Being OK with the Worst-Case Scenario: Anticipating Surprises

[Justin Feldstein]

We all (should) budget for CapEx/Maint. and because we are savvy, we've talked to other landlords and found out what they are spending on repairs and maintenance, so not worried about clogged toilets, broken fixtures, etc. These problems will come up, which should be able to be covered by cash reserves once the maintenance fund grows (or are minor and you just take care of it out-of-pocket until then)- but what about a major unexpected expense either so large it wipes out reserves or soon enough after taking possession that there's little cash flow to cover it and you have to reach deep into your own pocket. On a 3-4 family unit a water heater, unseen damage from a home inspection, or other major infastructure failure could wipe out 1+ years of profit, aside from having to pay the repairs in cash at time of payment. What else could go wrong along these lines? Market shifts? Municipal planning changes?

Should we be increasing our cash reserves on the first property or two in our portfolios as padding until we have enough units that we can spread out the risk? How should I plan for a doomsday scenario, no matter how unlikely? I do know and am comfortable with the fact there will ALWAYS be some risk in REI, but I think risk management and managing the downside is a valuable skill to learn. I’d be interested how other view this and what steps they take to manage risk. Anecdotes also welcome. Thanks for taking the time to hear me out!