What qualifies as cash reserves? HELOC? 401k?

Question

I have five investment properties and I'm fairly new to all this.  I'm slowly building my portfolio using the BRRRR method and also my own passive income, along with cash investors.  I don't want this pandemic to stop progress too much.  I understand it will somewhat.  I've been using this time to do A LOT of reading and learning about investing and property managing. I haven't had any problems with renters paying.  My question is how much should I calculate for reserves?  Can I consider my HELOC part of that reserve? What about my 401k? Or should it be hard cash in the bank?  I'd rather use my cash for my next investment:)

David Ginn · Answer

@Jessica FlintI'm going to give you an answer that will be tough to hear and competently against what everyone has been telling you.Renting homes is one of the highest risk investments you can get into and doing a cash-out refinance is even higher risk. Let me explain. In Las Vegas, in 2006 a home could be purchased for $150,000.00. You could rent it for $1300.00 and after taxes and insurance, you would cash flow at over $150.00 per month. Then came the great recession. Prices on that home fell back to $50k. That home could be rented for $600 a month.So let's look at the dynamics of a falling market. If I came to you and said, “I have a business that's worth $150,000.00. It will make you $150 a month. In two years the markets will fall and it will be worth $50,000.00.” Would you buy my business? You would say to me, “No! Do you think I’m crazy?”You see in real estate for some reason we seem to think that we can deny all business fundamentals and that somehow, our situation is different. I have heard everything from, “You don't take a loss until you sell." to "It will rent during a down cycle." Most people who hear me say this still believe in defying the odds. They think of all types of arguments to try to prove my business sense is wrong.Here is an actual example shared with me that happened at the start of the Covid-19 crisis. As you read this, keep in mind that this happened in one of the market segments that people would have said is the most recession-proof.There was an investor in Texas that owned a 30 unit complex. COVID-19 hit and they stopped all foreclosures and evictions. All the tenants got together and decided to not pay rent. Now, whoever owned that building and had the loan on it just got trashed by his tenants. He and his family's financial lives have been turned upside down. He cannot even get to a judge until June, and then the courts will be so backed up, it could take months to get his tenants evicted.Also, my local news reported that 1 in 5 market-rate apartments are missing rents right now, and nationally it's 1 in 3. The real issue is clear. You can buy and rent when a market is headed up a bit, just like a business or a stock that you sell before a market starts to fall.Buy and hold investing is a term that does not make good business sense. There are much better strategies to do in real estate when a market could potentially fall or is falling.

Cassi Justiz · Answer

I consider reserves if they are in a fully liquid account. Brokerage accounts, HELOC, 401k, etc can be great options for reserves when times are good. But right now we are seeing banks pull back HELOCs and stock based accounts lost a ton of value in a very short period of time. If you had your reserves in one of those types of accounts, you could have issues if you needed to access that money immediately. I keep my reserves in a very boring savings account. It's not as exciting as a brokerage account, but I know exactly how much I have and I am not subject to any market fluctuations.

Bill B. · Answer

Sorry David. You are repeating the same myth 100 other people who never owned any rental property in Vegas during the Great Recession heard somewhere. We were RAISING rents during the recession on SFR. Rents were NEVER $600. They went from about $1200 before the recession to about $1500 during the recession. It turns out everyone who was losing their house didn't want to move their family in to an apartment. That was too big an acknowledgment that they had failed.

Ps in case you think rents are falling in Vegas now, they're not, at least on SFR (the point of your post.) We're raising rents now too

Shaun Weekes · Answer

Fannie Mae has a detailed section on cash reserves, and this is a great place to start.  It will detail what is and isn't a cash reserve and how much reserves are needed for investment properties.

I would say at least have what they require and more if you feel comfortable.  I believe because of the corona virus that reserves like 401K, IRA or anything attached to the stock market you know can only use 70% as opposed to 100%  Also, private lenders, portfolio lenders and HML will have their own criteria for cash reserves.  This is just for Fannie

Example:  If you have 100K in your 401k you can use 70K towards the cash reserves needed for your specific loan as opposed to 100K.

I hope this helps.

https://selling-guide.fanniemae.com/Selling-Guide/Origination-thru-Closing/Subpart-B3-Underwriting-Borrowers/Chapter-B3-4-Asset-Assessment/Section-B3-4-1-General-Asset-Requirements/1736867481/B3-4-1-01-Minimum-Reserve-Requirements-08-07-2019.htm

Evan Polaski · Answer

@Jessica Flint, I agree with the others.  Cash and HELOCs are great.  HELOCs can get pulled at anytime, so be careful relying on those too much.  And as mentioned, stocks are typically liquid, but can disappear pretty quickly as well, and you would have to realize that lose, if you sold at a bottom to pay to replace a furnace.

Cash is always king.  It isn't going anywhere, and while you technically are losing the inflation game by sitting on cash, it also doesn't cost as much as carrying a balance on the HELOC.

Jaysen Medhurst · Answer

@Jessica Flint, broadly speaking I underwrite ~22% of rent to reserves (Vacancy 8%; Repairs 7.5%; CapEx 7.5%). That's held as cash, up to a point.

I wouldn't consider your 401k as a part of that. If you have cash available through your HELOC, that's fine...as long as your HELOC stays open.

Blake Dailey · Answer

Cash reserves is any liquid form of cash that can float you in an emergency. Cash in the bank, an established line of credit, liquid investments even. A 401k or retirement account is not liquid so that would not serve as a cash reserve. The purpose is for if something crazy happens, like a global pandemic, and everything shuts down that you have enough cash to cover your fixed costs for a period of time (6 months or more to be safe). For each property I buy, I ensure I have enough held back to cover the fixed expenses for a few months and then take reserves out each month to hold in a reserve account for when something does happen and I need it. Also for when things break or as big ticket items wear out over time. The cash piles up until needed and the cash flow after all of those expenses is reinvested for growth.

What qualifies as cash reserves? HELOC? 401k?

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