There’s no magic formula you can use to determine how much you should keep in reserve in your business as a real estate investor. When you rent properties, the four key factors to consider are the strength of the local rental market, eviction time line and cost, the age of the property, and the type of neighborhood.
Strength of the Local Rental Market
The lower the vacancy rates in your area, the fewer reserves you’ll need for vacancies. Your local newspaper or your city’s housing department may have articles or statistics on vacancy rates. You should, at a minimum, have enough cash reserves to pay for one month of vacancy per unit, which is only an 8 percent vacancy rate.
Even in a good market, you’ll deal with problem tenants who may stop paying rent and require an eviction. Good tenant screening will help solve this problem. If you plan to rent properties, you should always, without exception, do a rigorous background check on tenants. This includes reviewing credit reports, employment verification, references, and calling current and previous landlords.
Eviction Time Line and Cost
The length of time it takes to evict a tenant is relative to your cash reserves. In pro-tenant states like New York and Massachusetts, it could take months and thousands of dollars in legal fees to evict a tenant — all while you’re paying the mortgage. In addition, in our experience, collecting back rents or damages from tenants who’ve been evicted can be futile.
Age of the Property
With newer and recently renovated properties, you won’t need to anticipate many repairs in the first few years. As noted earlier, we recommend that you always hire a professional property inspector before you buy. Inspectors will go through the property with a fine-tooth comb, which helps ensure you’ll have no surprises later on. Another thing to keep in mind is that many utility companies offer a fixed monthly payment option so you don’t experience payment swings each season if you’re paying for heat, water, or other utilities as the landlord.
Type of Neighborhood
If you’re renting properties in low-income neighborhoods, you can expect the turnover to be much higher than in high-income areas. In addition, multi-unit buildings with small units and one-bedroom condos will attract more single people who tend to move more often than families do.
Rule of Thumb
A general rule-of-thumb is to have two to three months worth of the gross rent per unit. For example, if your property rents for $800 per month, then you should keep $2,400 in reserve in your real estate business's operating account.