Stop Saving Monthly CapEx, Vacancy, Etc After a While?

Question

I’m working on my first deal and considering the CapEx, Vacancy, and Repairs expenses in the BP calculators. If I have a large enough (approx 6 months of rental income) lump sum of money saved up and invested in safe investments not likely to loose principle, would it make sense to just reinvest these three expenses and then refill my lump sum as necessary? I could get 12% COC before reinvesting these three expenses, but if I were to reinvest the expenses the COC return would jump to closer to 25-30%. It seems logical to me but I wanted to get advice from an experienced investor to really stress test my opinion. Thanks for the help.

Nathan Gesner · Answer

@Tyler Barker there are a couple things to consider:1. Your reserve does not need to grow forever. Determine what you need and then anything above that is free to spend. For example, you may save $10,000 for a single-family home. But if you have ten single-family homes it wouldn't make sense to save $100,000.2. It depends on your personal finances. If living paycheck-to-paycheck then you'll need a larger reserve. A $7,000 roof could financially decimate someone with low income, high debt, and a risky financial lifestyle. If you're a surgeon making $300,000 a year with no debt then you can probably write a check for a new roof out of your monthly income without batting an eye.I don't even have a real formula to share with you. I just determined my tolerance based on past history and decided that $20,000 is a sufficient reserve for my 20 units. Anything above that can be spent. As I add more cash-flowing properties, the ability to maintain that reserve and have extra money on hand gets easier and easier.

Victor S. · Answer

Ally Financial is offering a savings account with a 2%+ rate currently. No minimums, no fees.

Anthony Wick · Answer

@Tyler Barker I do keep some as cash as well. But it really depends on the property. For one of my duplexes, for example, I negotiated new HVAC into purchase and the roof was only 4 years old in 2018. So I don't expect high capex any time soon. I can access my Brokerage account money within 48 hours, so I'm not too worried. I've been keeping $4-5k in cash for readily available expenses. Beyond that I'll access the Vanguard account for big expenses.Also one of my favorite maneuvers is to ask the seller for a 12 month home owners warranty for a new purchase. It gives me 12 months to acquire capex reserves on the property before I know I'll be paying for major expenses. I do not purchase home owner warranties myself, nor do I renew them when they expire after a year.

Michael Ealy · Answer

Tyler,I have acquired over 1,000 apartment units so I understand what you're trying to do.For Vacancy reserves - yes, after acquiring several units you will have an idea of the real vacancy rate compared to your projections. So yes, after a while, you can stop keeping more vacancy reserves.On the other hand, for repairs and maintenance, I would continue reserving for that because there will always be something that will break and you want to be ready.Lastly, for capex - since I buy 50+ unit apartment buildings and hotels, I always factor in reserves per every building because eventually I need to replace things. It also depends on my exit strategy also. If I determine that I will have a building sold in the next 12 months and I already have a healthy capex buffer, I will stop saving for that since I am going to sell it anyway.Makes sense?

James Galla · Answer

In theory, you don't have to hold anything on the side. In application, it may be prudent to hold cash for vacancy in the event your lease terminates and you don't have the income or cash flow from other sources to cover your debt. For repairs, you should do yearly inspections to verify the property is in working order and build up those costs as you get closer to the end of the lease and do that inspection. In fact, you may want a small emergency fund in the event that something bad happens to your property where insurance won't cover it.Capex is a little different because it is covering items over a sometimes significant longer term than repairs. It is smart to have some assets set aside, such as stock, that you can cash out when it becomes necessary so that you aren't losing out on potential returns. As you get closer to an the end of an items useful life, you want more funds or credit available.

Tyler Barker · Answer

@Michael Ealy it sounds like many experienced investors would agree with the following: it’s ok to use this strategy in order to ramp up COC returns as long as you have actual data for the capex, vacancy, and repairs from personal experience in a specific area. So not a great idea on a first deal without taking on extra risk, but it could be useful as a more experienced investor. It seems to mostly be related to someone’s risk tolerance so it seems to be finding a balance between risk and the financial returns like most other investment choices and strategies.

Anthony Wick · Answer

@Tyler Barker To delve deeper, in case anybody is wondering. This is not my full time income. I have a nice federal job of 23 years, so real estate is a "side hustle". And I am not a big player like many on BP. We actually do not spend any of our profits from real estate. We either roll them over to make another purchase (looking at 4-6 plexes right now), and will then use said cash flow for early retirement in 4-5 years. My money in Vanguard is in the VTSAX fund. I don't "play" the stock market. I just put it in a solid ETF and let her hopefully make me more money over the years. I have also stopped putting money into my Roth IRA because I want to access the funds before age 59 1/2. But I do max out my 401k because with my day job I will be able to access that before age 59 1/2 upon retirement without penalty. But that's getting bit off topic, and I would always recommend consulting with a CPA for things of this nature.

Michael J. · Answer

If this is your first deal I would plan on saving all expenses long term. After a few years of managing rentals you can get a better idea what to expect but in the long run I would anticipate spending every penny on repairs and capex. Some local people I know that own 200+ houses keep six months cash reserved for all business related expenses but they have 20 years of management data to base it on.

Tyler Barker · Answer

@Shawn Ackerman I’m considering residential at the moment. I wouldn’t ever pull from the reserves rather just stop contributing to the reserves once they hit a certain lump sum. My safe investments are a mix of treasury bond funds and TIPS (treasury inflation protected securities) so they balance different risks. Beyond balancing risk I also keep more than I think I would ever need in that mix of assets. So in a worst case scenario if I had a big CAPEX and both funds dropped I believe I would still have the money to cover it all.

Shawn Ackerman · Answer

@Tyler Barker There will be expenses...Even in an A class property there will be something. I do not encourage you to pull from that stash, ever. Now if you sell, then obviously it's yours to do with as you wish. However in my experience, the longer you hold a property the more likely you will have that reserve exhausted. Can you speak a bit about the "safe investment"? Are you considering purchasing commercial and doing a triple net lease with your tenant? If you are buying residential, cash flowing property, I would advise against it. All the best my friend. Persist and you will WIN!!!