Maintaining Responsible Capital Reserves

[Nick Gray]

I'm a 26 year-old real estate investor from New Hampshire and, as I grow my current 22-unit multi-family portfolio, I need to ensure that I maintain sufficient capital reserve funds. Under usual economic conditions, how much of a capital reserve fund is sufficient for a multi-family investor? 

For purposes of this discussion, let's describe capital reserve fund totals in $/unit, # months of scheduled income, or # months of fixed expenses. Let's also assume that these capital reserve benchmarks are for relatively well taken care of properties that are without major deferred maintenance.  

A further question is whether the minimum required capital reserve fund changes with the size of one's portfolio. For example, my sense is that, once an investor has more units and greater economy of scale, he/she can afford a slightly smaller capital reserve fund in $/unit because he/she is less reliant on a given property's income versus say a new investor who only owns a duplex.

[Matthew Stanizzi]

I think it depends on your risk tolerance.  There is no correct answer.  What do you use for your CapX, Maintenance and Vacancy percentage? Assume 5% each for example.   The capital reserve should reflect that.   Let’s say I had 10 units with a 1M value.  If I’m grossing 100K year  I might hold 15% each year for Cap Ex, Maintenance, and Vacancy.  I’d hold 3-5 years in liquid reserves. Maybe 50-60K. That should me enough to float the properties if you loose a roof and half your tenants for a few months.   If you want more of a safety margin you might want more.  If you have a family member who could bail you out you might feel comfortable with less.  

I’d personally hold the reserve as Cash Value in an properly constructed overfunded Whole Life Insurance Policy rather then the bank.  You’re young so you could build the cash value as you build your real estate portfolio. For the record I’m not an insurance sales person. 

However you store the liquidity, bank, life insurance, investments etc. once you have the sufficient reserves you can take the Cap Ex, Maintenance, and Vacancy as Cashflow until you need to replenish the reserves.