Reserves for Real Estate Investors

Bonus Module

Reserves are one of the most important financial safety nets you’ll have as a real estate investor.

They help you weather “unexpected” expenses and protect your investments during tough times.

We’ll walk through what reserves are, why you need them, and how they differ from other types of funds.

You’ll learn how to determine how much you should hold in reserves and how to manage them effectively.

Understanding and properly managing your reserves can be the difference between thriving as an investor or struggling when the inevitable happens.

Table of Contents

Included in this module:

• What Are Reserves and Why You Need Them

• Reserves Versus Other Money

• How Much to Hold in Reserves for Rental Properties

• Investing Reserves in Stocks

• Reserves Change Over Time

• Reserves on Multiple Properties

• How to Build and Replenish Your Reserve Fund

• Reserves in Return Quadrants™

• Reserves Required by Lenders

• Using Reserves vs. Borrowing for Emergencies

• Reserves for Insurance Deductibles

• Reserves for Measuring Risk

What Are Reserves and Why You Need Them

Reserves in real estate investing are not just a precaution; they are a necessity.

These funds are set aside specifically to cover the expenses and shortfalls that will inevitably arise as you manage rental properties.

While some investors may view these situations as "unexpected," the reality is that they are part of the normal cycle of owning investment properties.

It’s not a question of if you’ll need reserves, but when.

Here are common scenarios where reserves will be needed:

• Tenant Stops Paying Rent - At some point, you will likely have a tenant who fails to pay rent, forcing you to go through the eviction process. This can take time and money, but with reserves, you can cover your mortgage and expenses (including the costs of hiring an attorney) while you handle the legal proceedings.

• Property Damage After a Tenant Leaves - Sooner or later, you will have a tenant who leaves your property in rough shape, requiring repairs beyond normal maintenance to a property before it can be rented again. Reserves allow you to manage these costs without dipping into other funds.

• Renting at a Lower Rate Than Expected - It’s not uncommon to face an unexpected turnover during a slower season, such as the holidays. You may need to rent the property at a lower rate, perhaps resulting in negative cash flow when otherwise your property would have positive cash flow. Reserves can cover this shortfall until the situation stabilizes and you’re able to rent the property in a better season.

• Major Repairs or Emergencies - From failed furnaces to leaky roofs, major repairs are inevitable over time. Having reserves ensures you can take care of these issues quickly without financial stress.

These scenarios are not "unexpected" events; they are normal, recurring parts of managing rental properties.

The key is accepting that they will happen and being prepared by maintaining adequate reserves. This foresight allows you to manage the unavoidable challenges without putting your investments at risk.

Reserves Versus Other Money

Reserves serve a distinct role compared to other types of funds you might have in your real estate investment strategy.

While reserves are meant to cover inevitable but uncertain costs that will arise, other funds are allocated for specific, predictable expenses that you plan for in advance.

Each type of fund has its own purpose, helping you manage both the day-to-day and long-term financial demands of your properties.

Here’s how reserves differ from other key funds you should have in place:

• Personal Reserves/Emergency Fund - These are funds set aside for your personal living expenses in case you lose your job, get injured, or face a personal financial emergency. They are completely separate from your rental property reserves and meant to cover your basic needs like housing, food, and utilities, not your investment expenses.

• Maintenance Savings Account - This account is for routine and expected maintenance costs on your rental properties, such as painting, replacing carpets, and contractor service calls for HVAC, plumbing, or electrical repairs. These are costs you know will come up over time, and setting money aside for them helps you avoid financial surprises when they arise.

• Capital Expenses Savings Account - This account is specifically for large, planned expenses like replacing a roof, installing new windows, or upgrading major systems like HVAC or plumbing. You know these costs are coming eventually, and setting money aside over time helps you prepare for them without taking a hit all at once.

• Cumulative Negative Cash Flow - If you purchase a property that initially has negative cash flow—meaning you put a smaller down payment down and consequently your monthly expenses exceed your rental income—setting aside reserves to cover this shortfall is a more conservative approach to investing. Instead of putting more money down to achieve positive cash flow from the start, you can allocate some funds to cover the expected negative cash flow until rents increase enough to produce positive cash flow. The amount you’d need to set aside to cover negative cash flow until your property produces positive cash flow is usually less than the amount you’d need to add to your down payment to get to positive cash flow immediately.

• Next Investment Total Cost to Close - These are funds you set aside to cover the full cost of your next investment property, including the down payment, closing costs, and any initial expenses like repairs or renovations needed to get the property rent-ready.

Each of these accounts serves a different function in your overall financial plan for real estate investing.

Reserves, however, are specifically there to cover the irregular costs that are bound to happen eventually, even though you can’t plan for exactly when or how much. Having clear distinctions between these funds ensures that you’re prepared for both the planned and unplanned aspects of owning rental properties.

Examples of expenses for each category:

• Personal Reserves/Emergency Fund - Personal rent or mortgage, groceries, utility bills.

• Maintenance Savings Account - Painting the property after a tenant moves out, replacing worn-out carpet, service calls for routine HVAC repairs.

• Capital Expenses Savings Account - Replacing a roof, upgrading electrical systems, installing new windows.

• Cumulative Negative Cash Flow - Covering a $200 per month shortfall between rental income and expenses until rent increases and you have positive cash flow.

• Next Investment Total Cost to Close - Down payment, closing costs, rent ready costs, cumulative negative cash flow—all for buying your next property.

By having separate funds for each of these categories, you’ll have the flexibility to manage both the expected and inevitable costs of real estate investing without scrambling when issues arise.

How Much to Hold in Reserves for Rental Properties

When determining how much to hold in reserves, it’s important to move away from setting aside an arbitrary dollar amount, like $10,000 per property.

Instead, we recommend measuring reserves in months.

This gives you a more accurate way to ensure your reserves align with your property’s specific financial needs, regardless of property size, type or location.

General Guidelines for Reserves

There are two primary methods we suggest for determining how much to hold in reserves: