You never really know when disasters will strike, so a proactive approach might save your rental business. Most seasoned real estate investors will give you the same advice on that account, which is to keep enough reserve funds for a rainy day.
Rental property reserves can be used for various purposes, particularly in situations where landlords may struggle to provide a financial safety net. It can cover repairs, vacancies, extensive property damage, and even legal fees. But first, how much should you keep without it affecting your cash flow?
Key Highlights:
- Cash reserves are essential for protecting rental businesses from unexpected disasters, covering everything from repairs to vacancies and legal issues.
- The ideal reserve amount varies based on expenses, property type, age, rental demand, and vacancy risk. Standard methods include saving 8–10% of profits, three months' rent per unit, or 10% of rental income.
- Emergency funds ensure that landlords can handle sudden repair needs, such as burst pipes, HVAC failures, and roof leaks, without disrupting their cash flow.
- Reserves can also be used to cover vacancy losses, operating expenses, and legal or eviction costs, helping to maintain financial stability during downturns or periods of tenant turnover.
- While typically not used for capital improvements, reserve funds may be utilized for major replacements when beneficial. Storing reserves in separate bank accounts helps prevent accidental spending and facilitates more accurate tracking.
How Much Should I Save for a Rental Property Reserve?
This can vary due to several factors, including monthly operating expenses, income stability, rental demand, the number of properties, property condition, vacancy risks, property taxes, property age, and others. With those variables, you can start calculating the appropriate amount in the following ways:
- Profit Percentage: You can set aside 8% to 10% of your monthly profits to build up your cash reserves until you reach a comfortable amount for you. The cap amount would depend on the property type and the vacancy risk associated with your property.
- Thrice the Monthly Rent per Unit: Rental property owners will have more breathing room knowing that even without a rental income, they can cover operating funds and emergency costs for three months.
- 10% of Rental Income: While this can be too high a price for many, a hefty cash reserve can last you several months of downturn. In a fluctuating rental market, this could be the only thing that would save your property until everything stabilizes.
What You Can Use Property Reserve Funds For
Emergency Repairs
Since emergency and major repairs are typically sudden and unexpected, expenses can quickly accumulate. That's what the cash reserves will be for. If you don't have the necessary funds, you can use the reserve funds for burst pipes, water leaks, electrical issues, broken HVAC systems, appliance failures, roof leaks, or other maintenance issues that affect the habitability of your property, as well as your property value.
Vacancy Loss Coverage
Without tenants, you won't be able to collect rent and cover monthly operating costs for the vacant units. A cash reserve keeps you afloat when you have a month or more without rent. You also have to account for tenant turnover costs, and without an emergency fund, you might not be able to market your rental listing effectively. Watch the rental vacancy rates.
Property Operating Expenses
When your income falls short, even at full occupancy, you can also spend your property reserve on planned expenses. That includes mortgage payments, property taxes, insurance premiums, utility bills, HOA fees, property management fees, and other monthly expenses. If you really need to save your reserve funds for a rainy day, this would be the one time you should spend them, as it helps protect your investment property from experiencing negative cash flow.
Legal or Eviction Costs
If you ever encounter disputes that lead to legal issues, you can tap into your reserve funds instead of disrupting your rental property finances. Your expenses can include court filing fees, attorney fees, mediation fees, or payment for damages. That depends on whether the former tenant or the rental property owner wins the case.
Capital Improvements
These are usually not included in valid reasons to spend your property reserve funds, but you can if it greatly benefits your rental. These long-term replacement costs don't have to be deducted from your monthly rental income, especially if you have ample cash reserves; however, you should consider doing so if you can manage it. These replacements are typically for your roof, water heater, HVAC system, flooring, and plumbing. Just be sure to leave enough still to cover unexpected expenses.
Where Should I Store My Emergency Fund?
Just as with a security deposit account, it's also advisable to open a separate bank account to prevent accidentally spending the funds. You can even open multiple reserve accounts per property, making it easier to manage your emergency funds.
Rental Property Emergency Fund FAQs
How much should I save for my rental property emergency fund?
- There are several calculations you can choose for your reserve amount, such as allocating a percentage of your monthly income to reach a specific sum, three times the monthly rent per unit, or 10% of your monthly income, as long as it covers your unexpected or fixed expenses and your property remains profitable.
Where should I store my emergency funds?
- You can store it in a separate account, even one for each unit. It's a common practice in rental real estate to prevent accidentally using your rental income for urgent repairs, unplanned expenses, or other non-negotiable expenses.
Which expenses should not be covered by the emergency fund?
- Property owners should not use it for personal expenses, non-property-related business expenses, unnecessary upgrades, down payments for new real estate investments, or other regular expenses when there's enough to cover them.
How to avoid the need for a larger reserve fund?
- To prevent major, unexpected repairs and maintenance, effective property management is crucial, particularly in areas such as routine maintenance and thorough tenant screening. If you prioritize your long-term financial stability, you can cover your monthly expenses without needing an emergency fund.
Make It So There's No Need for an Emergency Reserve
While maintaining a cash reserve is a prudent move, the most effective strategy is still to avoid using it altogether. Some issues are unavoidable, such as damage from natural disasters, but the rest are easily preventable.
Harland Property Management can help you keep your property as profitable as it can be through expert and vigilant management. Your base income can cover your routine and irregular expenses, and your cash reserves can be allocated to more unforeseen circumstances.
Leave it to us, and we'll make sure your rental business thrives. We're just a call away!
