The Importance of Reserves

[Carrie Giordano]

Countless times, I've heard the question asked "How much do I need in reserves?" While the answer tends to vary based on the investors' risk tolerance, I thought I would share my experience. As a background, I live in Los Angeles and have 7 rentals in Northeast Ohio and one vacation rental in California. 

2017 felt like a winning year for me. I had successfully rehabbed a vacation rental which was up and running and my Ohio rentals were running very smoothly. At year end, (based on the long term rentals) my repairs were at 4.5% of the income and the cap ex was at only .03%! This was not because I had put off any repairs, was this luck or maybe a sign of what was to come??

In March of 2018, I had quite a large reserve built up and wanted to put some of it into purchasing a new rental. As coincidence would have it as soon as I closed on the new rental issues started to pop up with my other homes. First, after a city inspection, one rental was found to have mold in the basement which would need to be remediated, sealed and painted. In addition, the whole garage needed to be resided and a few other minor repairs.

Then last month, I received a late night call that one of my homes had caught on fire! Luckily, nobody was hurt but the repairs were extensive. Last week, I learned that a different home needed a new roof. This morning, I found out that one of my long term (but slow paying) tenants is moving out at the end of the month.  I later found out that the tenants in the fire house have not been able to be reached and have not paid rent this month. This could potentially put 3 of the homes vacant at once. 

Needless to say, my numbers for 2018 are looking bleak. While I do feel anxious to resolve the issues and be back to 100% occupancy I am not stressed about it because I have the reserves to cover the expenses and my debt service until the homes are rented. Recently, I have heard @Mindy Jensen mention that many newbies want to get started with no money. She's said sure it's possible to acquire a home with no money down but to be successful one will need some sort of reserves. I think my experience proves that to be true. On the bright side, at least I'll have a lot of write offs this year!  As a buy and hold investor I just have to remember that I am in this for the long haul and while 2018 has been bumping, I know other great years are ahead. I would love to hear from other investors who have been in the game longer and can share their experiences.

[Nathan Gesner]

This is a nice example, Carrie. I hope others listen.

I knew nothing about investments or setting a reserve when I bought my first property. It was a townhome and I bought it in 2000 with about $6,000 down. A tenant was placed immediately so we already thought it was smooth sailing. A month later the sewer backed up but was caught quickly. A month after that, it happened again and we learned the sewer line was destroyed by tree roots. We spent almost $6,000 removing the tree and replacing the sewer line.

We had been Landlords three months and thought the sewer was our final test. But on the fourth month, we received a notice from the HOA saying we owed $3,700 for a special assessment to replace the roof and siding. I know these decisions aren't made on a whim so I called the HOA and said, "I just bought the place four months ago and this is the first I'm hearing about the special assessment. Can I assume the Seller already paid for this?"

No, it turns out the HOA President (also a REALTOR) told my agent that this special assessment was coming due. She even provided my REALTOR with letters explaining what the assessment was for and what it would cost. My agent failed to provide me with any of that information so I was stuck with another $3,700 expense. Please read to the end before giving me advice.

If you kept count, I bought this rental with $6,000 and in the first four months I experienced nearly $10,000 in unforeseen expenses! I didn't have a reserve. I didn't even have time to build one! But I managed to live cheap for a few months, sell a few things, and save my bacon. Now that I'm older and wiser, I know better than to spend all my money on a purchase. I ensure money is set aside to handle the emergencies because they can happen at any time.

Now, some of you are dying to ask me: why didn't I sue my REALTOR for failing to disclose the up-coming special assessment. That's a fair question. The answer: my REALTOR was my father-in-law. We chalked that up as an educational expense and - though I really did like him - I never used him to purchase a property again.