If you have multiple rental properties (SFH) and you are faced with what I call "big ticket expense items" like new HVAC units, new roofs, or anytime something major is going to cost $3,000 or more,...how do you pay for it? In other words, do you go straight to your emergency cash account or do you borrow the money on a Line of Credit type account?

And if you don't have an Emergency Cash account and your business Line of Credit is almost maxed out,...what other options do you have ?

Roy, you probably know my answer.... (grins)

I have a savings account at the same bank as our rental property operating expense account. In my online banking set up I named it "Rental Property CapEx Reserves." When we acquire a new property, I set aside $500-$2000 immediately, depending on how soon a big ticket expense is likely to happen. Then each month we set aside 5% of gross potential rents (because some items like roofs wear out whether people live there or not) added into that account. When stuff happens, we have cash to cover it.

Stuff wears out. Gotta plan for it. I think Aesop had a fable about the Ant and the Grasshopper that says much the same.

I think there are several risks of borrowing to fix stuff. 1) you don't really see the operating costs of the property accurately and just keep kicking the can down the road. Profits look larger when expenses are spread out over a longer period and there's a risk of spending money that should be reserved. 2) the risk of credit tightening/being closed down in an economic downturn. Remember how people who relied on L.O.C.s saw their credit limits reduced or eliminated during the last recession.

Cash in the bank is always available.

Sid's response is what SHOULD have happened. Roy, if you have an emergency cash fund - what is the purpose of it? I mean, is it YOUR PERSONAL emergency cash fund or is it for the properties? If it's for the properties then I would expect it comes from there. Although - a new roof or HVAC system wouldn't necessarily become "emergency" unless there was a flood or a storm that took them out and insurance didn't cover it.

Emergency to me would mean "holy cow - I can't believe that just happened" and now you have funds (or hopefully a good chunk of funds) to repair/replace. If you don't but have that "emergency fund" then use it if you can't or don't have any other means.

On the last sentence you basically state "you don't have money or a way/means of getting it easily via LOC, etc. In that measure I guess the only thing you can do is figure out where you DO have some funds. Cut costs ASAP and repair/fix vs replace OR if there is a way to finance (some HVAC companies offer it and so do some roofing companies). You may need to pay a little more but that's better than not getting it done.

Sid,

I can think of about 10 'big ticket' items that I have to plan for during any given year. Just to name a few are:

1. Property Taxes for 17 houses -$6,500.00 check is usually written on December 31st.

2. Property Insurance for 17 houses - this is paid twice a year, but it is still a $3,000 expense paid 2 twice a year.

3. Several of my houses need new roofs and HVAC units. They do work now but they are operating on borrowed time (ie. they are more than 20 years old). I bought a new Heat Pump last week,...cost $4,000.00 ! And that house needs a new roof too.

4. This is just the tip of the iceberg here. It does not take long to deplete an Emergency Cash account here.

At some point, you have to borrow money.

Any suggestions? How do you plan for the unknown future in this business?

I'll agree with Sid on this one. No need to repeat this logic.

The thing I do is to make an estimation of these type expenses on a quarterly and yearly basis and compare this to the actual expenses you incurr. Then add a safety factor. No use tying up a large amount making almost zero in returns while waiting for something to break.

Let's look at an example: say an investor has 15 houses and each quarter there is one major item to replace (a/c, heater, etc) and that item costs $5000. So using these numbers and adding a safety factor of 50 percent, our investor should maintain about $7500 in the account for these expenses and be contributing about $5000 each 3 months. That's $1666 per month divided by 15 houses or about $112 per month from each house. If an item costs more, there's the safety factor money to draw against or you can borrow the money on credit cards or against the line of credit and repay that. These are just estimates of course.

A problem I run into is that $112 a month verses a $500-600 rent is close to 18-25 percent of the rent which is too much.Expenses on these lower lever rentals (C types) cost an extraordinary percentage as compared to A or even B type rentals.Extraordinary and, in my opinion, untenable in certain conditions.

There's a thing called, I think, the law of diminishing returns. I'll make a separate post on this in a few minutes.

All rents flow to our operating accounts. We draw only what we need to live, and we keep our personal expenses low. We still do personal savings as well. Every year, though, that seems to go to buy another house. We need to stop that.

All property expenses are paid out of operating accounts. I don't do an extra savings set-aside for the properties, I assume that by not spending every dime that comes in on personal stuff, the rents will more than cover the expenses or we'd better not be in the business!

When we purchase a place we assume 50% of rent towards eventual repairs, and place must cash flow at $500 on top of that or we don't buy it.

Having more properties does give us the luxury of spreading the pain around - we can rob Peter's fund to pay Paul's in any given year for unexpected expenses without hurting anyone.

Thank-you Richard in MI - That was the first intelligent answer I have read so far. I hope to read more too.

Running 17 sfr's is a business, just like running 17 coffee shops: all repairs, maintenance, expenses must come from revenues.

If your expenses are more than your revenues, and if your emergency account is empty...you have a problem. You can borrow, but borrowed money has to be paid back (from future revenues or other outside capital investment).

WMH,

When i buy I follow the find em, fix em and forget them formula.

That consists of new heat,wiring,roofs, windows etc.

Basically all big ticket items are replaced.

Pay now or pay later.

I buy cheap only and force appreciation through repairs

That being said, the assumption 50% rule is not applicable.

As far as emergency expenses, I collect all $ in my business accounts and pay all expenses from same.

Roy I don't have intelligent answer-- just answer.

I can't understand why at this point in your investing life (experience) you have to worry about any type of emergency payout?

A compressor cost 400. and install is 150. furnace new is 465 install is 150. Aren't you buying this stuff wholesale? Stove - scratch and dent is 265.00. water heater is 400 and install yourself.

I learned this way back when time just started. I applied for credit cards and opened accounts at h-depot and lowes and everywhere they would allow (especially credit unions) . Yes I pay them off each month and have always have but if you run into an expense you can carry the interest.

Having money for taxes and insurance isn't an emergency fund??? no way no how. Each month money is set back to cover these.

WMH said, "Every year, though, that seems to go to buy another house. We need to stop that".

M. M. 101 ?

Kinda like a Yo Yo. Up,Down. Up,Down. Up,Down.

Add a little around the world, Eiffel tower, forward toss,

and I'll show ya how to walk the dog,

right after I rock the baby !

Roy you have explained one item I thought you were confusing with emergency funds and that was buying more properties.

Regular yearly expenses such as taxes and insurance are accrued by setting aside a portion of rents each month.

I have 4 accounts: Operating Expenses (maintenance, supplies, utilities); CapEx reserves; Escrow Set Aside (Taxes & Insurance); and Tenant Security Deposits.

Each year, I review what my last year's taxes and insurance costs were, add 3%, divide by 12. Then each month I set aside that amount so that when the bill comes due I simply pay it. I have done this since 2008 when we bought our first property where the lender didn't require us to escrow, so we just escrow ourselves. It has worked well for 11 years and we have never come up short. Rather, the account has seen a small, steady cushion build up over the years which will be handy if we ever see a dramatic jump in premiums or taxes. But generally 3% / year is more than plenty.

I do not need to borrow money to meet ongoing monthly/yearly or even once-every-20-years expenses. I simply plan for them today and then pay for them as they happen. Not all of my units will need roofs the same year, so I don't have to have enough money sitting around to replace every roof in a single year. Rather, I have enough to handle about 10 major emergencies (HVAC swap out, roof replacement, re-plumb with PEX, etc), and I keep growing it all the time. If we had a horrible year, I could reduce the profits I take home each month and handle 1-2 more major emergencies and still be okay.

I also just leave some cash in our Operating Expense account as Retained Earnings...or I also think of it as "shopping money" in case I find a steal of a deal. That money could be re-purposed for CapEx or emergencies if needed, if my other reserves were not sufficient.

Sorry my answer wasn’t intelligent.

I guess I should have simply said’ Live within your means.’

Roy, since you have sai this information is not for you, AND you have the ability to discern an intelligent answer from ( just noise?, blathering? , idiocy???, you didn’t say,)

I require that I examine the short term needs of a rental property and fund a savings account, from the monthly rents, to cover repairs needed down the line.

Having had partners, I know that "most" people don't have enough reserves to cover the Needs Of Real Estate Maintenance. One time my partners didn't have the funds to cover needed expenses so I gave them a choice:

Busy (WI)

I sincerely apologize for my 'intelligent answer' remark. It was 'off the cuff' and was not meant to be taken personally.

My answer? My answer is I need to start managing money better than I do now. I need to adopt Sid's management skills in having multiple accounts for different expenses. (Thanks Sid). I need to keep a min. of $10K in an emergency cash account and not raid that account to buy more houses with, because buying another $5K house is not an emergency. Do I need to continue? I am showing my dirty laundry here.

Roy, you are still among friends here. Sometimes coming clean is cathartic. ( Hopefully, this year I’ll finally finish my waaaay too long rehab, and I can post the tale for others to criticize and poke at, for the sake of the readers who are learning. Hopefully this year.)

I suggest you use an envelope system. This is basically Sid’s system. I think you should do an internet search of ‘envelope money management system.’ No, don’t buy the envelopes. Scrounge them from your recepycling bIn. Either physical envelopes, or, keep that money in the bank, as Sid does. But, earmark a certain amount each month for different expenses. And if an expense is higher that month, too bad. Got to wait a bit.

Well, obviously, a hole in the roof wouldn’t wait, oh, hmmm, yes, it can. I have two tubs in one of my attics. I spent time looking for roofers this week, as that roof is on this year’s list of projects. Last year, it didn’t make the cut, hence, the buckets and some roofing tar slathered on. (6 year old shingles, slapped on by the foreclosing bank, over two layers of curled shingles. Nail pops every year. )

My city taxes and insurance company offer monthly payments. City doesn’t charge an up charge, as far as I remember. Doesn’t matter, I need cash flow, so paying monthly helps the budget. In a few years, when I am not spending for bad roof jobs, I could switch to a annual payment, if it was less.

In previous threads, you have mentioned selling properties, but, your area seems to be not such a ‘hot market.’ I’ve often wondered if you could buy ( when the funds are there! In the envelope!) in hotter housing markets, hours away. What you’d do is, buy a dump, live there, not at home, for a couple of months while you fixed it up to flip. Once ready, turn it over to a great realtor, pack the truck, and head home. Not in a city so far away that it would be a great big deal to get back to your city if a rental had an urgent issue, maybe five-six hours away. Just thinking out loud. Since you have skills, still enjoy the challenge of fixing. No temptation to keep the flips for rentals, too far to maintain in the long run.

BUSY! MOG! My mom was QUEEN of the envelopes! The whole time I was growing up, she would say, "Take an envelope and mark it ... X" and you then always put a tiny portion of your money in that envelope no matter what. That was for things you WANTED vs. needed. OTHER envelopes were for RENT LIGHTS HEAT INSURANCE...

The time to open lines of credit is when you don't need it. When you do need it the sharks smell blood in the water. This includes credit cards.

Hoosier,

Do you keep enough cash in your account to buy 3 houses and pay for all rehab expenses in a 6 month time frame? It is only when I am buying and rehabbing one house after another (summer/fall of 2018) that my money management skills get challenged.

You're welcome, Roy. I try to be useful, and failing that, I'll buy ya a beer and at least be friendly. ;-)

Here's an encouraging thought: because you are thinking about this topic, you're light years ahead of many rental property owners I know who just take whatever money is left over after paying this month's bills and spend it. Or even worse they'll pay for small stuff that should come out of monthly cash flow by using a credit card and spreading a bunch of nickle and dime repairs over 5 years of payment. They fail to plan for the proverbial "rainy day", and that's when they start to get caught in an endless downward debt spiral.

I remember a time about 10 years ago when I thought, "What's the point of this? Sure, I'll pay these houses off in 10-15 years, but then I'll just have to borrow a ton to fix them all back up again."

That's right about the time I changed my buying strategy to target high cash flow. "The 2% Rule" became my guiding principle. It allows me to set aside the cash in advance today to pay for those repairs tomorrow so I don't get trapped in an endless cycle of debt.

Sid,

The 2% Rule is gospel to me too. Anything less and I would operating at break-even (or less) and praying that future house appreciation would bail me out in the end. As you know, Class C houses generally do not appreciate, unless they are located in CA or NY.

Sid, I am going to disagree with you here. Roy needs envelopes. Here is my rationale: Sid, you, and I, and Many, many other landlords who post here have a strong INTERNAL locus of control. In our viewpoints, We are in charge of our destiny, we make our luck, control of a situation comes from within us, thus internal locus of control. Roy Seams to have an EXTERNAL locus of control. In that perspective, others are in charge, luck just happens. I have a good friend with an extreme external locus of control. She is constantly asking questions, a lot of questions about finance, but, she doesn’t take the advice. Because, unless someone else is ‘ in charge’, she is out of her comfort zone.

Those envelopes can help retrain one’s thinking about money. When it’s in the bank, unless one keeps 27 different accounts ( just grabbed a number there, don’t get distracted, by the number,) if one just sets up three or four different accounts, it’s too easy to say, well, I had the money in the account for X, and, Y is a part of X, so I can spend it on Y. It’s too, too easy to shuffle money around in the mind. After all, the BANK controls it, and the BANK doesn’t want me to have 27 different accounts, so THE BANK is in charge.

The envelopes stay entirely in Roy’s possession. I agree he should be putting a chunk into a bank account for retirement, NOT to be touched in ANY way for rentals. Period. And, a chunk should be going into an account each month as rents come in for for those annual large repairs/ replacements. The roof that is within the end of its lifespan, the older furnace. NOT for splurging on another project house . The caveat, he will need to DEFINE what is the next two -three projects, and that savings account is for those projects ONLY. Because he keeps raiding that account on another house.

All of those houses should be cash cows, just flowing money, in a strong economy. An envelope system can help STRUCTURE Roy’s process. All within HIS control. Not, the bank, the economy, the tenants, or his friends. . Just Roy.

Oh, btw, I don’t see the need for the envelopes forever. Just till thinking changes. And occasional tune-ups later.

When my husband and I used the envelopes, it lasted about six or eight months. By then, we had different habits, had learned to define what the money in the bank was for, not just money available to spend on whatever? There was no more whatever. All Money had a defined purpose. Two-three years after we stopped the envelopes, my husband noticed we had started to slip back into old ways. Money in the bank was just money that could be spent on, whatever? So, he asked me to get out the envelopes again. It was a good tune-up. We got back in the habit of defining the purpose for all different amounts of money. No more money without an intended purpose.

Roy, I suggest that you borrow against the 3 recent acquisitions. Take the proceeds and set up your reserve accounts, Continue to fund them each month from rents.

Busy, I don't disagree with your analysis from a view point of locus of control. However, I would never advise anyone to risk keeping large sums of cash at home, even for a short period of time, due to the possibility of theft or destruction by fire, flood, or other natural disaster. Not sure I have a better alternative if you are correct, though. Perhaps retraining could happen via one's personal finances and then carry over to the rentals?

‘Perhaps retraining ...via one’s personal finances then carry over to rentals.’ Exactly.

That was exactly what I was thinking. Glad you clarified the point. The training can carry over.

Roy, I am hoping you have glanced online at the ‘envelope cash money management system.’ Might find it through different words. It a system as old as the hills, but, good old solid training on forecasting expenses, planning for large Capex items, mandatory savings, all of those good things. Different types of financial gurus teach this. Often a lot of religious groups mention it. It works!

Possibly consider lease-option for more monthly income and the tenant is responsible for the repairs.

Hoosier,

Do you use debt for anything? Personal residence? New car? I applaud anyone in this business who can grow and prosper without using debt. Do you have a 6-figure day job? Money has to come from somewhere.

Roy and Hoosier personally think your kind of thinking will never allow your business to get to its full potential. There is no way under heaven we could have purchased our 80 homes had we not borrowed-- re-borrowed-- used lines of credit (not cc's) every day of our 25 year buying spree. Yes maybe we could have 7 or 8 SFH's but not the quantity we have now. We had 80 and cashed out some and are now down to 63 with only 5 mortgages left. Could we have spent the profit from the sales-- sure but we didn't. We paid off and paid down mortgages.

At the time I never thought the borrowing was a risk for 2 reasons-- the homes were making money (not much though) I just never saw that we could Lose buying SFH's.

Title of thread- managing money 101.

But, then, apparently, the question was how to finance EXPANSION of the business? That’s NOT managing money 101.

To finance EXPANSION many options:

Bank

Hard money lender

Credit cards

Fix N Flip

Savings

Seller financing

Lottery winnings

Partnership, one partner provides cash, other partner provides labor

But, for the MANAGING MONEY 101 question, I’ll type

s l o w l y and succinctly,

since you missed it:

a CHUNK into a BANK account for retirement, not to be touched in ANY way for rentals. Period.

a CHUNK into an ACCOUNT for annual large repairs/ replacements.

Pay ANNUAL expenses monthly . Property tax, insurance can be paid MONTHLY.

the REST of the money can go into envelopes. If there is a large amount of cash to go into envelopes, go back to items one and two , and fund them PROPERLY.

That’s money management 101.

For those who are not prone to impulse shopping, and can forecast ( plan ahead ) , would , of course, already have realized they could open a third account, where a monthly amount would be saved for expansion. (See Savings, under methods to fund expansion above. ) Someone who plans ahead, would work to get that account up to the level needed to fund expansion. But, NOT, by raiding the retirement or CapEx accounts.

For those who can ‘ Make the leap’ the envelopes wouldn’t need to be used at all. Use an accounting ledger to budget, forecast, keep the money in the bank.