How much is enough?

Question

My question... how do you all know how much reserves is enough?? What is "safe" or responsible to start? I've read 6 months reserves on all fronts, but I've also read people "making it" with zilch to their name. Do you guys with a bazillion properties have enough to cover if all your places went vacant at the same time (unlikely, I know, but still...I've consumed too much Dave Ramsey, I fear)?

Side-dish info: My hubs and I have quite a chunk stashed in 401k and IRA's, home equity, stocks and kiddos college funds, but not a lot of "cash on hand". We want to start investing. Time waits for no one.

In-laws are interested in selling us their fixer upper with seller finance in April. I'm thinking we should buy a small LTR conventionally first -down payment and cc with the cash we do have. Our DTI will be low to start (vs waiting until after the seller finance deal). Not sure if any of this is responsible considering the cheddar is kind of tied up.

Mike Dymski · Answer

If you have a lot in retirement accounts and home equity, that is a good back stop.  Most of us do not buy properties that would ever experience extended periods of vacancy or problems selling regardless of conditions; so, that is just part of our fundamental property selection criteria.

Shiloh Lundahl · Answer

@April VanCleve this is what I usually teach people. For a regular single family home, I would say having 10k in reserves is a good rule of thumb. The reason being is because if you have a turn over and someone trashed your place, usually you can get is fixed up again for 5k. Or if you had an AC go out, then it could cost about 8k to replace.

For the second house, I would suggest having additional 5k because you can now spread out the risk over 2 properties and it is unlikely that 2 AC units go out at the same time or that you have 2 tenants trash both properties the same month.  Similarly, I would encourage an additional 3k  for each additional property after your first 2 for the same reason - you can spread our your risk over multiple properties.

Henry Clark · Answer

Congrats on having a balanced approach to investments.

We do self storage, subdivisions and flex buildings, but have the same cash concerns and reserve concerns you have.

I always tell people to look at needs and failure.  This will help reduce the concern on cash.   1.  Use the lookup function and read my post, what happens if you die?

2.  Now calculate failure.  Roof needs replaced, renter won’t pay rent or house hasn’t rented, etc.  Do each scenario independently.

Normally failure is not a zero sum game.  Example your house hasn’t rented at the price you had.  You can still rent at a lower price.  So instead of being out say $1,200 per month you rent at $900 and are out $300 per month.

One of you looses their job, you can still get a part time job for less and cut back on spending.

Basically don’t worry about small things, but identify large issues and consider what failure looks like.  If you do this then you don’t have fear of the unknown dictating decisions.  You can then back into your reserve figure.

Scott Trench · Answer

I like $15,000 for the first property, and another $5-10K for each additional structure beyond that - normal duplexes/triplexes/quadplexes and SFRs. Another good rule of thumb is 6 months of mortgage payments.

Really it needs to be enough such that when you have that problem tenant, who puts you through a month's long eviction process AND an expensive unit turn or CapEx problem (or several that hit all at once) that you are able to cash flow it without having to impact your lifestyle, other investments, or otherwise be forced to make a hard choice.

Jonathan R McLaughlin · Answer

as alluded to above, retirement accounts count as reserves in the eyes of the bank, so thats all good. You would want to be able to cover a major expense without using that ideally but you can in a pinch.

Don't overlook dollars to pick up pennies; a mutually beneficial seller finance deal for a good property is an amazing opportunity and I would put my energy into that first. A lawyer drafted promissory note and clear terms is a necessity. Make sure terms of exits and refinances are clearly outlined. This interest rate environment offers a great chance for your in-laws to have a safe ongoing return and you either a lower downpayment entry or excellent debt structure. And having the cash on hand to light rehab is a great way to gain experience

As for the "zillion" properties...there is some safety in numbers as you will have income likely have income coming in even as you wrestle with the expenses in one area. Just make sure you underwrite using appropriate projections of vacancy, repair and capital expenses. In any given month(s) you will likely be ahead in one or more or all of those categories. Thats cool, but remember they are reserves.

Seems like you are in better shape than you think you are.

Paul Sverdlin · Answer

Great suggestions shared already by all of the earlier contributors. Our approach is to have 2x the typical monthly renovation budget as reserves. For example, we know that in our portfolio it is typical for one tenant to leave every month. That means a rehab has to take place, and at least 1 month of rent will be lost. A typical rehab is about $5k, lost rent is roughly $1k, for a total of $6k.

Keeping 2x that amount for the entire portfolio so far served us well. In the event of a major cash shortage we can tap into our investments, HELOCs, etc. Had not happenned in a dozen years.

Andrew Freed · Answer

@Scott Trench Great advice! I totally agree that the property has to be self sustaining. When you have 20+ properties, you can only feed so many properties at once without going bankrupt. That's why I am a big advocate for stabalizing your assets before moving onto the next deal.

Andrew Freed · Answer

@April VanCleve - For my rentals, I tend to set aside 3-6 months of overhead in the bank for each property prior to start issuing distributions / cash flow. Owning real estate is expensive and 1 or 2 vacancies can wipe out the reserves pretty quickly.

My advice to you would be, whatever money you make from rental properties, either keep it in the account or use it to buy more real estate, aka commit to use the concept of compound interest on these investment dollars for at least 2-3 years. At a certain point, the cash flow with snowball and taking a little distributions here or there will barely affect the compounding of wealth in your rental portfolio.

Alecia Loveless · Answer

@April VanCleve As long as you have access to funds in the case of a largish emergency you should be fine. While it’s good to have some set amount of reserves saved up, only you know what amount is the level you are comfortable with.

I’m currently in the process of BRRRRing a property that’s got great cash flow currently because I want to buy a new larger property that may come available. While I like having all the cash flow each month it would seem to make some sense to be able to grow my portfolio and regain the same amount of cash flow in the new property.

I think that buying two properties in close succession if you’ve never been a landlord before might be biting off more than you can chew. I usually recommend buying the first and getting it stabilized for several months while you figure out how to get tenants in place if they don’t come with it, while you learn to collect rent, I recommend a separate checking account for good accounting practices, and learning how to manage the property a little.

If your in-laws don’t mind waiting a few more months while you get situated with the first rental then I say buy both!!

Kevin Sobilo · Answer

@April VanCleve, budget for the expected and identify flex-abilities and options for the unexpected.

I budget for cap-ex, maintenance, vacancy. So, there should be adequate cash the VAST majority of the time for those items. In addition I keep a small open line of credit open on one property as some emergency reserves.

So, what if circumstances happen that exceed those funds?!? That's where you want to know your options. Maybe you have a property that you can cash-out refi or take another line of credit on. Maybe you sell a property to bring in some funds. Maybe you dip into other types of credit such as your Lowes/Home Depot credit card to rehab a property to fill some vacancies faster and bring rents up higher.

It is not realistic to budget for catastrophic occurrences but you want to understand what moves you can make if extreme things do happen. Just part of running any business.

How much is enough?

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