Too Conservative Replacement Reserve?

[Monika B.]

I bough my first rental (duplex, non-owner occupied) 2 years ago and would appreciate feedback on my replacement reserve amount, and thoughts on needing flood insurance in a non-flood plane.

Monthly income is $1,995, PITI is $1,253, water/sewer is $110, and repair/maintenance set is apprx. $30/month. I had approximated the remaining useful life of each major house system and the approximated next replacement date and backed into a $423/month reserve for both units ($211/unit). That is over $5k set aside annually on a $240k home (purchased for $215k). The amount I estimated is over $3k higher than the national average of $900/door. I had needed to replace the furnace and some electrical, and updated the bathrooms before renting it. How are other people calculating this? Including my approximated reserves, I'm still managing a 1.13x DSC. The top-down duplex is 100 years old, rented at market rate, near a college and military base, and has been 100% occupied over the past 2 years. I'm looking to buy my next property, and would appreciate the feedback for my next model.

Part 2: I don't have flood insurance on the property. The property is not located in a flood plane, however this is  a hurricane-prone area at sea level and I believe the risk is higher than the flood map indicates. The building has a brick foundation. Would you go without flood insurance, and risk self-insuring in case of hurricane. I think in a minor hurricane (category 1-3), this would result in $20M in damage max. A large hurricane (4+) would cause almost a total loss. How do other investors deal with this issue? Do other investors diversify the location of rentals to deal with area specific issues, or is that a risk that's usually assumed by the investor with hope for the best?

[Jordan T.]

It's good that you've been conservative with your estimates...you only get hurt when you underestimate.

I think  you might be a bit high because your numbers are based on the next replacement date, and not the average usable life of each item.  For instance, maybe the HVAC unit only has 5yrs of life left, but normally it would have a 20yr life.  You'll want to reserve a high amount now, but in the long run it's a much lower reserve.  I think your maintenance amounts are a bit low, but you probably have good tenants that keep up the units really well.

I estimate about 2.5-3% of building replacement cost for my repairs and capex (doesn't include land value).  You own an old property, so depending on the condition it may run higher.

I don't own properties where flood insurance is an issue, so I can't speak to that.

As a commercial lender you'd know this better than me, but the 1.1-1.2x DSCR is lower than I'd recommend for future purchases - I don't feel comfortable with anything under 1.5 on my properties.