REAL ESTATE INVESTING- PART 2- The Importance of Reserves
By Janet Fetterman, Broker Associate, CAM
As we discussed in the previous blog, the three ways you can make money with real estate are:
- Cash Flow
- Tax Advantages
The purpose of this article is to discuss Cash Flow and how it is impacted by your reserves. A reserve is a budgeted line item for determining the cost of replacements that are projected to take place in the future.
Saving for Reserves
When you are buying and holding real estate, saving for reserves can make all the difference in the world to the success of your investment. This concept is also vital in the successful operations of Community Associations and Homeowner Associations and the need to evaluate their financials and “reserving practices” as an integral part of your decision making process.
In any real estate endeavor, it pays to always be conservative with regard to your financial projections. Careful planning and properly reserving for future repairs and replacements is a must if you are going to maintain your cash flow each month. Remember, it is easier to save a little bit of money each month for future replacements than to pay for one large payment right away.
To illustrate, let’s use the following example. You are looking at an investment property, a single family residence that is 10 years old. The roof is “okay” today and shows normal aging for a roof its age. Your home inspector evaluates the useful life of the home’s roof to be 5-8 more years. I have actually seen some amazing inspectors who measure the grit on the shingles among other tests to make the determination of a roofs remaining useful life.
You then consult your CCR’s (Covenants and Restrictions), ARB Rules (Architectural Review Board) and regulations for your community (if applicable). All of these groups tell you the type of roof that is allowed to be installed within your community. Keep in mind, if an architectural shingle is called out and identified, installing a metal roof or barrel tiles will need to go through an ARB review and an authorization process before beginning the project.
Next say your builder/roofer looks at the roof and confirms you have 8 years left on the roof at best. The builder then gives you an estimate of $30,000 to replace this roof the same day. To maintain a good relationship with the roofer or any tradesmen, be sure to pay them for their quote. They are taking time out of their day for a job that may or may not get in 8 or more years. Your consideration of their time and respect for their opinion will come back to you tenfold if a branch breaks through the roof during a storm and you need their emergency service.
For this property’s roof estimate, you need to reserve a minimum of $3,750 annually for the replacement cost in 8 years. Your accountant can give you a more refined number based on inflation trends and advice regarding your personal tax situation as to when to make the repair.
This amounts to $312.50 per month, at minimum. This amount can wipe out any of today’s cash flow on a normal property. Depending on your goals for this property- short term flipping or long term holding- you must make a decision:
- Put a roof on now for $30k and reserve a minimum of $83.33 + per month over 30 years for the next replacement.
- Purchase the property today, cross your fingers and hold your breath the roof will last 8 more years while you keep your $30k in the bank or invest it in other properties.
- Pass on the property all together.
- Buy to hold for 4 years and then sell in “as is” condition.
Trust in Your Team
Remember your team and their input is part of this matrix. If the property is appreciating steadily and you have good tax advantages, you’ll have 2 legs of the 3 legged evaluation tool working for you. All of this information will impact your decision.
Real Estate Investing can be profitable but the better you are armed with accurate information from experts in their fields, the better you can make your investment decisions.
Eagles Landing is our newest real estate community at Golden Ocala. This out of the ground construction means your replacements and updates are years away. Some investors only look at new homes because their goals are to hold the property for a period of time, for example, 10 years. That new home of today, sold 10 years into the future would likely be in good condition and with normal use, not needing any major refurbishment and replacement expenses. If you would like to see our Eagles Landing models, call our Sales Center at 352-369-6969 and we will arrange a tour for you.
For more information about Real Estate at Golden Ocala visit our blog.