When is Reserve Account “Good”

Question

So I have 6 months of expenses set aside in reserves. Is this an acceptable amount to then increase my cashflow a bit and decrease the amount going into reserves? When below 6 months reserves, I do 10% maintenance, 8-10% vacancy, and 8-10% capex. I’m curious to hear what a reasonable scale back would be when at or above the 6 months reserves mark.

Nathan Gesner · Answer

This is not an exact science. It depends on your financial strength, the quality of the property, how many properties you own, etc. I like to start with one major expense and three months of vacancy. Imagine if you had one single-family home. The tenant fails to pay their last month's rent and leaves the place needing new flooring and paint. It will take two months to turn it around and get it rented. That's three months of mortgage and utilities, the cost of flooring, and the cost of painting. That's a pretty common scenario and could cost you $10,000 - $15,000 so that would be a good starting point for your reserve. But there's more! What if you're a cardiologist with no debt and making $250,000 a year? You could probably afford $20,000 without much impact on your personal budget. If you're a single mom with student loans, a car payment, and living paycheck-to-paycheck, then $20,000 would be devastating and a reserve is critical. What if you have an apartment complex with 20 units? Do you save three months of vacancy for each unit and $50,000 for the roof replacement? That would be around $90,000 sitting in a savings account! At this point, I would recommend having a line of credit to cover these things so you don't have money sitting in the bank doing nothing when it could be put to work. I have 33 units, no debt except for mortgages, and excellent income. I can pay for all my problems using the cashflow from my current rentals. I also have a $175,000 line of credit at the ready if something catastrophic happened. A reserve is unnecessary, but I still keep around $15,000 - $20,000 in my account. The point is, you should sit down and assess your personal finances to determine what the worst-case scenario may look like, how much you would need to cover it without impacting your life, and whether you will need to build a reserve.

Edward Zachary Samperio · Answer

Congratulations on having 6 months of expenses set aside in reserves! This is a great achievement and shows that you have taken the important step of planning for unexpected expenses or income disruptions. When it comes to increasing your cash flow and decreasing the amount going into reserves, there are a few things to consider. First, it's important to remember that having a comfortable amount of reserves is crucial to your financial security and peace of mind. While it's understandable to want to increase your cash flow, it's also important not to sacrifice your financial stability in the process. One possible approach could be to gradually scale back your contributions to reserves, rather than making a sudden change. For example, you could decrease your reserve contributions by 1-2% per month and monitor your cash flow and financial situation closely to ensure that you are comfortable with the changes. This will give you time to adjust and make any necessary changes if needed. Another thing to consider is your overall financial goals. Are you saving for a specific goal, such as a down payment on a house or a child's education? If so, it may be wise to continue contributing to reserves at a steady rate to ensure that you stay on track with your long-term financial goals. In terms of a reasonable scale-back, it ultimately depends on your personal financial situation and goals. You may want to consider consulting with a financial advisor who can help you determine the best course of action based on your individual needs and circumstances. Overall, while it's tempting to increase your cash flow, it's important to prioritize your financial stability and ensure that you have a comfortable amount of reserves to fall back on in case of unexpected expenses or income disruptions.

Charles Carillo · Answer

@Nick WehrleyThe actual reserve amount depends significantly on the age and condition of your properties. With properties, some future CAPEX work is always required (a new roof, new bathroom, HW heater, or a new HVAC, etc.). You can start putting money away (usually every month) for these future CAPEX items, and adjust the number depending on what the expense will cost relative to what you already have in reserves.

Carlos Ptriawan · Answer

I am very conservative in risk management, so if I have 5 rentals with $100k valuation each, I have to make sure I have 250k in my liquid position.