Real Estate Investing: Cash Reserves

Cash reserves are an important part of any real estate investment strategy.  Not having enough cash reserves can mean the difference between a failed investment and a successful one that provides monthly income and long term growth.  It is easy to assume (hope) that tenants will never move and nothing will ever break in your rental property but a wise investor can be prepared for whatever may come their way.

Surprises:  How do you plan for a surprise?  It is very tough to do because by definition a surprise is unexpected.  It could be Cash reserves for real estate investmentsomething as cheap and easy as a leaky faucet or as expensive as a leaky fridge that goes unnoticed and damages the flooring and sub-flooring.  Either way, it can be tough to come up with the cash to fix surprises unless you have some set aside already.

Major Items:  Things like a roof or paint or floor coverings are a little easier to plan for because they don’t usually fail over a 24 hour period.  Even though you can see these big repairs coming it can still be tempting to ignore them until they become absolutely necessary.  However, if you don’t have enough reserves for a repair that needs to be done NOW you can find yourself making substandard repairs as a stop-gap measure which can end up costing more in the long run.

Vacancies:  Vacancies are usually pretty easy to see coming but it can be hard to know how long it will take to find a new tenant.  Another kind of vacancy that can be tough to see coming is the one where the house is still occupied but the tenant has stopped paying rent.  Not having enough cash reserves to get through a vacancy can lead to bad decisions by an investor.  A real estate investor who feels financial pressure to get the income flowing again might be tempted to accept a poorly qualified tenant.  Having cash reserves can allow your to take your time and find a good tenant.

How much do you need?  If you will be financing the rental property with a conventional loan, lenders will generally require two months reserves of principal, interest, taxes and insurance (piti) for each of the first four investment properties.  If you have five to 10 properties they will require six months of reserves for each property.  So if you have three investment properties and the monthly piti payment is $800 for each, the lender will require you to have $4800.00 cash reserves.  Once the loan closes it is pretty much up to the borrower to decide if that money is kept as reserves.

There is no standard formula for how much money investors should set aside as reserves.  What it really boils down to is each investor needs to decide what they are comfortable with.  Do you have enough disposable income each month from your day job to cover lost income from vacancies or a tenant who decides not to pay rent?  Do you have enough reserves that you won’t lie awake at night wondering what might break next and how you are going to come up with the money to fix it?

 

About Dan Seim

Dan Seim is the primary contributor to Preferred Residential's blog. He has been writing about real estate issues that affect home owners in Bend and Central Oregon since 2011.

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