Cash reserves: How much should a buy and hold investor have?

Question

I'm a buy and hold investor and I have a question about cash reserves. How much is enough?

We have 2 and soon to be 3 (closing on December 3) SFRs. One is rented now and the 2nd one should have a tenant in it soon.

Is there a good rule of thumb for how much cash reserves we should have? I want to have at least some cash reserves in case there is an emergency and I need money to fix it quick. I also want to know how much is enough so that I can use the remaining to make more deals.

Any help or guidance would be appreciated.

Thanks,

Scott

Ned Carey · Answer

Partly it depend on how conservative you want to be. A management company will calculate a true reserve account. I learned this from the guy that managed my local HOA. He said the roof on the community center will last 14 more years and cost $25,000 so they need to put away $1,786 every year. The pool will need to be resurfaced in 5 years for about $12,000 They need to put away $2400 for that. Look at everything you would need to replace over a 20 year period and figure how much does it cost and how much longer will it last. That will tell you how much to put away. EX: Water heater $600 and lasts 6 years, that water heater is costing you $100 a year. If you do a spreadsheet and add up all those costs you will be shocked at how much you ought to be putting away. What I described above is a reserve account for capital expenses. This doesn't include a reserve to pay your mortgage etc when you have a vacancy. I have heard as a guideline 6 months of expenses for PITI. I use $1500 per unit as a forecast for repairs and anything that doesn't get used goes to a capital reserve account. Good luck - Ned

Dustin DuFault · Answer

No rule of thumb here - but I'll give you my experience both as a broke newbie kid and what I'm doing now :) When I started out in rentals - I had little cash on hand. My emergency plan was 3 fold... 1. Appeal to older / established family. I did actually use that too! My father in law (who does real estate as well) provided a short term loan when I needed a re-roof. That was super helpful. 2. 401k Loan - This can be a source for a substantial short term loan if required. Of course you are taking your money out of the market and the loan will convert to a taxable and potentially penalized distribution if you leave employment for some reason. So it has it's perils to say the least. 3.. Credit Cards - I've never been particularly spendy. The few times I've relied on plastic for financing where to get thru a real estate crunch. I always made sure to focus on paying them down over a short period. Now that I've been at this a while, this is what I do, generally... 1. Usually I keep about $20k ready to go. This covers my 5 rental properties, my own personal emergency fund, and a decent size binder in case a deal presents itself (or some other investment). That's probably considered a small amount for the risk of my properties and income as I have a regular job as well. Therefore I also... 2. Invest additional capital in the stock market. I call this 'easy access' money. It's not cash per se... but if you keep too much in cash that's really a wasted opportunity IMO. So I invest the additional - I use a margin account for this purpose. I never borrow for the actual investments, but if I were to need short term access to some of that money, I can temporarily borrow against the account, without realizing any capital gains. This also speeds up the period of time until you can get your money. A stock sale takes 3 days to settle - not a long time, but on a cash foreclosure purchase you don't have 3 days to pay so that won't work! I guess I can't say I gave you a methodology to tackle this question. Hopefully that gives you some good ideas about the mechanics of handling this predicament though!!!

J. Martin · Answer

Hi @Scott C. This is a tough question, and will start with what I hear every day at work: it depends!!! Ned is spot on with what they do on HOA's (search for HOA reserve estimates on google) - but is missing one point- you also have to estimate what point in the life cycle the items currently are. The older and crappier the building/roof/interiors/appliances, the more you need. In other words, if you have a beat-up roof on one of your properties, electrical wiring from the 1940's on another, and you can see soft spots of wood rot around windows and downspouts of the other, I would want to have a lot. Roof= $7-10k in 3-5 years, electrical=$20-25K in 3-5 years. Wood rot = $5-10K in 1-2 years. I might want to have $20-25K or so today and saving at a brisk pace. If I did substantial rehab at purchase, fixed everything, 7-yr old roof, newer appliances/AC, built in 1980's, no wood rot. Maybe $5-10k and saving at a decent pace.. A little cushion over any immediate surprises if they come due more quickly than you expected.. I don't do a full-blown "precise" calculation of the years for everything on my properties (4plex & 2 SFR's). Here's a few major points of consideration that will point you in whether it should be on the thin side or fatter. Start with the big stuff. These will be the biggest "lumps" that you should plan for.. How much deferred maintenance is on the building? (Wood rot, termites) How old is the building? (need new electric? plumbing?) How does the roof look? AC units, appliances, heating system works well and not about to bunk out? Are you planning on doing upgrades/remodel when a tenant moves out? How much excess cash flow do you have coming in on a monthly basis? How much access to financing sources (family borrowing, credit cards, HELOC etc.) do you have? What is your cash flow like? The more access you have, the less I would sweat having every last dime for every contingency. Same with CF. If you have $4K in free cash flow coming in every month, I wouldn't be as worried about having every dime, because you can make it up quickly. If you're scraping by, I would want to have everything I need for repairs, plus a big cushion. I think a HELOC may be a good product for you if you have a decent amount of equity and qualify. MOST of the time, it's there like cash. But you don't have to let it sit idle and you only pay while it's outstanding. Maybe can "replace" some of your liquid cash if you have lots of equity and already set up, w/ a checkbook. And the more units you have, the more likely you may be able to be to get a more predictable rolling average of expenses. The expenses might be a bit "lumpier" when you just have a few.. Good luck!!

Marcia Maynard · Answer

We are buy and hold investors too and strive for good cash flow. In addition to saving for capital expenditures and saving for hard times, it is important to mitigate risk. Have good insurance in place. Especially liability. We put our properties into LLCs. We maintain a one million dollar umbrella policy. We maintain appropriate fire insurance. We look for opportunities to improve our properties to reduce risk and attract better tenants. Have cash readily available. Our personal home and most of our rental properties are paid off, so that helps. Our personal liquid savings is 10 times our monthly personal expenses. Our business liquid savings is 6 times our monthly business expenses. And for emergency use only, we maintain a $100,000 home equity line of credit. We will not touch our 401(k), 403(b) or IRAs before retirement, lot's of penalties if you do and tax consequences too. We have both personal and business credit cards that we use often (lots of frequent flyer miles!), but we pay them off each month so we never carry a balance. Risk tolerance has a lot to do with it. The older I get the less risk I take.

Aaron Mazzrillo · Answer

First off, congrats on the new rental. When people ask me how I got to where I am, I always tell them, "It started with 1." I ran pretty skinny for many years. I bank account was literally running on fumes to get that next deal. I was willing to take a lot of risks and cut corners wherever necessary to speed up the process. I've leveraged the heck out of some credit cards and equity lines of credit. Sometimes, I laid in bed at night thinking how I was literally on the precipice of a financial landslide - and not a good one! There have been many, many occasions I thought about asking the friends with small businesses if they might consider giving me some hours working sales for them. Yeah, there were some bad days in the early years. Some people talk of keeping X number of months in reserves. Great idea, but once you get past a few dozen rentals and you are still growing the business, tying up that much money for a rainy day doesn't make that much sense to me. Of course, there also comes a time when it gets hard to spend the amount of money you have. I was talking with a woman today who wanted to buy one of my rentals that I decided to list. She said she's been making offers every day looking to buy 2 houses. My comment back, "It's a lot harder to spend $200K than most people would think isn't it?"

Michael Lee · Answer

Similar to Joe and Ned, I try to use a CapEx model for my properties. Very surprising at first how much you should be allocating or planning for! Good way to be disciplined and conservative though.

Cuong Le · Answer

6 months PITI per home is a good general rule. Some suggests 6 months rent per home to help cover capital expenditures but it really depends on your risk tolerance. For us, we keep 6 months of our J.O.B. income for our personal savings and try to keep 6 months of PITI for each of our rental homes in a business savings. We have to tell you that it was difficult in the beginning since we kept dipping into our personal savings but we're at a point now where we can separate the two. With everyone's suggestions so far, what are you thinking your strategy on your reserves would be?

Account Closed · Answer

Principal, Interest, Tax and Insurance.

Account Closed · Answer

Scott, Lenders require 2 months PITI reserves on each property. When you have more than 4 mortgages, they want 6 months reserves for each. They will count 60% of your IRA and/or 401k net worth as your reserves. There's no right or wrong answer. It comes down to having liquid cash available when you have a big ticket repair hit you. If you're planning on buying another property, the money must be seasoned for at least 2 months. Gift funds cannot be used to purchase investment properties unless you pay all cash for it.

Joe Fairless · Answer

Similar to @Ned Carey - my reserves are based on looking at how long each big ticket item will last and dividing it that that # of years. Plus, I take into consideration how often the properties turn over and allocate the monthly expenses for each property as though I don't have a tenant.