Image Source: OTA Photos Capital reserve requirements are a common question among investors and often generate plenty of controversy. Cash reserves for items like property maintenance are often mandatory when applying for mortgage loans, however maintaining reserve capital is a good practice, even when it is not required. These reserves can either be held in investors' private accounts, in designated operating accounts or in many cases held in escrow by the mortgage lender. These financial reserves can be used to cover a wide variety of cash flow short falls or expenses that arise. This can include:
- Vacancy
- Property repairs
- Property maintenance
- Replacement of major appliances
- Loan payments
- Legal costs
The requirements of mortgage lenders frequently change depending on the market and the details revolving around a particular project. Normally reserve requirements range between three to six months of operating expenses per property. While some investors feel this is outrageously expensive, others agree that it is just common sense. Factors that may impact how much makes sense to hold in reserves include:
- Current and forecast vacancy rates
- Number of units/ tenants in a property
- Age of the property
- Condition of property
- Major replacement needs coming up
- Access to other capital and income
- Tenant quality
When not mandatory, there may be other ways for real estate investors to minimize exposure to unexpected costs and reduce the amount of capital reserves needed to be kept on hand. This may include:
- Property, business, and umbrella insurance coverage
- Service plans
- Warranties
- Reinsurance
The big issue here for most investors is keeping this amount of cash liquid and parked on the sidelines. This is especially true when expanding a portfolio. It is crucial to have access to fast cash in a crunch, but too much idle capital can drag down overall portfolio returns. Some alternatives may include keeping the bulk of these funds in interest bearing or investment accounts, which can be accessed relatively quickly, while others may find it more beneficial to use a substantial line of credit to cover immediate short-term expenses.