Owning rental properties is a fantastic way to build wealth and buy financial freedom for yourself. But to ensure you can withstand whatever comes your way, it’s critical that you maintain proper cash reserves. When bad weather hits your real estate investment in the form of tenant issues, maintenance, or unexpected expenses, you can weather the storm if you have sufficient cash set aside. Understanding cash reserves can help you avoid falling short when your rental properties require funds.
Your reserve fund covers unexpected or uneven expenses associated with your rental properties. As a landlord, you need to expect the unexpected and plan for it. Cash reserves are one way you do that.
Gaps in Rent Collection
Occasionally, tenants pay late or even not at all. Your bank still expects you to send your monthly mortgage payment, however. Even if it is just a vacancy period of a few weeks between tenants, your income decreases but your expenses don’t. Cash reserves fill that gap.
What will you do if a severe weather event hits your property? Tenants may be unable to pay, and your property may not even be inhabitable for a time. Usually, insurance will cover much of the repairs, eventually. Many policies even cover lost rent due to damage, but that takes time to sort out. In the meantime, you have all the usual expenses. You may also be shelling out for your insurance deductible or any damage that isn’t covered. If you have a healthy reserve account, you can survive the impact of a major storm without straining your finances.
It’s the Little Things
Even if it isn’t something as significant as a hurricane or blizzard, you will still need your reserves eventually. Sinks leak and fuse boxes need the attention of an electrician. Over time, properties need new appliances and new roofs. When your tenant calls to tell you that the garage door opener died, you can rest easy knowing you have the reserve account available to pay for a remedy.
‘Tis the Season
Your reserves also cover seasonal expenses like tree trimming, home winterizing, mulching, or snow removal.
Many real estate investors aim to have the equivalent of three and six months’ rent in reserve, if not more. Some experts base reserves on expenses instead of rent, often recommending saving a full year of projected expenses.
To determine where on those scales you need to be, start by looking at the age of your property. In general, older properties require more maintenance. Consider not only the age of the home but also the age and condition of major systems and equipment. If your roof is 20 years old, you may want to beef up the reserves a bit more than if the roof is brand new.
If you own a condo where many of the maintenance items are covered, you may need less than if you own a single-family home where everything is your responsibility.
Another factor to consider is your insurance deductible. The higher your deductible, the more you’ll have to pay toward any insured losses. That translates to needing more cash reserves.
If you don’t escrow your property taxes as part of your mortgage payment, you will want to add that estimated amount on top of a typical reserve fund. You can use the prior year’s taxes to estimate how much to set aside, although they typically increase yearly.
Ideally, you will have at least some reserves in place before you close on your purchase. If not, make it a priority as soon as you have income from the property. Put any money left over after paying property expenses into your reserve account until you’ve hit your target amount. Your goal should be to save 100% of the net profit until your reserves are filled.
If you have to use your reserves, don’t worry. That’s what they are there for. Rebuild them after an expense until they are back where you want them to be. To replenish your reserves, go back to saving all of your profits until you hit your target number again.
The cash reserves for your rental property should be kept separate from your personal accounts. Determine what funds are for your rentals and only use them for that purpose.
Hold the reserve funds in low-risk savings. You can’t afford to have a drop in the stock market wipe out the account at the same time a hurricane hits your property and expenses are barreling toward you. High-yield savings accounts or money market funds are an excellent option for holding your reserves. They are incredibly secure, stable, and highly liquid, meaning your money will be there for you when you need it.
Sufficient cash reserves provide the cushion you need to properly care for your rental real estate, no matter what surprises may come. Setting up a reserve account to accompany your investment is essential. Once you have an appropriate reserve fund, handling your rentals’ finances will be a breeze.