Every business needs to have cash reserves. From Google, Apple, Walmart, etc. all need to have capital reserves for the business to run on.
Without cash in the bank, businesses go out of business and your cash reserves will help you stay in business.
Today, we talk about how to make sure you have enough money in cash reserves to cover the expenses, updates, loss of rents, etc.
What are Cash Reserves?
Cash reserves are funds saved for future unexpected expenses as well as expected expenses. The cash money that is saved in a designated account for future spending is usually earning interest at a good savings rate.
A huge benefit to having cash reserves is that you can avoid taking on debt of any kind to pay for the unexpected expenses.
The bank that I personally use for my banking is CIT. They give an amazing return on my cash reserves. Check them out here: CIT Bank
Listener Question on Cash Reserves:
“Hey Dustin, I imagine you have a cash reserve account for unexpected expenses and what not for your rentals. What is your system in regards to that? I have reserves, but if I’m adding to my portfolio I was curious how you pad your reserves as you accumulate more properties?”
And one that does not take much to explain a successful plan for accomplishing it.
In any given month, you may run into any number of expenses that will come up out of no where. Just 2 weeks ago, I paid to have a roof replaced on a property that I thought was going to cost only $1,700 for a repair.
Turns out that the repair would not fix the problem and I needed to replace the entire roof and rebuild the chimney.
This was a $4,000 hit in one month!!slideshow_deploy!
Because I have money saved in an interest barring account making me 1.75%, I was able to pay for this with cash. To run your business well, you must have a capital reserve account to pay for future expenses that may come up.
Why You Need A Cash Reserves / Capital Reserve Account
Cash Reserves and Capital Reserves are the same thing but with two different terms.
It is easy to overlook a crucial expense that most people do not account for. Cash Reserves must be an expenses you put into your expenses ever month.
This can be as much or as little as you would like it to be. I recommend to all my rental property students to set aside 5%-10% of each months rent as capital reserves for future expenses.
A furnace may go out in the middle of winter or the water heater could spring a leak at a moments notice. You need to have money saved up for these future expenses. Here is a small list of reasons why you need an reserve account.
- Operating Capital
- Emergency Fund
- Unexpected Expenses
- Property Upgrades
- Avoid Borrowing Money and Paying Interest
- Make Money In Interest Storing Your Money at a Bank
Where You Should Keep Your Reserve Capital
Your money should ALWAYS be making you more money. No matter where you put it, real estate, stocks, bank, etc. it should be putting money in your pocket.
Recently, I found a great bank that gives a terrific return on my money.
I use CIT Bank. They give an amazing interest and a monthly return on your money stored there.
How to Manage Your Cash Reserves
1 to 5 Rental Properties
To account for these types of issues, I try to save 10% of the rent each month until I have one months rent of the property saved.
If the rent is $1000, you should have $1000 saved in the bank for expenses. Same goes for a property that has $2000 in rent, you will need to have $2000 saved.
This is basically a rule of thumb and can be adjusted. But this is a good way to start your rental business.
Reserves for Your Rental Business – Not Just One Rental
5 to 15 Rental Properties
Now, when your business gets larger and you have more properties, you don’t need one months rent per property. The reason is that you don’t need one months rent for 10 of the 20 properties saved since you will not pay all that at one time.
When you go from one property to many, you need to start thinking of this as a business, not a rental. One property is a rental. 10 properties is a business. Now you need to think about reserves for your business.
This is operating capital.
A rental property business is the same as any business where cash is it’s life blood.
All the properties work together for the reserve for the business.
How much your business needs in reserves depends on you and what you feel comfortable with. I personally have $5000 saved just for my rental properties for all expenses that may come up.
With 15 properties that bring in $500 a month, the total income would be $7,500 each month. 10% of $7,500 would be $750 a month saved for expenses and repairs.
With my 20+ properties, when that reserve is spent on a new roof, furnace, etc, it usually gets replenished in a couple months. I personally have not had 5 furnaces go out in one month but I am sure that it is possible that it could actually happen. (although unlikely)
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Personal Reserves for When You Do Not Have A Job
Another thing you may be concerned about is your own personal reserves if you do not have a job. Without a constant amount of money coming in each month, it is a good idea for you to have a healthy savings or emergency fund ready for months with low income from your businesses.
I personally keep 6 months expenses saved in an interest baring account at CIT Bank where I earn 2.45% each month in interest.
6 Months * $4,000 = $24,000 Emergency Fund
Your personal reserves will be different than mine.
This is just where my wife and I feel comfortable with the ebb and flows of passive income where one month is fantastic and the next is not so much.
What About Other Expenses and Cash Reserves in a Rental Business
Another Question I received is similar to the one above but touches on the aspect of expenses and cash reserves.
This question is from a reader named Chevy who is already investing in multi-family homes. Good for you Chevy!
“I read How to Quit Your Job with Rental Properties, and after acquiring 21 units in 5 buildings in 6 years myself, I realized you forgot some expenses. Namely: Repairs (10% gross income), vacancies (5%), management (10%), utilities/trash (varies). Not to mention umbrella policy for all the units (and probably LLC fees because you don’t want all them in your name). And you propose single family homes. So 15 houses is 15 roofs & 60 exterior walls of possible repairs! Thankfully, I only have 5 roofs and 20 walls.”
These are all great things you need to account for when you have your business. Now, each property, property manager, taxes, insurance, etc. will be different with each property and area you invest. My book “How to Quit Your Job with Rental Properties” focuses on investing in your own area where you can manage the properties yourself and keep your expenses low.
There are plans for a future book and online coaching course on how to invest out of state and be successful.
I have properties in Ohio, Texas, AZ, and CA. Each area of the country has different expenses and each need to be accounted for differently.
So for those expenses you brought up:
- Repairs – Save 10% of rents until you have enough money to handle most major repairs repairs. You are not going to have to replace all 20 furnaces at once so you don’t need to have all that money saved.
- Vacancy is number that I use when I buy the property. It is put into the numbers to make sure that the rents will be able cover the vacancy. If the property cannot make money with 5% vacancy, I don’t buy it. For my general income, I personally don’t add that into my monthly numbers
- Trash/Utilities – paid by tenant
- Umbrella Insurance Policy – This is a must when you get more properties to protect yourself. Usually though, regular homeowners insurance is plenty for a few properties. Also, this depends on your risk tolerance. If you need an umbrella policy, get one. I just don’t figure those into my monthly numbers. It is just a business expense.
- LLC/S Corp Fees – For my, the fees are $150 a year so I don’t figure that.
How Much Money To Have In A Cash Reserves Account
There are many business expenses that you can possibly add. What about Book Keeping, Tax Prep, Accounting and auditing, and many others.
I find these are the cost of doing business and is added on top of everything as the business gets bigger.
A rental property business is just like most other businesses and require “Operating Capital” to keep your business running. Your inventory is your property and you need to keep that inventory in good enough shape to rent out.
The difference with the rental business is that the costs are not fixed.
The amount of money you need to have in reserves depends on you business and your risk tolerance. I personally have 6 months of personal expenses saved for hard times.
This can be used to help pay for repairs but hopefully your properties will bring in enough money to pay for themselves. I had a furnace I needed to replace last month but I didn’t pay any money out of my pocket because my income far exceed the expenses.
With 20+ properties, the income covers most all expenses I encounter.
The issue is making sure I have enough money to live on in savings. (6-8 months personal expenses saved)