3) I really wouldn't go "all in" on a rental without some sort of reserves.  I don't have that kind of risk tolerance.  Some people do, and that's fine for them, but that's just not for me.

When i started I tried to save 10% until i felt comfortable "10K per house and 20K per multi". Until i got to a # that was big enough for all my rentals around 100K i feel that it could handle just about anything. As i'm semastly saving 10% and it get over that amount i wait till its large enough to fund the the next purchase. 

The hardest part is to start once you have been doing if for a few years and have several propertie it gets a lot easier. 

Peter MacKercher, Real Estate Agent in MO (#2010004223)

Great advise all. I am seeing a common thread here in that it looks like getting through the first few homes is a major hurdle (financially), but once you get up and running, it becomes easier to ensure you have enough reserves to cover unforeseen expenses.

I bought my first rental (condo) last month, and my number one priority now is to build my reserves to cover 3 months of repairs and 3 months vacancy. I've been saving as @Kimberly T.  suggested by living below my means. Every extra dollar goes into this dedicated bank savings account. As I see it, the sooner I have the reserves in place, the sooner I can start saving the down payment for my next property. 

I'm about half way to meeting the reserves goal, so it's great to get this confirmation from @Cal C.   and others.

I own two rental properties. Both are 4 plexes. One is 100% occupied, and the other is soon going to be only 50% occupied because I am in the process of evicting a tenant, and I already had a unit that was vacant. 

Things happen, already in my first year I have spent thousands on repairs. The last few months have been good, and calm, but I will probably have to spend hundreds getting that unit ready to be rented again. 

Be prepared is all that I can say to new landlords. I keep emergency reserves of $5000 for each one of my two buildings just in case I have a major issue.

Thanks to everyone who's shared their personal experiences for the betterment of the BP community.  I especially appreciated the way Sam Leon outlined things. It's very easy to look at REI with "rose colored glasses" and this thread will increase my standards for liquid savings.

Happy New Year to all and thank you for making BP a godsend for focus group education like this.

@Cal C.  I agree!  An eviction can easily add up to $2000 or more (counting legal costs, lost rent, unpaid utilities, damages). Replacing floor covering for a two bedroom unit $1000. Hot water heater $500. Furnace $1000 - $3000. Next year we will need to replace the roofs at our 8 plex (four duplexes grouped together) and the estimate is $6000 per building = $24,000, which we have already saved.

Here's how we cover our need for reserves... We pay our credit union $25 per year to maintain a $100K line of credit (at 3.5% adjustable rate) which is secured by our primary home, which itself is paid in full. We haven't had to access the LOC because we also hold business reserves of $15K liquid cash, which equates to $1K per rental unit. Our cash flow is such that we are consistently building cash in our business accounts. We also maintain excellent credit history (our FICOs hover at just under or just over 800) so we are able to get loans at great rates and we hold several credit cards with high limits (20K or more) which we pay off at the end of each month and we never carry a balance on them. Six of our 15 rental units are paid off. We only hold mortgages on our 8-plex and one house. We maintain a $1M umbrella insurance policy, as well as other insurances policies for fire and auto. We also have a personal emergency fund of $50K liquid cash. We are not too well leveraged in our properties since we are paying them down, but we are ready for the unexpected and we do sleep well at night. :-)

Originally posted by @Kimberly T. :
Originally posted by @Alex M.:

Great post and sage advise. For those of us, though, without the benefit of hindsight and experience in the industry, and without existing wealth or rental portfolios to build reserves to cover future unseen costs - can some of you please expound a little more on the following:

  1. 1. how much is enough to get started? 
  2. 2. what did you  do to build these reserves?
  3. 3. for those out there who are getting by paycheck to paycheck, but wanting to get started, do you really recommend not just jumping in at the first opportunity, but instead waiting until you have a pot of "reserves" at whatever level you recommend (see answer to question 1.).

Thanks all.

Great post, Cal.

Alex, in answer to your questions:

1) It will never feel like enough, honestly.  However, I'd recommend at least five grand, preferably ten, as a reserve.  That should at least cover most of the possible surprises you might face.

2) My husband and I simply lived below our means.  Well below.  Pretty spartan, actually.  We still do, to be honest.  We are both engineers, so yes, we have good-paying jobs, but we also live in Orange County CA, which is quite expensive.  I set up a budget spreadsheet in Excel so we could see how much we could live on, then we stayed focused on being cheap.  We didn't have cable tv (still don't), I clipped coupons (still do), pretty much didn't spend money on anything unless we had to.  We also put off having kids, for 2 reasons: first, kids are expensive, and second, I plan to be a stay at home mom, and doing that wouldn't allow us to save up money.  That's how we saved up the down payment and reserves to buy our first rental, and it's how we've continued to buy rentals and grow our reserves.  We are now finally at the point where we're ready to start a family.

3) I really wouldn't go "all in" on a rental without some sort of reserves.  I don't have that kind of risk tolerance.  Some people do, and that's fine for them, but that's just not for me.

Love your approach with investing! Very similar to how we are doing things...except we aren't at that pay scale quite yet ;)

To echo the others, there is always something.

This summer I had the a/c unit overheat for the nifty tune of 2k.

10k / unit is a good balance.

Great post @Cal C.  

One question for the experienced investors: do you set money aside each month or do you simply have a reserve fund setup prior to purchase? I would imagine things like a new roof would cost more than the $5-10k or so people seem to be stashing away so I'm curious how those items get funded. 

Originally posted by @Marc M. :

Great post @Cal C. 

One question for the experienced investors: do you set money aside each month or do you simply have a reserve fund setup prior to purchase? I would imagine things like a new roof would cost more than the $5-10k or so people seem to be stashing away so I'm curious how those items get funded. 

 Roofs for SFRs are normally around $5K around here.  The overall point is when you buy at that moment you should have some sort of reserves, cash, credit card, access to 401k loan, etc... available for when things go wrong.  A quick example say you put $20K down on a $100K property (including rehab), if you have  $2,500 cash and cc cash advance available of another $2,500 you will likely be covered.  As you save money from your day job and from the money you make on a monthly basis from your rental you'll be more and more able to pay for problems with cash.  Remember the month to month money you are making on the property is not really the cash flow, since you have to pay taxes, insurance, for vacancies and for repairs out of the money.    

One of the big takeaways from this thread is to make sure exactly what you are purchasing, such as property that will shortly need a new roof or a new A/C.  This reinforces one more time that you really need to be able to inspect a property or at least have a professional who can do the job.    

Unlike your post on the landlord being the boss, I agree entirely with this one.  Not having reserves is not only incredibly risky for the landlord, I would argue it is actually unethical.  We have obligations to our tenants.  If the sewer line breaks or a tree comes crashing into the roof, we cannot just shrug our shoulders and tell them to wait.

DON'T DO WHAT I DID.

Many years ago I purchased my first three unit from my wife's uncle. He was moving out of the lower and had one vacancy in a upper. He told me what day he was turning off the power and that I should call and have it turned on in my name. Well that meant having 2/3rds empty scared me (not having two nickel) so I let the power go out in the lower while I worked on the upper.

Little did I know my uncle still had a chest freezer full of food in the basement. He was not happy with me to say the least.

That my friends is penny wise pound foolish. Have some reserves in one form or another.

I am not oppose to building up your credit limits just for emergencies if that's your only option. It has saved me many times But have a plan to pay it back.