How Much Cash Reserve Do You Need For A Rental Property?
If you ask a random real estate investor how much they have in cash reserves per property, their answers may vary greatly. And to be honest, the amount of cash reserves an investor decides to have is largely dependent on their risk tolerance. With that being said, there are some rules of thumb and factors to consider when deciding the appropriate amount for your cash reserves.
For a rental property, it is very typical for a real estate investor to have between 3 to 9 months of expenses as cash reserves in the case of an extended vacancy, an eviction, or any other emergency. The expenses will vary depending on the property, but they must include property taxes, insurance, mortgage, homeowner association fees, utility bills, repairs and maintenance, and capital expenditures.
These are just a few examples of what an investor should consider when trying to gauge how big or small their cash reserves should be; however, there are a few other factors when deciding how much to keep as your cash reserves.
What Factors Should You Consider When Creating a Cash Reserve?
Property's Age & Condition
Identifying your property's age and condition can give you a gauge of how much cash you should have as a reserve. One can quickly assess this by knowing what condition the property is in and if it will need any major renovations in the near future.
If the property is over 50 years old and hasn't been renovated since it was built, it will be a good idea to have extra cash set aside for when things start to break. However, if your property is only one to two years old and is in really great condition, you may not need as much cash set aside for repairs and renovations.
If you don't know what condition the property is in based on its age, then it would be a great idea to get a home inspector to help you with the process. Home inspectors are experts who have experience investigating properties and are able to foresee any potential problems that may exist. It may be a great idea to get a home inspector to check out your property before deciding to buy it, regardless of your past construction experience.
Evictions Cost
Another key factor that you should consider when deciding an amount of cash reserves is the cost of an eviction. Even though trying to find the exact cost of an eviction can be very difficult, especially if you haven't ever experienced an eviction before. You will have to account for legal fees, court costs, financial damages, potential property damages, and lost rent. All the fees and other various costs can add up quickly, and you want to have a hefty cash reserve just in case you are in this position.
Turnover Costs
In most cases, traditional investors love tenants who signed long-term leases because the investor would save money from not having to turnover the property as frequently. Turnover is the time when one tenant moves out of a property and before the other tenant moves in.
In this timeframe, the property manager or investor will get the property ready for the next tenant, which usually costs money. Maybe the property needs new paint on the walls, or the entire property requires a deep cleaning. Either way, money needs to be set aside for when a turnover happens.
Market Vacancy Rates
If an investor is in a market with a very low vacancy rate, they would not need a huge cash reserve because the property would remain occupied most of the time. Vacancy is one of those things that every landlord will experience but should be kept to a minimum.
Whenever your property remains vacant, the landlord will have to fit the bill for ALL of the expenses without having any income coming in from the property. This can be a huge issue if it is not planned accordingly and the cash reserve is not set aside for when a property becomes vacant for an extended time.
You can try your best to do some research to find out the vacancy rate for a particular market; however, this information isn't readily available in most cases. Some resources like Mashvisor or AirDNA can gather some data related to vacancy rates within a market, but it may not be the best data for smaller or rural markets. Another recommendation is to ask other investors already in your market what their vacancy rates are.
In Summary
To gauge how much cash reserves you may need for a property, you should keep in mind these 5 factors:
The overall cost of your expenses
The age of your property
The cost of evictions
Turnover cost
Markets vacancy rate
These five factors will all vary depending on the investor in the market that he or she is investing in; however, as an investor, you should understand your comfort and risk level when deciding how much money to have in your cash reserves. There is no one right answer but just make sure you are always prepared when an emergency comes knocking at your door.