What to do with rental income?

[Annelise A.]

I've been dividing my monthly rental income into 3 buckets.

Bucket 1 goes into repairs for the property
Bucket 2 goes into the mortgage payment
Bucket 3 goes into future investment savings (MM acct due to higher interest %)

I bring this up because it's frustrating. There has to be a more efficient way to responsibly divvy up my monthly rental income.

What is your strategy with your monthly income?

[J Scott]

If you like the bucket approach, here's another way to approach it, with 4 buckets:

1. Immediate Expenses: These are your monthly expenses, such as mortgage, utilities, property management, taxes, insurance, etc. This bucket should be immediately and always be funded with 2 months worth of estimated expenses (refill each month with what was actually spent to ensure you always have 2 months in there).

2. Short-Term Expenses: This is your maintenance budget. Set aside funds in this bucket every month until you have at least 1 month of gross rent set aside. This should suffice to cover short-term maintenance if the property is in good shape; if the property is in rough shape, set aside 2-3 months worth of gross rents in this bucket. Every time you eat into this bucket, refill to the 1 month (or 2-3 month) mark.

3. Long-Term Expenses: These are your capital expenses. In general, I think of capital costs as Roof, HVAC, and "Surprise". On a typical one of my houses, I will spend about $4000 every 20 years on a new roof, $3000 every 20 years on new HVAC and about $5000 every 20 years on Surprises (Plumbing, Electrical, Termites, etc). That's $12K I need to save every 20 years, or about $600/year or about $50/month. So, I would take $50/month and put it in this bucket. If your roof or HVAC is closer to end-of-life than 20 years right now, save more, as you'll hit the replacement time sooner. Figure out your estimated capital costs, and save every single month the pro-rated amount into this bucket for as long as you own the property.

4. Emergency Funds: This is for emergencies. For example, if you go a couple months without a tenant and need to pay your own mortgage and utilities. In general, you should probably keep 3 months worth of total expenses in this bucket, unless you reasonably think you may need more. If you ever spend anything out of this bucket, replenish to the 3 month mark.

Once you have all those buckets filled to their maximum point (other than the Long-Term Expenses, which you keep filling every month), you should be able to safely take the additional money you have coming in and allocate it to other projects, salary, etc.

Btw, notice that the 3 buckets (other than the Long-Term Expenses) total about 6 months worth of gross rent. In general, I think this is the right amount to keep in reserves (plus the Long-Term funds), regardless of how you break it down into buckets.