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Updated about 9 years ago on . Most recent reply
No reserves necessary
I have seen a bunch of questions about reserves for things like vacancies, major repairs, and capital improvements. In my opinion, these are not relevant to my rental empire.
I try to find properties that at a minimum have rent, or should have rent of at least 1% but preferably closer to 2% of purchase price. If that is the case, the rental should have a decent cash flow. I don't use cap improvements, or possible future vacancies, or roofs to make a buy decision. I want properties that have good rental rates, that are a good value. If you get enough properties, repairs, minor and major, will be taken care of with cash flow.
The reserves are also not necessary for beginners. Here's why.
The new investor buys a rental and then what. 100% of the income should be used for debt service! repairs! and to get reedy to buy more properties! or for retirement. 100%. In fact for me, until I owned close to 50 rentals, I did not spend much income at all. All kept paying down debt, making repairs, and buying more properties. Once my wife started working for the rental business, we started taking out money for her work. I still don't take out for what I do. I just keep buying properties.
Therefore if you are saving 100% then it is not called a reserve! but a reinvestment.
Now in a retired persons case: if retired and a few rentals are owned to supplement retirement then some rent should be saved for major repairs, if no other saving exist.
Now on the subject of vacancies. Vacancies are not expenses, they are just times when you are not collecting rent. These should be rare. And if you are continually buying, and paying down debt, an occasional vacancy is not a concern, but they may be a sign that your rents are too high. Now if you own property in an area where vacancies are a regular occurrence, then you may have rentals in a poor rental area and may own a bad investment. Sell.
Since most on this sight want an empire, quit worrying about reserves and get to buying properties.
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#5 Private Lending & Conventional Mortgage Advice Contributor
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#5 Private Lending & Conventional Mortgage Advice Contributor
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To be only slightly more blunt, this is among the worst business advice I've ever read on this board. I can't tell if you're serious or just bragging to show how great a businessperson you are. Lucky so far, in my view.
No serious business should be run without reserves. It's irresponsible. Plus, you seem to only focus on repairs. A lawsuit (even if you win), a large tax bill, a city assessment, or large insurance bill without the means to pay, can take your entire empire down.
Worse yet, with 50 properties, I imagine some of your loans are portfolio or at least individual commercial. Have you read your deed of trusts or mortgages? They will almost always require reserves. Don't know if you'll ever get caught or not, but you are likely in default on your loans. A default of one can mean a default on all and a demand for immediate payoff of all your properties by an astute lender. You might run your business as a cowboy, but it doesn't mean a lender will want to participate in such nonsense.
On the other hand, please don't tell me you obtain owner financing and put unknowing home sellers in such a precarious position. How selfish.
This is very shortsighted management and not a terribly well thought out idea. Most businesses would consider it a problem to be fixed, so it's actually hard for me to believe anyone would actually brag about or be proud of this.
So what happens the first year the new investor has some unexpected expenses and doesn't have money set aside to pay for it?
they use a credit card. Or whatever savings they have, the 100% reserve.
@Sharad M. You and I are really on the same page. Building a rental empire.
@Arlan Potter I don't agree with using credit card as a backup for surprise expenses.
I also don't agree with using 100% of income to pay down loan, because chances are you are making a lot more (2-3 times) on your money than your loan rate, then why would you want to take money from a much higher ROI asset to pay off a low interest rate?
So, you don't keep any reserves? If you have a major expense on the 6th of the month for a particular property, do you make the contractor wait until you collect rent at the beginning of the next month in order to get paid? What if that major expense is more than a full-month's rent? Do you make the contractor wait two months (or more) for full payment?
Of course, for someone who has many units, this isn't an issue. You can use rental payments from multiple properties to pay an unexpected capex expense on another property you own.
But, most of the people reading this are going to be buying their first property.
So, the question is: If somebody buys their first property, it grosses $750/month in rent and they have a $1000 surprise expense and no reserves, what do you recommend they do?
I included three items in the use of the income. I don't usually pay off term loans ahead of time. I do pay down on my line of credit, and use the money for repairs, and to buy more properties. Again all rules are different for a guy with one property verses 50 rentals. Or ones with no equity vs $1m equity.
Originally posted by @Arlan Potter:
I included three items in the use of the income. I don't usually pay off term loans ahead of time. I do pay down on my line of credit, and use the money for repairs, and to buy more properties. Again all rules are different for a guy with one property verses 50 rentals. Or ones with no equity vs $1m equity.
I do agree that it will be different for someone with 1 unit vs 50 units or $0 equity vs $1 mil equity, but your post original post is for new investors and I think not having any money set aside is a disaster waiting to happen for a new investors.
There are so many things that can go wrong with a property and a in a lot of cases, your repair expense will far exceed your monthly rent, what happens in those cases? Even worse, you have a situation where you need to spend money and because of that situation, the tenant ends up leaving. Now you have zero money coming in and need to spend some $$$ to get the place move in ready.
Originally posted by @Arlan Potter:
@J Scott I said that the person with one property should save all the income for debt service, repairs and buying more rentals. If the one property dude was doing that then after 6 months he would have $1000 for the repair.
100% reinvestment in the empire being built
How do you break down the money between debt service, repairs and buying more rentals? Isn't saving part of the income for repairs same as setting a reserve for repairs?
maybe the newbie should never buy a property until they have a cash reserve of $10,000 for what ifs?
Except that if they had that much cash, they could invest in another house.
When I started buying we just kept everything in the business. Within a couple years we had a dozen properties and cash built up pretty fast. I just never thought about reserves. I just kept going to work every day and working on rentals at night. And kept buying cheap houses.
Originally posted by @Arlan Potter:
@J Scott I said that the person with one property should save all the income for debt service, repairs and buying more rentals. If the one property dude was doing that then after 6 months he would have $1000 for the repair.
Isn't the money they are saving for repairs considered "reserves?"
If so, it sounds like you're just suggesting that -- in addition to saving for reserves -- they use the rest of the cash flow to pay down debt as quickly as possible so they can buy more properties.
And if that's the case, we're in agreement... :-)
I say that investors should keep all income in the business until they have enough reserves to buy their vacation home. After that, they can spend what they want.
Are We are all in agreement that RE investors should own a vacation home(rental)
Mine is one of the best investments I ever made. Loads of family fun and good times.
Call it what you will, reserves or an emergency fund or money saved from cash flow, in any case the wise investor should have a solid plan in place for unexpected expenses that might occur in the first month or in the tenth year. For us, having quick access to money is important, whether that be money in a liquid account at our credit union, or a substantial line of credit that we maintain (ours is $100K), or the ability to borrow money from family on a moment's notice. Also, establishing and maintaining excellent credit history is important, so we have the ability to borrow on credit with good terms. In addition, the right kind of insurance is key to cover the risk of catastrophic events. The unexpected can happen at anytime. It is a matter of mitigating risk.
As a new RE investor I understand and agree with what Arlon is saying. Every penny should be going back into your business if your desire is to create your personal RE empire BUT all of that is for not if you don't have a plan like Marcia said. Do I take my first months rent and make an extra payment or do I collect and save twelve months of cash flow then take half of it and make an extra debt service payment. Its all in the plan. There are some very intelligent investors on this post so I will ask this question...Early on, I f you don't need the cash flow to live and you do want to build your "empire" as quickly as possible, do you use your cash flow to service the debt you have or to accumulate more properties? My instincts tell me to buy as often as you have the down payment. Thoughts?
Sounds like using monthly cash flow to pay unintended bills that pop up which is a great idea provided that you have enough properties/ income coming in on a monthly basis. I prefer to initially set aside reserves of 3K per property plus a global reserve fund as well. The goal seems to be to come up with a seamless formula that works overtime and can stand up to a 10 to 50 property load.
You're using cash flow to pay down your equity line. If you have an unexpected expense, you will cover it from your equity line. Ergo, you are putting cash flow into a reserve.
Also, 50-100 units is more like a barony.
I'm waiting for something to go through here in January... once it does I'll post a re-introduction and 3 year history of my rentals and will tell a story FAR different than what you just suggested.
I'm with you, @Arlan Potter If I have $25-50k available on my credit cards at any time, I am not afraid to use my cash to buy another property. If an HVAC goes out the day after clear out my account to close on a new house, I can easily cover it.
So it sounds like it's a question of cash reserves vs credit reserves. Th OP seems to prefer building up credit reserves first and then reinvest cash reserves as soon as there is adequate funding for a new property. Still are there any guidelines such as Cash + Available_Credit >= Operating_Expenses * X_Months?
From the sound of this, you are just not calling "reserves" "reserves." You don't take any of your cashflow out to pay yourself, so you have combined a normal investors terminology of "cashflow" and "reserves" into one group. Most investors use cashflow for debt repayment and purchasing other properties while saving reserves for repairs etc. You call it cashflow and use it "for paying down debt, making repairs, and buying more properties."
Although this terminology works for you, a smart investor will always plan to keep money in reserves for the unexpected rainy day.
All this post will do if new investors listen to you is confuse them and give them confidence to jump on a deal without properly understanding their numbers.
I am happy you are successful and this train of thought worked for you, but it is not best practice, sorry.
#5 Private Lending & Conventional Mortgage Advice Contributor
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#5 Private Lending & Conventional Mortgage Advice Contributor
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To be only slightly more blunt, this is among the worst business advice I've ever read on this board. I can't tell if you're serious or just bragging to show how great a businessperson you are. Lucky so far, in my view.
No serious business should be run without reserves. It's irresponsible. Plus, you seem to only focus on repairs. A lawsuit (even if you win), a large tax bill, a city assessment, or large insurance bill without the means to pay, can take your entire empire down.
Worse yet, with 50 properties, I imagine some of your loans are portfolio or at least individual commercial. Have you read your deed of trusts or mortgages? They will almost always require reserves. Don't know if you'll ever get caught or not, but you are likely in default on your loans. A default of one can mean a default on all and a demand for immediate payoff of all your properties by an astute lender. You might run your business as a cowboy, but it doesn't mean a lender will want to participate in such nonsense.
On the other hand, please don't tell me you obtain owner financing and put unknowing home sellers in such a precarious position. How selfish.
This is very shortsighted management and not a terribly well thought out idea. Most businesses would consider it a problem to be fixed, so it's actually hard for me to believe anyone would actually brag about or be proud of this.
If you're wanna run your properties like a business, you will need liquid reserves. Also, most banks won't give you a loan without it. Especially traditional loans such as Freddy Mac and Fannie Mae.
