Lesson 2: Reserves are important
Reserves are so crucial for real estate investors since owning rental property means you’ll have to cover the costs of breaks and repairs.
he reality is that repairs are hardly ever the proverbial broken toilet at 2 A.M. They are much more mundane, and they come in waves rather than consistent monthly expenditures.
Repairs cost money, so you need to be prepared. Gary Beasley, the CEO of Roofstock, has given some great advice about owning rental property in past interviews that many other professionals echo. I couldn’t say it better myself: “Start setting aside a small percentage of your monthly cash flow into a contingency fund of about 1-2% of the purchase price of the rental property.”
Ultimately, what you keep in reserves is up to you. We are much more conservative in this area, so we like to keep about 3-6 months worth of rental income per property in reserves as a base. On top of that, we follow the general advice to save 1-2% of the purchase price for the inevitable expenses and tenant turnover.
Here is a practical example from our first year of why you need reserves:
Our first five months of owning rental property were smooth. Really, really smooth. In total, we only had $250 of expenses across three properties outside of the mortgage payments and PM fees. Rent was paid on time, tenants were happy, we were happy—all was good in the world.
We could have quickly become comfortable and over-confident.
However, as the saying goes “When it rains, it pours.” And pour on us for the second half of the year it did. $2,000 later and owning rental property was a little less fun. HVAC units needed repair due to a scorching summer, pipes started breaking when it got a little too cold, bugs decided to try and come indoors, and a heater wouldn’t start. We were okay with it though because we stuck to our numbers and didn’t let emotions get involved.