In my original post about cash reserves, I mentioned the three key accounts you’ll want for your business.
- Operating Account
- Cash Reserves
- Tax Reserves
In Real Estate, you might want to consider a fourth for capital improvements.
For a Real Estate Agent and the operations of a Property Management Company, I think the following table would do the trick, but if you’re flipping homes and buying income property there are a few adjustments I would make.
Fliping Homes (Construction)
Most home flippers will work with a private lender or hard money lender, or they have their own funds for the cost of construction. My recommendation for each project is to budget for overages and have some reserves for holding costs, especially if you’re in a buyer’s market.
This article will be most beneficial to those that are involved in rental property either as a landlord or property manager.
Setting Up Cash Reserves for Income Property
Using the table above, smaller properties may want to have 30% in reserves while a larger property may lean more toward 10%.
An easy way to do this is to score yourself 10 for left and 30 for right.
- High recurring Revenue – Unless you have at least 10 units you might want to consider the 30% side due to fewer units.
- You shouldn’t have any days in accounts receivable unless you’re not enforcing late rent payments, so you could cross this item off.
- Pipeline – This generally refers to sales. One way you could look at this is to gauge how much interest there is in your property from potential renters.
- Partners – What age are the investors? It’s not likely someone will retire and withdraw their funds, but it’s something to consider
- Growth – Are rents expected to rise or remain the same
- Big Purchases – We’ll come back to this one when we talk about Capital Improvements. For now, we’ll exclude it.
- Owners – How many investors are involved?
- The last two go together. How many units does the property have? Fewer units, then a higher reserve
Now add up all of your scores and find the average. That’s approximately how much you should have in your cash reserves account for operations.
Cash Reserves for Capital Improvements
The Capital Improvement Reserves are going to replace the big purchases part of your cash reserves. The difference here is you will continually fund this and only draw from it when major repairs happen. That way the funds are always on hand for major renovations.
Figuring out how much to put towards capital improvements requires some work. For each major item you have on the property – roof, HVAC, laundry, windows, parking, etc, you’ll want to figure out how much life is left and then divide that into the estimated cost to replace. You might also want to take into account the average rate of inflation when you do your numbers.
Every property will be different in this area, so you’ll want to collect good information, and if you want to save yourself some time line yourself up with an accountant.