Cash Reserves: When Is It Necessary?

Question

Hi BP members,

I am currently saving some capital to finance my downpayment and closing cost on my first property. I'm planning to purchase a single-family house or small multifamily then househack it. My question is: How necessary it is to have cash reserves on getting my first deal? If it is necessary, should I have 6 months, 3 months cash reserves? What is the minimum amount that I should reserve on this?

It would take longer to get my first deal if I wait to have the full amount for a down payment, closing cost, and 6 months' cash reserves. Since I am planning to acquire an FHA 203k loan, the cash reserves are the most expensive part of my starting capital. What I am thinking is I can come up with at least 2months cash reserves then purchase my first deal. I can then save up more later to have enough money for 6 months' cash reserves.

I would appreciate your answers! Thank you in advance!

-Vince

Kyle J. · Answer

@Vince Espiritu It’s super important to have cash reserves. There’s always going to be unexpected expenses in this business, and you have to be prepared for them.

Here’s just one of the most recent posts (out of the many on here) where a new landlord is talking about all the expenses associated with owning rental properties:

https://www.biggerpockets.com/forums/12/topics/905376-im-getting-my-butt-kicked

I’ve had to replace a roof, re-pipe a house, and put in a new heater/AC - all across several properties - but all in the same year. Talk about an expensive year!

If it’s your own personal house, MAYBE you might have the option to delay some things. However, with rentals, the law generally requires you to keep them habitable and actually says the tenant doesn’t have to pay rent if they’re not.

So if the heater doesn’t work in the winter, or there’s a major plumbing issue or a serious roof leak in a tenant-occupied property, there’s usually no option not to fix it just because you don’t have the money. You must fix these types of things, which is why it’s so important to be properly capitalized.

Alexandre Marques dos Santos · Answer

@Vince Espiritu

You need to have reserves.  Not necessarily cash reserves.

If you have access to a HELOC ( or any line of credit) you can use that if needed.

But if you are acquiring a property with negative cash flow, then cash reserves becomes more important.

Also i do not like to use x months of rent.  It depends very much of the state of the property and the monthly income.  A 100 yrs old property might demand more reserves than a brand new one.

Good luck

Account Closed · Answer

Always, 6 months min on a single property. But the needs go down as you build a portfolio. If you have 10 properties you don't need 60 months reserves as all are not going vacant or have big repairs at the same time.

David Kelly · Answer

@Vince Espiritu

Most cases will require 6 months Of PITI for qualification purposes.

Michael Swan · Answer

You need about $15,000 for your personal reserves, in case something bad happens or you lose your job and then $20,000 for your house hack project.  One rental property is pretty risky.  You don’t have economies of scale and we are still in a pandemic and the tenant has a lot of power etc... until we lift the eviction moratorium too!!

Swanny

Mike D'Arrigo · Answer

@Vince Espiritu it's extremely important. You need to keep a reserve for vacancies, tenant turnover repairs and general maintenance which are inevitable.

Brian G. · Answer

@Vince Espiritu people lose property primarily not because of using leverage but being undercapitalized in their portfolio, so just be careful and keep that in mind as you grow. Being well capitalized allows you to hold the property for some length of time, which for a lot of investors is the name of the game, ie longterm wealth creation.

Steven Foster Wilson · Answer

@Vince Espiritu

I would like to suggest you to have at least 6 months cash reserves with min amount of $15,000.

James Ma · Answer

I always like to run conservative numbers on deals with a 5% vacancy rate to help give me a buffer but there should always be costs that you expect when taking on a new property even if it is pretty turn key (ie. change locks, be prepared for something to break like a lighting or toilet issue etc. so you do want to have a bit of extra cash budgeted). In your deal analysis, you should also be taking into account maintenance fees that your rent will have to cover in the future (ie. replacing appliances)

In regular times, having over 3 month of reserves should be enough IMO but being able to access a couple months more in the event of an emergency is helpful. However with COVID, I'd like to be closer to the 5-6 month range if I didn't have other rentals to prop up my income - I've got 5 rentals now so if one goes down, I'm still getting income from the others which can help cover the mortgage & expenses.

Having too much in your cash reserves is also bad as it's money that is not working for you.

Cash Reserves: When Is It Necessary?

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