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Why You Need Cash Reserves When Investing in Rental Properties
When investing in rental properties, it is pretty important to be prepared for unexpected things to happen. The worst rarely happens, however, if it does and you are prepared you will definitely thank yourself! Cash reserves are a good way to help prepare for the worst when investing in rental properties.
What are Cash Reserves?
Cash reserves are the funds that are set aside in order to cover unexpected or unplanned costs. Typically, cash reserves are used for emergency or short-term needs. Think of them as an “in-case-of-emergency” fund.
However, cash reserves are different from your personal emergency fund. You need to have separate reserves for your rental properties and for any personal emergencies.
Do not use your personal emergency fund for your rental properties. This could potentially put you in a very tight position.
Reasons To Use Cash Reserves for Your Rental Property
It is better to dig a well before you’re thirsty.
You want to cover your needs before you actually have them. That is why it is better to dig a well before you get thirsty! If you get “thirsty”, you will already have the means to cover your needs. Cash reserves work in the same way by having the well of money before you have a need for it.
4 Reasons To Use Cash Reserves
- Evictions
- Tenants can’t pay rent (divorce, job loss, medical reasons)
- Legal fees
- Capital expenditures (water heater burns out, windows need to be replaced, natural disasters)
The list is really endless as far as when you might need to use cash reserves. But really, cash reserves are your own type of insurance against the worst, even if you are doing background checks on your tenants, and you are keeping up with preventative home maintenance.
Background Checks DO NOT Screen Everything
Every landlord should be running background checks on potential tenants before they are approved to live in a rental property. Checking their credit scores, income, job history, past due debts, etc. However, screening tenants doesn’t protect you against the unforeseeable!
When I was working in property management, we used to have a phrase, “You can’t screen for crazy!” Some of the tenants that looked the best on paper, turned out to be the ones who “went crazy” and caused the most issues for us.
You also can’t screen for relationship problems, family deaths, medical complications, or job loss. It is possible that the family provider may get ill and not have the ability to work, and therefore not pay rent. Life happens to the best of us (we all saw what 2020 brought to our economy and to many families).
So be prepared just in case the unforeseeable happens! Some people are handed more than they can handle and will be put into a very tough position.
Related: How To Make Real Estate Investing ‘Easy‘
How Much Do You Need In Cash Reserves?
There is no hard and fast rule for how much you should have saved up in cash reserves. Some would argue it should be a specific amount, like $5,000. While other landlords will say it should be a percentage of the rent.
A good guideline I would recommend is to have about 6 months of cash reserves for each of your rental properties.
If your rental property sat vacant for 6 months, would you have the cash reserves to cover the expenses?
These expenses are things like:
- Mortgage
- Utilities
- Taxes
- Insurance
- Lawn care
- HOA fees
- Maybe a good cleaning of the property before new tenants move in
You need to decide for yourself what the right amount of cash reserves is. The important thing is that you do have the reserves!
Related: Top 3 Reasons Your Property Isn’t Renting
Saving For Your Cash Reserves
Don’t panic if you don’t have money saved up for your rental properties. You can start saving up today.
Put away the rental income you are getting now and start to create your reserves, or start saving from your paycheck each month. It is better to get that started now than to wait until it is too late.
If you are operating your rentals as a business it is best to save the money directly from your rental income. However, you can also “invest” in your business with your own finances.
Blog Article Spotlight
Trevor Ewen shares his own experience with cash reserves on BiggerPockets. He learned a lesson on the importance of cash reserves when his rental properties suffered through a hurricane!
What Does The Bible Say About Cash Reserves?
Did you know that the Bible talks about real estate investing? There are also many times the Bible talks about being prepared (Matthew 25:1-13; Luke 21:36; Mark 13:32-33). Though these passages mainly speak about being prepared for the return of Christ and for the Kingdom of God, they apply to preparation in general.
Christ can return and any time and we are called to be prepared and always sharing Jesus with others. If you take that idea and apply it to cash reserves the concept is to be prepared in case anything happens. Not only should we be prepared, but we should also share with others how they can be prepared.
Having cash reserves for our rentals is also a way we can love our tenants, and work hard in order to honor God.
For example: Let’s say a flood happens at one of your properties. You would want to be able to repair the property promptly. That way your tenants are able to continue living there safely and comfortably.
Our calling in life is to love God and to love others. If we continue to be prepared we will be rewarded for our efforts. So let’s love God and love our tenants be being prepared.
Related: 9 Unique Ways to Use Real Estate as a Ministry
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