Business cash reserves are a basically an emergency savings account. If you treat your rental property as a business, you should be putting a little aside each month for the unknown. You know, like a pandemic. So how much cash reserves are enough for your rental property? We’ll get to that in a moment.
Why Do Landlords Need Cash Reserves?
These cash reserves are used for circumstances such as:
- Unexpected vacancies or turnover that takes longer than expected.
- To carry a good tenant facing sudden health issues.
- To cover expenses and missed rent in the event of a fire or flood, or God forbid another pandemic.
- For replacement costs for damaged windows, doors, carpet, or appliances like water heaters, air conditioners, or refrigerators.
- Those unexpected repairs to damaged floors, heating systems, or issues caused by mold or pest infestations, or dry rot.
- Costly capital improvements like a new roof, fence, kitchen, bath, or painting the exterior of your rental property.
As you can see from the examples above, capital reserves carry you through many different circumstances. Had we not had a sizable reserve, we would have been in a very different situation during the pandemic.
How much cash reserves do you need for your rental property?
The basic rule of thumb is much like you should have for your personal reserves, six months of income and expenses in the event you are incapacitated and your income stalls. So that would be six months total of:
- Total income earned by your rental property. This includes monthly rent and income derived from any other sources like washer/dryer coins, additional storage income, parking space income, and concierge services offered to tenants.
- PMI: Property taxes, mortgage, and insurance fees.
- Maintenance and Utilities you provide: Water, gas/electric, trash, landscaper, and/or property manager.
- Expenses you run through your business: Car payments, gas allowances, health insurance, employees, etc.
Two approaches on to how to reach your goal reserve:
1) We like to hold or reserve 10% of rental income each month. This goes back to what we learned 20 years ago where you reserve 5% for vacancies and another 5% for capital improvements. It seems like quite a bit of money but we started lower (around 5%), then upped it when rent increases came and continued to save until we reached our goal of 6 months worth of total income and expenses were covered. It honestly didn’t take that long to achieve.
2) You can save your own income or use a personal line of credit and invest it into your rental property “business” but we don’t recommend that. It’s not advisable to put stress on your own financial situation for the sake of your business. Many landlords found this out when the pandemic hit. This is especially true if the rental income you earn is your primary source of income. In this case, you are basically borrowing from yourself to pay yourself. You need to ask yourself, “What if I need this cushion for my personal use?” Do your best to keep your business and personal finances separate. Losing an investment property is much different than losing your personal one.
The bottom line is to just start saving the amount you can afford from your rental income and work towards your goal. Every little bit each month helps. Before you know it, you’ll have what you need in capital reserves and can rest easy knowing you are covered in the event of any worst case.
Additional Notes
Once you reach your goal, you will be conditioned to saving this reserve and can continue to save for any improvements you’ve been dreaming of! Our kitchens are looking a bit dated and worn so we are now working on saving towards replacing those in our 6-plex.
An additional benefit once you reach your goal, is that you can begin saving for your next investment property. Imagine how quickly you will grow between savings and equity built on your existing properties!
Lastly, when evaluating potential rental properties to purchase, make sure you account for the percent of savings per month when calculating your ROI. If only profiting $100 per door on a duplex and you forget to account for reserves of $150 a month, you’re really only earning $50 a month. Not a wise investment.
We hope you now know how much you need in cash reserves for your rental property and will start putting away a little each month. We were pleased at how quickly it added up.
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