Do you ever stop setting aside 35%?

Question

I know the general rule of thumb is that you put aside 35% of your rental income for repairs/maintenance. Is there ever a point where you don't need to set it aside anymore? Common sense would tell me no because things always come up. But am I wrong?

Roy N. · Answer

Ryan  D.

When we only had 1 or 2 properties, we focussed on having a 6-month reserve on hand.  Now that we are a littler larger, we do not maintain a 6-month reserve for each property as statistically we are less prone to have catastrophic vacancy or major repairs across the entire portfolio.  We still do aim for a heathy reserve and could handle a 50% vacancy rate for about 3-months (this will likely change again as we grow).

Jerry W. · Answer

@Ryan Dossey, my answer to your question is yes. A lot on how you handle reserves depends on how many properties you have. When you get where you have more than 3 or 4 I have found you do not need to keep as much in reserve percentage wise as when you only have 1 or 2. The same when you hit 10 or 12. You need to be able to pay several months of mortgage payments for all of your properties. However it is unlikely you will need to replace 5 roofs in one year unless it was a bad storm and you have insurance for that. After having problems with a few roofs, I began planning for roof repair, and bought materials when they came on sale and planned on replacing them as time allowed. Now I look at every house on a regular basis and estimate when it will need a new roof and start funding it now. I may not be that smart however as I had 3 serious plumbing issues pop up in 6 weeks. One was planned though. The place had some ongoing problems we were aware of and when it emptied we dug in (literally dug a 5 foot hole in the 2 foot crawl space) and fixed the problem, and I had set aside money just for that. Perhaps you should keep setting aside 35% but I have a day job that leaves me with disposable income I can use in a pinch, and credit cards with large lines of credit but no monthly balances. If I have much setting around I try to buy another rental, or add money to my smallest mortgage payment. I only buy on 15 year terms so there is not a lot of extra cash flow. However if I have $40K set aside in savings I lose $2,000 per year in interest. So I keep it around $5K-$10K, and plan for as many contingencies as I can. I do keep separate reserves for taxes as those are a huge hit now if you don't have some reserves set aside.

Sorry this got so long.

Account Closed · Answer

Just thought I would point out that there is a distinction between current expenses, and what I call deferred maintenance.  Current expenses are going to be things like lawn care, or fixing a plumbing issue, legal expenses etc.  These are the routine expense items that regularly occur across your properties.  Then there is the deferred maintenance.  I use this term to indicate things I know I will have to spend in the future, that I want to reserve now, typically for me mostly capital expenditure type items.  Examples would be furnace, AC, roofs, and painting (painting isn't strictly speaking a capital expenditure according to the IRS, but I categorize it that way internally.)  OK, so the current expense items I pay out of ongoing rent.  The things I want to reserve are the big capital items.  So for instance, let's say my furnace and AC are going to approximately cost me $4000.  Let's say that I assume that the furnace AC units are going to last 15 years.  So I want a set aside monthly of $270.  Further, I want to estimate how old my furnace AC already are.  So if they were for instance 7 1/2 years old, I'm going to want to put $2000 into my set aside.  So in other words I'm going to start my deferred type account by allocating $2K, and then setting aside $270 per month for the future expense of replacing the furnace and AC.  I do the same thing for my roof and exterior painting.  And I do this on every property.

When you stop to think about it, these large items aren't necessarily a percentage of your rent.  They cost certain identifiable amounts which you can plan for.  I figure the exterior paint may last 10 years.  The roof 20 years.  And as someone said, if you're doing this on every property the odds are that you won't have everything break down at once.  So if you haven't allocated the full amount, and something happens, you can always use the money for one of the other properties, and then replace it as your rent comes in.

The ongoing expenses I don't reserve for because they typically aren't going to be so large that I can't handle them basically from the rent.  Again though, the deferred maintenance set aside is going to be large enough that I can borrow a little from that if something unusual happens.  And too, as someone said, I've always got the credit card to even things out if the rent isn't quite what it needs to be.  Just make sure you pay your credit card bill off every month.

James Wise · Answer

35% reserve? I thought that's what credit cards were for.   :)

Ryan Dossey · Answer

I appreciate all of the advice guys!

Michael Seeker · Answer

I aim for a general reserve amount that I want on hand at all times.  This way if I've got a couple furnaces that go out at the same time or need a new roof or whatever, I'm covered.  If I get below the "reserve" amount then I wait for rents to build it back up before taking a distribution or looking for another property.

You may find you need more or less than 35% depending on the type of property and as you mentioned that's really just a rule of thumb.  I think a better approach is giving yourself a cushion and always replenishing it if it ever gets depleted.

Do you ever stop setting aside 35%?

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