Newbie here. I have a quick question regarding "vacancy reserves". Im having a bit of a hard time wrapping my head around this, but I think its very simple and Im over thinking it.
When calculating vacancy reserves- Do I simply tally up what the property would make if every unit was rented, and then set aside a percent of that for "vacancy reserves"? Like if the property grosses $8000 in rents and I want to factor a 10% vacancy, I would plan to set aside $800/month for that?
If so, does that money just go into an account to help offset months where the property does not bring in $8000 in rents?
Or am I subtracting $800 from the $8000 to account for not really always having every unit rented, and then I base my whole budget off of $7200 instead?
I guess im just confused on if the "vacancy" is actually money set aside, or just money I subtract from my gross income when making my budget to account for the possibility of not having every unit rented.
Thanks so much!
Bob - I'll take door #2 (Price Is Right reference)
You can not put away money that you never receive otherwise if totally vacant you would be getting $8000 (in your case) by magic from someone and not have to do anything (how I wish this was possible ;).
The vacancy is not a 'reserve' but 'unrealized' income.
As a budget item, make it your % on the max gross income, yes. Not just "gross rents". (Think of it like any other expense.) Don't forget to include other income if it's there, like coin op laundry, storage or garage rentals, vending machines, if you have 50% vacant units your coin op laundry income will be 50% too.
Here's what I do.
Set aside 10% (or whatever you determine) more for each of your allotted expenditures (maintenance and repairs, taxes, insurance, utilities that you pay for, trash, debt service, cap ex, etc.) each month. For example, if your debt service is $500 each month, set aside $550 from gross collected rents; if your maintenance averages $200 monthly, set aside $220. This builds up a positive cash balance in your reserve account over time.
In the future, when you have a vacancy, and you are only collecting 75% of rents (in a 4-unit building, for example), this cash reserve can be used to pay your expenses until you fill the vacancy and start collecting all of your gross scheduled rents once again. Coincidentally, I like to have one full month's worth of debt service in the account PLUS the reserves. That way I am not dependent on the current month's rents to pay my mortgage, and any "late payers" don't delay me making a prompt mortgage payment to the lender.
It goes without saying, but it's prudent to be very conservative with your reserve estimates. It's better to have too much in reserve than not enough.
Does that make sense?