How much should I save before purchasing my first rental?

Question

Hello all, I’m an aspiring real estate investor in the DMV area looking to purchase my first rental. I’ll be using my VA loan to finance this property. I spoke to a lender and was pre-approved for 300k which I plan to use in order to purchase a single family home, (3 bedrooms and 3 bathrooms) live in the basement and rent out the top level.

I’m curious as to how much money I should save before closing on this house and what factors should I consider when deciding whether or not it would be a good idea to become a landlord. If any other information is required, please don’t hesitate to ask as I would be glad to tell you. Thanks in advance.

Michael Ealy · Answer

Darnell,

It depends.

You need to have 2 types of reserves:

1. Capital; and

2. Operating

Capital reserves is for replacing the different parts of the house because they depreciate over time. For example, the roof is getting older and after 20 years need to be replaced. So if the roof costs $20,000, over 20 years, you need to budget $1,000/yr or $83.33/month just for the roof. You do this for your appliances, windows, carpet, water heater, HVACs, etc.

Capital reserves should aso include the money you need to repair items that need to be repaired and parts of the house that need to be renovated. You should add 20% for miscellaneous items.

Operating reserves on the other hand - you need to save money every month for taxes, insurance, vacancy, property management, repairs and maintenance, etc. You have to save about 30-40% of the rent you're collecting every month for these items.

If the property is "turnkey" - it's recently renovated (and does not need any repairs at all) and it's in a hot area so you'll have no problem leasing it, you don't need much capital reserves and maybe just 1-2 months of operating reserves and 1-2 months of mortgage payments upfront.

However, if the property needs to be renovated and it could take 6 months to finish the renovation and lease it up, you need to have ample of capital reserves and at least 9 months of operating reserves (include 9 months of mortgage payments) saved upfront. By doing this, you will not run out of cash until you get the property renovated and leased up.

Lastly, if the property is older and in a great area, then maybe allocate more capital reserves and again 1-2 months of operating reserves and 1-2 months of mortgage payments.

Jaron Walling · Answer

Before you purchase a $300K house and move into the basement... I would spend the next 12 months getting educated. Read some books, listening to real estate podcasts, and the BP forums are wonderful sources. It took me 2 years to save, research, and buy my first a property.

Establishing a game plan for investing and understanding the numbers is everything. Without it you're shooting targets in the dark.