Reserve Fund Estimate?

Question

Hi BP!

I'm working on some calculations for an apartment building. 6 story, approx 30 units. For an SFR, I typically keep about 8-10% of the homes values as cash reserves. What rule do you use for a large multi family?

Ming

Giovanni Isaksen · Answer

@Ming Lim When you get to a property with that many stories it definitely pays to hire a qualified engineer to do the inspection (The lender will probably require it anyway). In the states these are called a Physical Needs Assessment or a Property Condition Assessment and they will include an estimated useful life and replacement cost estimate for all the building's systems. From these life expectancies and projected costs you can build a reserve schedule that is much more likely to cover the costs than just dartboarding a number per unit.

RE @Michael Jobe's point to make sure you reserve more than most people think is necessary, Dupre+Scott is just out with their annual apartment expense report for last year and the average per unit actual expense for capex was.... wait for it..... $900.00! Granted that's for the greater Seattle area which is the territory they cover but they've been doing it for 35 years and review the actual income and expense reports for more than 800 properties/90,000 units. In their research they found post 2000 properties averaged around $400 while the pre 2k vintage properties averaged more than $700 with most ranging from $600 to over $1,000. Who is reserving a grand per unit for capex?

They also have must read research on the cost/benefits of reserving appropriately depending on your anticipated holding period. Check it out here:

http://www.duprescott.com/productsservices/articleinfo.cfm?ArticleId=659

One great point Mike makes in the video report (corny as his intro is) is that capex isn't just for roofs, HVAC and repaving the parking lot, it also includes refreshing the property with new/updated amenities to keep it competitive. That 'C' property in the 'B' neighborhood we're all looking for exists because the current owner didn't reserve enough to fund the upgrades to keep it a 'B' property: Don't be that owner.

Good hunting-

Roy N. · Answer

@Ming Lim

We aim to establish and maintain a reserve of between $300 & $600 per unit depending on the building and the age of its major systems and components.

Account Closed · Answer

Ming,

Giovanni is dead on with the numbers. Our lender uses $500-$900/unit/year for reserves in their calculation/underwriting depending on the age and size of the unit. In addition, they want us to put 10% of the loan amount in reserves for the first year. Example: $100k in reserves for a $1M loan. The good news is that...we are able to obtain a 5/1 ARM loan at 3.0% interest rate at 70% LTV with 10 year balloon. Loan is amortizes over 30 years. You can withdraw the $100k reserves after 12 months.

Since we are relative conservative, we put an additional $10k/unit in reserves for rehab if need be.  So how much reserves is adequate? It depends on your comfort level.

Good luck with the deal.

Roy N. · Answer

@Ming Lim

@Giovanni Isaksen raises an import point, I neglected to list in my prior posting:  location.   While we budget a reserve of $300 to $600 per unit, all our multi-unit properties are located in the Maritimes.  In your instance, you would need to adjust this range for the GTA bubble, or other location in which you are investing.

On a 30-unit building you will need to engage an engineering firm for a Property Assessment / Structural & Systems Assessment.  Your lender may also insist upon a Phase I Environmental Assessment {but, hopefully not a Phase II}.  You should budget $150 - $400 per unit into your diligence costs for these studies.

Michael Jobe · Answer

For me personally I'd shoot for $500 per door in reserves. Better safe than sorry. I can tell you that a flat roof on a building that large is going to be pretty expensive. My dad ran a roofing company for 30 years and he always said that for every additional story he had to go up, the price would go up as well. Definitely have all those things you mentioned (elevator, roof, water systems) checked sooner than later. May be able to do some preventative maintenance that will save you a headache down the road.

Joe Fairless · Answer

@Ming Lim - it's a rule of thumb I use for 150+ unit communities. If the community has something out of the ordinary then it would increase.

Michael Moikeha · Answer

The more amenities there are in a complex, the more you charge for rent, and that extra is added into that margin. This applies to places that are runnin smooth, and there is no deferred maintainence. If there is, then you really run into the risk of having things go bad, and that is negotiated before closing.

Michael Moikeha · Answer

Typical expenses on a commercial MF property is 40%- 50%, and part of that money goes to building your reserve. make sure you allow room for that in your expenses when you are calculating the NOI, and evaluating your cash on cash and ROI.

Joe Fairless · Answer

@Ming Lim I do, at least $250 per unit per year but obviously the more the better. However, if you do too much in your projections then that could kill a deal. You've got to walk the fine line.

Giovanni Isaksen · Answer

Good hunting @Ming Lim looking forward to your success!

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