Establishing Reserves when doing deal analysis

[Tyrel Gordon]

Hi guys, I'm a new real estate investor looking to purchase my first multifamily. I've been doing reading on deal analysis, listening to the podcasts here (Great source of info!) and everything else needed to be successful as an active real estate investor. I'm specifically interested in multifamily housing, and I've been gearing my reading towards gaining information in that niche. Now, my question is for those of you who are experienced in deal analysis generally how do determine the amount of rent collected per unit that you set aside as a reserve for Cap Ex, emergency repairs and other unforeseen costs? I've read both as a percentage of each unit's rent or a flat amount per month per unit. I'm sure either method can be viable under any circumstance, but I'm more so curious about what the experienced investors have found to be the better route. Is there anything besides deferred maintenance that might increase/decrease the reserves you set aside?

[Todd Dexheimer]

$300/unit is the general rule of thumb. I would also highly recommend starting with at least 6 months worth of principal and interest payments in a reserve account. 

If you have a small property, I would put 5-10% of the income into a reserve account

[Charles Carillo]

@Tyrel Gordon

A percentage is a good idea but it can change depending on deferred maintenance and the size of the property. Personally, I feel with new investors the reserves and working capital are overlooked when purchasing. If you have a 20 unit building with one roof vs. a 3 unit with one roof; the 3 unit should have a higher reserve for future CapEX per unit than the 20 unit (assuming they are in the same condition). For under 75 units; rule of thumb is $250-$350 a unit per year for reserves (and for repairs and maintenance $500-$800 per year). I would definitely bump this up on smaller properties. Don't forget to keep at least a couple months of working capital. Large complexes normally do 6 months when passive investors are involved.

[Todd Dexheimer]

$300/unit is the general rule of thumb. I would also highly recommend starting with at least 6 months worth of principal and interest payments in a reserve account. 

If you have a small property, I would put 5-10% of the income into a reserve account

[Tyrel Gordon]

@Todd Dexheimer @Charles Carillo

Thank you for the info! Having a higher percentage of the income per unit makes sense on smaller properties since there's less to draw from vs large complexes. Therefore, if I was doing an analysis on a property going by the rules of thumb the sheet should include something like the following: $250-350/unit/year CapEx + $500-$800/unit/year for repairs/maintenance?

And Charles, going back to your point about new investors often underlooking reserves and working capital when purchasing I have noticed that they do get mentioned less in the educational material about deal analysis than the more prominent parts such as understanding NOI or COC. Which, as I've slowly built up my understanding of multifamily, I found strange. I would imagine planning properly for unforeseen events would be one of the most pertinent things to teach new investors.

[Todd Dexheimer]

Yes, repair and maintenance are always outside of Cap ex. on a 75+ unit property you should see $300-500 in repair and maintenance and $300-$500 in unit turnover expenses. You also will have to pay the salary of one maintenance person per 75-100 units. 

On smaller properties, I usually budget around 15% of the income to repairs. 

[Tony Lin]

I do my reserves on a per unit basis, and long term reserves on a per month basis. 

$200-300 repair reserves per unit, as required by lender

2 Months of expenses in operational slush funds

3 Months of expenses (loan, tax, utility, payroll) in rainy day reserve fund

and more in reserves for long term repairs (roof, HVAC, sewers)

With the long bull run we've had, you want to make sure you have more than enough reserves to survive a downturn.