Real Estate Investors: Keep Reserve Funds On Hand
By Paul Esajian on January 13, 2014
The thing about unexpected expenses is that they are, in fact, unexpected. They will come at the worst times and typically out of the blue. In order to brace for this scenario, you need to keep an ample supply of reserve funds on hand. This should be money that you can pull out of an existing account or from some other source on short notice. If you do not have this money put away for a rainy day, you will find yourself stuck when taxes increase, the furnace breaks or there is a leak in the roof.
As a rule of thumb, you should have six months of PITI (principal, interest, taxes and insurance) in savings to draw from if need be. This is a good practice if you are considering buying additional properties, as lenders will look to see cash reserves in place for at least 60 days. Secondly, there is not much that gets investors in trouble faster than trying to scramble to find money or options after something bad happens. This can lead to a trickle-down effect. The rest of the decisions you make in your business are ultimately impacted by a lack of funds.
If you are renting the property, there is no guarantee that your tenant will continue paying. You may think you are protected by your lease, but that will not keep your mortgage paid for the next 60-90 days. You may get some of that money back, but if you do not have it to pay, you can quickly fall into foreclosure and soon enough your credit will be damaged. You may be faced to give up the property as a result. Reserves will give you options or buy you time to make the best decisions possible.
Some consider it counterproductive to place profits into an account that you may never use. It is easy to think that this money could be used for a multitude of other things, including paying down other debts or upgrading old appliances. If this reserve money is not available, you cannot properly run your business. You will make rash decisions on a shoe string budget. All of your future decisions will be based on trying to recover money you lost. Sooner or later, it will catch up with you.
Even allocating a small percentage every month will slowly have an impact. Your bottom line on every deal or every month will be impacted, but you should be able to sleep better at night knowing that your business won’t crumble the next time a storm hits or when your tenant is a month late. Reserves give you options, flexibility and peace of mind. These funds are essential to running your investing business.
At the end of the year, you can roll over what is in your reserves or take a small chunk out for property upgrades and maintenance. Be careful not to take too much out and deplete what you have worked to build for the past few months. You may not think about how much reserves you have until you need them. By that time, it may be too late.