As a real estate investor, ROI and cash flow are everything. You’re constantly on the lookout for ways to make your Katy rental properties more profitable, which means maximizing the upside and counteracting the downside so that it doesn’t come back to bite you. And even though there are no bulletproof methods of downside protection, there is one method that can significantly lessen your chances of experiencing a financial catastrophe. It’s called an emergency fund.
Rental Property Emergency Funds: What and Why
You’ve probably heard of an emergency fund in reference to personal finances. You might even have one of your own. But did you know that you also need an emergency fund for each rental property that you own?
In the simplest terms, an emergency fund is a source of stable and liquid assets that you’re able to draw on in an emergency or unforeseen situation. This may include a sudden repair, maintenance issue, or prolonged period of vacancy where there is no income to offset expenses and bills.
As a general rule of thumb, you want at least three to six months worth of expenses inside your emergency fund. Thus, if it costs you $2,000 to pay the mortgage and all bills associated with the property, you’ll want somewhere between $6,000 to $12,000 in your emergency fund account.
In order for it to be considered an emergency fund, the money needs to be accessible, yet out of reach. It should be in its own checking or savings account seperate from the rest of your personal or business expenses – clearly designated so that you know which property it belongs to. An emergency fund should not be tied up in risky investments like stocks (or even bonds and CDs, which can be difficult to convert to cash in a timely fashion).
A properly stocked emergency fund does a few things, but it serves two primary purposes:
- Protection. The purpose of an emergency fund is to protect you in a situation where a sudden expense emerges. It allows you to easily float the cost without having to take out a loan or delay a much-needed repair.
- Peace of mind. Your emergency fund shouldn’t have to be tapped very often. Most of the time it simply provides peace of mind so that you don’t have to worry about potentially negative outcomes, like not finding a tenant or getting an expensive home repair bill.
In other words, you don’t want to do without an emergency fund. Doing so is like walking on thin ice in the middle of a frozen lake. You might be able to tiptoe around for a while, but you’ll eventually find yourself in trouble.
How to Build an Emergency Fund
Okay, so you’re on board with the whole emergency fund thing, right? Well, you’re probably wondering how you do it – practically speaking. So here are a few helpful tips:
1. Organize Your Bank Accounts
Disorganized finances will get you in trouble. They’ll also defeat the purpose of having an emergency fund (as expenses will get commingled). Feel free to take whatever approach you think will work for you, but we recommend the following:
- Have one operating account through which you deposit rent, pay the various mortgages, taxes, insurance, etc.
- Have a security deposit account for each rental property. Nothing else goes into this account.
- Have an emergency fund account for each property. (This may eventually turn into one fund, but you can read more on that in tip number five.)
This sort of organization might seem over the top, but the more organized you are, the more efficient and profitable you’ll be.
2. Calculate Your Expenses
You can’t build an adequate emergency fund without first knowing what your monthly expenses are for each property. To calculate this amount, add up all of the following:
- Monthly mortgage payment
- Insurance premiums
- HOA or condo fees (if applicable)
- Operating expenses
It’s usually the operating expenses item that gets people. For a realistic view, go back and review your bills from previous months and take the average.
3. Fund the Account
If you currently have no emergency fund (or a very low cash supply), it could take some time to build up the fund. You can do it gradually over a period of a few months – taking as much of your monthly rental income as you can and designating it for the emergency account.
4. Keep it Safe
As previously mentioned, an emergency fund should be kept in a safe place. This means a traditional checking or savings account. Since this account could have a fairly large sum of money, it’s best to shop around and look for the best savings rates. You won’t earn much, but a small difference in interest rates could earn you a few hundred dollars per year.
5. Start Big and Gradually Taper Off
When you have just one or two rental properties, maintenance and repairs are going to represent a larger percentage of your pie. When something goes wrong, it can eat up a lot of your savings. So it’s for this reason that you should maintain at least three to six months of expenses per property. But as you add more doors to your portfolio, you can taper off and create one big fund.
Something like two months of expenses per property in a single emergency fund checking account can work when you have a large portfolio. (You’ll still have emergencies, but not every property will experience an emergency at the same time. This gives you greater flexibility)
6. Always Replenish
An emergency fund only works if you replenish it after use. If you take out $500 to pay for a new kitchen appliance, you should put $500 back into the account the next time you collect rent checks. A failure to do so will eventually drain your emergency fund and leave you in a precarious situation without any protection against unforeseen circumstances.
Partner With Green Residential
At Green Residential, we serve Katy real estate investors by providing comprehensive property management services. In addition to offering all of the basic property management services that landlords have come to expect, we also have a Certified Public Accountant (CPA) on staff to oversee finances of every home under management. Katy landlords find this helpful in keeping their finances straight.
For more information on our Katy property management services, please don’t hesitate to contact us today!