Do I Need a Cash Reserve for My Rental Property?
Owning rental property comes with a certain amount of risk. Landlords deal with bad tenants, natural disasters, and vacancies, all of which can be costly. When major expenditures occur, your monthly rental income probably won’t be enough to cover the cost. So, yes, you need a cash reserve. But does it need a separate account? Which costs should your reserve cover? Don’t worry—today we’re covering the basics of cash reserves and savings tips that you can start using immediately.
What the Reserve Covers
Your monthly rental income should cover your normal operating costs. But your business also has planned expenses, insurance deductibles, and irregular costs. That’s when your reserve comes into play. The point of the reserve is to cover items that fall outside the scope of your monthly income.
Use your reserve to cover any of these expenditures:
• Major or unexpected repairs
Eventually, your rental property will need a new roof. But you may also need to replace a main water line, fireplace liner, fence, sump pump, or garage door. You might even have to deal with mold or a pest infestation.
• Eviction or vacancy costs
It could be weeks or months before you get paid, plus you’ll have additional legal or professional fees to cover.
• Planned spending
These are outlays like property taxes. They aren’t monthly, but you can estimate them.
• Seasonal or irregular expenses
Things like snow removal, gutter cleaning, or tree removal aren’t typical monthly expenses, so they may not be part of your monthly budget.
• Insurance
Keep your full deductible in your reserve. When you need to make a claim, you’ll have one less thing to worry about if you have the deductible already covered.
Your reserve helps you stay in business even when things go wrong. It’s best to have cash on hand to deal with an emergency instead of relying on credit. If you don’t have reserves, you risk suffering personal financial damage or selling your property at a loss if you can’t cover repairs or rent loss.
Where to Keep Reserves
Commingling your accounts is one of the top errors in rental property bookkeeping. Depending on how you structure your real estate investment, you may need two to three accounts per property. But rental property owners should have two or three business bank accounts, at minimum.
1. Operating account - Use this account for your general operating costs.
2. Security deposit account - Some states require that landlords keep security deposits in a separate account.
3. Reserves account - Have your reserve linked to your operating account for easy transfers. Set up your reserve as a low-risk, liquid savings account, like a money market fund or high-yield bank account. Don’t experiment with your savings. Keep them safe and stable.
When and How to Start Saving
Your reserve should be in place when you buy the property, but it’s not too late to start saving if you skipped that step.
If you’re just beginning to save, consider setting aside a percentage of your monthly income. You can start small with 5% per month, then as rent increases kick in, you can increase to 10% each month. Depending on your financial situation, you may be able to direct all monthly profits, not just a small percentage, to your reserve account until it’s funded.
Before you start spending from the reserve, have a replenishment plan in place. Can you save 100% of your net cash flow until reserve is rebuilt? Is a smaller monthly contribution better for your situation? However you decide to fund the reserve, be disciplined and make saving a habit.
Savings Tips
• When you’re setting a goal amount for your reserve, remember to account for your total rental income. That’s your monthly rent, washer/dryer coins, storage fees, parking fees, and any concierge services you offer.
• Get in the habit of saving. Starting with a small amount is better than not having anything set aside.
• Include your savings per month when calculating your return on investment and budget.
• Once you reach your savings goal for one property, start building up a down payment for a new one or make extra mortgage payments.
Takeaways
Rental property owners need a cash reserve to cover outlays that fall outside their monthly operating costs. These reserve funds cover more than just unexpected expenditures—you can also use the fund for planned spending. Set up your reserve in a separate bank account that’s linked to your operating account. And remember, it’s never too early or too late to start saving. It’s a habit you can develop over time. It takes some effort, but having a cash reserve for your rental property pays off since it helps protect your business even when things go wrong.
