Ultimate Guide to Reserves for Real Estate Investors

Reserves are one of the most important financial safety nets you’ll have as a real estate investor.

They help you weather “unexpected” expenses and protect your investments during tough times.

We’ll walk through what reserves are, why you need them, and how they differ from other types of funds.

You’ll learn how to determine how much you should hold in reserves and how to manage them effectively.

Understanding and properly managing your reserves can be the difference between thriving as an investor or struggling when the inevitable happens.

What Are Reserves and Why You Need Them

Reserves in real estate investing are not just a precaution; they are a necessity.

These funds are set aside specifically to cover the expenses and shortfalls that will inevitably arise as you manage rental properties.

While some investors may view these situations as “unexpected,” the reality is that they are part of the normal cycle of owning investment properties.

It’s not a question of if you’ll need reserves, but when.

Here are common scenarios where reserves will be needed:

Tenant Stops Paying Rent – At some point, you will likely have a tenant who fails to pay rent, forcing you to go through the eviction process. This can take time and money, but with reserves, you can cover your mortgage and expenses (including the costs of hiring an attorney) while you handle the legal proceedings.
Property Damage After a Tenant Leaves – Sooner or later, you will have a tenant who leaves your property in rough shape, requiring repairs beyond normal maintenance to a property before it can be rented again. Reserves allow you to manage these costs without dipping into other funds.
Renting at a Lower Rate Than Expected – It’s not uncommon to face an unexpected turnover during a slower season, such as the holidays. You may need to rent the property at a lower rate, perhaps resulting in negative cash flow when otherwise your property would have positive cash flow. Reserves can cover this shortfall until the situation stabilizes and you’re able to rent the property in a better season.
Major Repairs or Emergencies – From failed furnaces to leaky roofs, major repairs are inevitable over time. Having reserves ensures you can take care of these issues quickly without financial stress.

These scenarios are not “unexpected” events; they are normal, recurring parts of managing rental properties.

The key is accepting that they will happen and being prepared by maintaining adequate reserves. This foresight allows you to manage the unavoidable challenges without putting your investments at risk.

Reserves Versus Other Money

Reserves serve a distinct role compared to other types of funds you might have in your real estate investment strategy.

While reserves are meant to cover inevitable but uncertain costs that will arise, other funds are allocated for specific, predictable expenses that you plan for in advance.

Each type of fund has its own purpose, helping you manage both the day-to-day and long-term financial demands of your properties.

Here’s how reserves differ from other key funds you should have in place:

Personal Reserves/Emergency Fund – These are funds set aside for your personal living expenses in case you lose your job, get injured, or face a personal financial emergency. They are completely separate from your rental property reserves and meant to cover your basic needs like housing, food, and utilities, not your investment expenses.
Maintenance Savings Account – This account is for routine and expected maintenance costs on your rental properties, such as painting, replacing carpets, and contractor service calls for HVAC, plumbing, or electrical repairs. These are costs you know will come up over time, and setting money aside for them helps you avoid financial surprises when they arise.
Capital Expenses Savings Account – This account is specifically for large, planned expenses like replacing a roof, installing new windows, or upgrading major systems like HVAC or plumbing. You know these costs are coming eventually, and setting money aside over time helps you prepare for them without taking a hit all at once.
Cumulative Negative Cash Flow – If you purchase a property that initially has negative cash flow—meaning you put a smaller down payment down and consequently your monthly expenses exceed your rental income—setting aside reserves to cover this shortfall is a more conservative approach to investing. Instead of putting more money down to achieve positive cash flow from the start, you can allocate some funds to cover the expected negative cash flow until rents increase enough to produce positive cash flow. The amount you’d need to set aside to cover negative cash flow until your property produces positive cash flow is usually less than the amount you’d need to add to your down payment to get to positive cash flow immediately.
Next Investment Total Cost to Close – These are funds you set aside to cover the full cost of your next investment property, including the down payment, closing costs, and any initial expenses like repairs or renovations needed to get the property rent-ready.

Each of these accounts serves a different function in your overall financial plan for real estate investing.

Reserves, however, are specifically there to cover the irregular costs that are bound to happen eventually, even though you can’t plan for exactly when or how much. Having clear distinctions between these funds ensures that you’re prepared for both the planned and unplanned aspects of owning rental properties.

Examples of expenses for each category:

Personal Reserves/Emergency Fund – Personal rent or mortgage, groceries, utility bills.
Maintenance Savings Account – Painting the property after a tenant moves out, replacing worn-out carpet, service calls for routine HVAC repairs.
Capital Expenses Savings Account – Replacing a roof, upgrading electrical systems, installing new windows.
Cumulative Negative Cash Flow – Covering a $200 per month shortfall between rental income and expenses until rent increases and you have positive cash flow.
Next Investment Total Cost to Close – Down payment, closing costs, rent ready costs, cumulative negative cash flow—all for buying your next property.

By having separate funds for each of these categories, you’ll have the flexibility to manage both the expected and inevitable costs of real estate investing without scrambling when issues arise.

How Much to Hold in Reserves for Rental Properties

When determining how much to hold in reserves, it’s important to move away from setting aside an arbitrary dollar amount, like $10,000 per property.

Instead, we recommend measuring reserves in months.

This gives you a more accurate way to ensure your reserves align with your property’s specific financial needs, regardless of property size, type or location.

General Guidelines for Reserves

There are two primary methods we suggest for determining how much to hold in reserves:

6 Months of Reserves in a Savings Account – In this approach, you set aside enough money to cover six months of expenses in a savings account or another low-risk, highly liquid account. You can expect to earn about 1% per year on this money. The goal here is to prioritize liquidity and safety over returns.
12 Months of Reserves with a Higher Return Investment – For a more aggressive strategy, you can hold 12 months of reserves but invest most of it in something more volatile, like the stock market, where you can potentially earn 8% per year on average. This could mean earning 10% on the majority of the investment, with the remaining portion in a lower-yield, stable savings account earning 1%.

Components of Reserves

When calculating how much to hold in reserves, you should account for several key expenses, including your operating expenses and loan payments.

Here’s what makes up your reserves:

Operating Expenses – These are the costs required to keep your property functioning on a day-to-day basis and include:
- Property Taxes – Annual property taxes that must be paid regardless of whether the property is occupied or vacant.
- Insurance – The cost of insuring your property against potential risks like fire, storms, or liability.
- HOA Fees – If your property is in a homeowners association, you’ll need to cover these fees, which often include maintenance of shared areas.
- Landlord-Paid Utilities – If you’re responsible for utilities like water, gas, or trash collection, include these in your reserve calculation. Landlord-paid utilities is more common in multi-family properties; in most single family homes the tenant is responsible for all utilities.
- Maintenance and CapEx– Funds allocated for routine upkeep, repairs, and major capital expenditures. This includes regular maintenance like painting and carpet replacement, as well as significant long-term investments such as roof or HVAC system replacements.
- Property Management – If you have a property management company, make sure to include their fees as part of your operating expenses.
Total Principal and Interest (P&I) Payments – This includes the total monthly payments you need to make on all loans associated with the property.
Private Mortgage Insurance (PMI) – If applicable, don’t forget to include PMI costs as part of your reserve calculation.

Applying This Approach to Different Property Types

The beauty of calculating reserves in months is that it works for all property types—whether you’re managing a single-family home, duplex, triplex, fourplex, or even larger apartment buildings. By focusing on months of reserves rather than a set dollar amount, you can ensure you have the necessary financial cushion based on your property’s actual costs and not a one-size-fits-all number.

This approach gives you flexibility, stability, and peace of mind, knowing you’re prepared for whatever comes your way in the inevitable ups and downs of property management.

Investing Reserves in Stocks

When you invest your reserves in stocks, you’re aiming for a higher return than you’d typically get from a traditional savings account.

Stocks can offer significantly better growth, with potential, non-guaranteed returns of 8-10% or more per year, compared to the 1% you might see in a savings account.

However, with these higher returns comes additional risk.

The Tradeoff Between Risk and Return

Investing your reserves in stocks introduces the usual risks of the stock market—volatility and uncertainty.

While stocks may deliver higher returns over time, they can also experience sharp drops, especially during market downturns.

If the stock market takes a hit right when you need to access your reserves, you could be forced to sell at a loss, which would reduce your financial cushion during a time when you need it most.

Why 12 Months for Stocks and 6 Months for Savings?

To balance this risk, we recommend setting aside more months of reserves if you’re investing them in stocks.

Specifically, you should hold 12 months of reserves in stocks compared to just 6 months in a savings account.

Here’s why:

Stock Market Fluctuations – Unlike a savings account, where your balance remains stable, the stock market can fluctuate dramatically. You might see your balance go up, but it could also go down—sometimes just when you need it the most. By keeping more months of reserves invested in stocks, you build a buffer for these fluctuations, ensuring you have enough cushion even if your portfolio temporarily drops in value.
Margin of Safety – Having twice as much in stocks (12 months vs. 6 months in savings) gives you a margin of safety. If your stock portfolio takes a hit, you’re still likely to have at least 6 months of reserves that you can access should you need them.

In essence, while stocks can deliver a higher return over time, the increased risk means you need a bigger reserve pool to compensate for potential volatility.

With 12 months of reserves in stocks, you’re better positioned to protect your real estate investments even during periods of market uncertainty.

This strategy balances growth with prudence, ensuring you have the reserves necessary to keep your real estate investments secure no matter what happens in the stock market.

Reserves Change Over Time

Reserves aren’t static—they change over time as various costs associated with your property increase or decrease.

A single month of reserves tends to grow until you pay off the mortgage, primarily due to rising operating expenses.

Let’s take a closer look at why and how this happens.

Why Reserves Increase Over Time

The amount you need for a single month of reserves tends to increase because several key operating expenses naturally rise over time:

Property Taxes – Property taxes usually increase as property values rise and local governments adjust tax rates. Even without significant changes in your property’s value, municipalities often raise taxes to meet budget needs.
Insurance – Insurance premiums typically go up over time due to inflation, rising costs of construction, materials, and labor. Additionally, if your property appreciates in value, you may need to increase your coverage, further raising your premiums.
HOA Fees – If your property is part of a homeowners association (HOA), you can expect HOA fees to increase over time as they account for inflation or budget for larger projects and repairs in the community.
Landlord-Paid Utilities – Utility costs generally rise over time as utility companies increase rates. If you’re responsible for any tenant utilities (like water or trash), those costs will gradually increase as well.
Maintenance and CapEx – Maintenance costs often increase as a percentage of your Gross Operating Income (GOI). As your rental income rises with inflation and market conditions, so does the amount you need to set aside for routine maintenance. Capital expenses (CapEx) like roof replacements or HVAC systems also grow over time, as inflation impacts the cost of major repairs and replacements. The amount we set aside for capital expenses tends to increase with inflation if you’re using our capital expense spreadsheets.
Property Management – If you use a property management company, their fees may increase, especially if they charge a percentage of rent. As rent goes up, so does the amount you pay in property management fees.

Mortgage Payments and Reserve Changes

While operating expenses tend to increase, your mortgage payment on a typical amortizing loan remains the same until the loan is paid off.

Once you pay off the mortgage, the amount you need for a single month of reserves decreases by the amount of that mortgage payment, which is a significant reduction in your reserve requirement.

If you have a loan with Private Mortgage Insurance (PMI), once you drop below the required loan-to-value (LTV) threshold and PMI is removed, your reserve requirement will also decrease since you no longer need to cover PMI costs.

The Impact of Refinancing on Reserves

Refinancing a property can change your reserve needs as well. If you do a cash-out refinance and your monthly mortgage payment increases, your reserve requirement will go up accordingly. Conversely, if you refinance to lower your payment, your reserve requirement will decrease.

Reserves on Multiple Properties

When you own your first rental property, there’s no debate—you need full reserves.

The same is true for your second rental property.

Having adequate reserves is non-negotiable when you’re just starting out. You need that financial cushion to handle any unexpected expenses that come up.

But when you start adding more properties to your portfolio, the question of how much to hold in reserves becomes a bit more complicated.

Debating Reserve Requirements for Multiple Properties

Full Reserves for Each Property? – Some argue that if you need $10,000 in reserves for one property, you should set aside another $10,000 for your second property. But as you acquire more, like 10 properties, do you really need $100,000 sitting in reserves? The argument goes that the chances of all 10 properties needing reserves at the same time are slim.
Reducing Reserves as Your Portfolio Grows – There’s logic in the idea that you don’t need full reserves for every single property in a large portfolio. After all, it’s rare that all of your properties would face major issues simultaneously. Some investors choose to reduce their reserves per property as they add more to their portfolio, freeing up more capital for new investments.
Less Conservative, Higher Risk – While the argument makes some sense, it’s a less conservative approach. Reducing reserves might work when you have a larger portfolio, but it introduces more risk. You could find yourself in a difficult situation if multiple properties encounter issues, or if there’s a major market disruption.

Market Dynamics Impacting Multiple Properties

Sometimes, the need for reserves isn’t triggered by a single property issue. Instead, it’s the overall market that creates challenges across your entire portfolio.

Take the COVID-19 pandemic as an example. It affected all properties, not just one or two. Tenants struggled to pay rent, and vacancies became harder to fill.

In times like these, your entire portfolio could be impacted at once, increasing the need for reserves across the board.

Full Reserves for All Properties

Even with multiple properties, it’s prudent to aim for full reserves on all of them. You don’t want to be caught short if a widespread event affects all your properties.

You can still invest these reserves in a way that earns a decent return, as we’ve discussed previously, to avoid having the money sit idle. Just be mindful of the additional risk this introduces.

In the end, it’s about balancing risk and return. Full reserves for each property may seem excessive, but they provide the safety net you need when managing a large portfolio.

How to Build and Replenish Your Reserve Fund

How should you approach building and maintaining your reserve fund as you invest in real estate?

Fully Fund Your Reserve Account at Purchase

When you purchase a property, you’ll want to fully fund your reserve account right from the start.

This ensures you have the necessary cushion in place to cover any unexpected costs that will inevitably arise.

Setting aside reserves at the time of purchase is the safest way to ensure you’re prepared from day one.

Increase Reserves Over Time

As we’ve discussed, the amount you should set aside for reserves typically increases over time as operating expenses rise.

The best way to build these extra reserves is from positive cash flow from the property. Direct a portion of cash flow to your reserves.

If your property is not generating positive cash flow yet, you’ll need to fund those additional reserves from outside the deal. This means pulling money from other sources and investing it back into the property over time. This looks like more negative cash flow on the property because you’re funding it from outside the deal itself.

Prioritize Funding Reserves Over Buying Your Next Property

While it may be tempting to save for your next investment property, fully funding your reserves should take priority.

Before you think about expanding your portfolio, make sure your current properties have sufficient reserves.

This financial cushion is crucial for handling unexpected situations without scrambling for funds or taking on unnecessary risk.

Some investors with fully funded reserve accounts who have started saving for their next investment property may occasionally tap into a small percentage of their reserves if an exceptional deal arises before they’ve saved the full amount.

This is more easily justified if you’re reducing some of your 12 months of reserves in the stock market to 6 months in savings. By doing so, you can stretch your funds to take advantage of a great investment opportunity while still maintaining a sufficient safety net.

This approach allows you to strike a balance between growing your portfolio and ensuring you have enough reserves to manage your existing properties.

Replenish Your Reserves After Use

If you ever need to tap into your reserves, make replenishing them a top priority.

In fact, you should forgo all spendable cash flow from the property until your reserves are fully restored.

This ensures that you always maintain the proper financial buffer to protect your investment.

Reserves as Asset Protection

Think of your reserves as an essential part of your asset protection plan.

In the event of an emergency—whether it’s a major repair or a vacancy—having reserves in place is your first line of defense against losing your property.

They give you the flexibility and time to address the issue without being forced into a fire sale or borrowing at high interest rates.

For more on how reserves fit into your overall asset protection strategy, refer to our asset protection material.

Reserves in Return Quadrants™

When using The World’s Greatest Real Estate Deal Analysis Spreadsheet™, you’ll notice that reserves play an important role in calculating returns.

Unlike other spreadsheets, which often ignore reserves, our approach correctly accounts for them, making your investment analysis more accurate and realistic.

Why Other Spreadsheets Are Wrong

Most spreadsheets fail to include reserves in their return calculations, which gives an incomplete and overly optimistic view of returns.

In real estate investing, reserves are essential—not optional. You can’t prudently invest without them. Ignoring reserves in deal analysis is simply incorrect.

Including Reserves in Return Calculations

In our approach, reserves are factored into the denominator as part of your overall investment.

This means the money you’ve set aside for reserves is included in the total amount you’ve invested in the property.

Additionally, the returns you earn on your reserves—whether they’re invested in savings, stocks, or another vehicle—are factored into the numerator.

This approach ensures that you’re seeing the full picture of your investment performance.

The Role of Reserves in Return Quadrants™

We include reserves in our Return Quadrants™ by adding +R6 or +R12 to indicate the number of months of reserves included in the calculation, as well as the expected return on those reserves.

+R6 – Indicates we’ve included 6 months of reserves, typically earning 1% annually in a savings account.
+R12 – Indicates we’ve included 12 months of reserves, with most of those reserves earning 8% annually in stocks, while a smaller portion remains in savings.

Examples of Return Quadrants™ with Reserves

RIDQ™ (Return in Dollars Quadrant™) – This shows the raw dollars you’re earning from appreciation, cash flow, debt paydown, and tax benefits, but does not include reserves in the calculation.
RIDQ+R6™ – This version includes 6 months of reserves. It shows the dollars you’re earning from appreciation, cash flow, debt paydown, tax benefits, and the 1% annual return on your reserves in a savings account.
RIDQ+R12™ – This includes 12 months of reserves, with most of those reserves earning 8% annually in stocks. It shows the dollars you’re earning from appreciation, cash flow, debt paydown, tax benefits, and the return on your reserves.
ROIQ™ (Return on Investment Quadrant™) – This calculates your return on investment by dividing your total returns by your cost to close, but it excludes reserves.
ROIQ+R6™ – This version includes 6 months of reserves, showing your returns from appreciation, cash flow, debt paydown, tax benefits, and the 1% annual return on your reserves, all divided by the total cost to close, including reserves.
ROIQ+R12™ – This includes 12 months of reserves, with an 8% return on those reserves. It calculates your returns from appreciation, cash flow, debt paydown, tax benefits, and the return on your reserves, divided by your total investment, including the reserves.

How Including Reserves Affects Returns

When you include reserves in your calculations, your overall return on investment typically decreases. This is because the total investment in the denominator has increased by the amount of reserves.

However, this approach provides a more accurate representation of your true return since reserves are an essential part of prudent investing.

Although including reserves might slightly reduce your ROI, you also get to count the return on those reserves, whether it’s the 1% from savings or the higher return from stocks. This boosts your overall return slightly, but not enough to outweigh the larger denominator.

Ultimately, your calculated return may be lower, but it’s much more accurate and realistic when reserves are properly accounted for.

Reserves Required by Lenders

When securing financing for rental properties, lenders will often require you to have reserves in place.

Typical Reserve Requirements

The amount of reserves required depends on several factors, including the loan type, the borrower’s financial situation, and the type of property being financed.

Generally, lenders require anywhere from two to six months of reserves for standard loans, with more risk leading to higher reserve requirements. These reserves are typically based on your total monthly PITI (principal, interest, taxes, and insurance) payments.

Reserve Requirements by Loan Type

Conventional Loans (Fannie Mae/Freddie Mac) – For single-family primary residences, reserves may not be required at all. However, for investment properties or multi-unit properties, lenders typically require two to six months of reserves. The exact number depends on your credit score, loan-to-value ratio, and other risk factors.
FHA Loans – For 1-2 unit properties, FHA loans usually do not require reserves. However, for 3-4 unit properties, three months of reserves are generally required. This applies whether the property is an investment or owner-occupied multi-unit property.
VA Loans – Most VA loans do not require reserves unless you’re financing a 3-4 unit property and using rental income to qualify. In these cases, six months of reserves are typically required. Additionally, if you own other rental properties not backed by a VA loan, you’ll need three months of reserves for each of those properties.

How Lenders Assess Reserves

During the loan approval process, lenders will examine your liquid assets to determine whether you meet the reserve requirements.

This includes money in savings and checking accounts, as well as stocks, bonds, and retirement accounts.

However, not all assets are counted equally.

For example, lenders may only count a percentage of retirement accounts (typically 60-70%) since accessing those funds could result in penalties.

Reserves are assessed as a part of the overall risk evaluation.

The more stable and liquid your assets, the more favorably your loan application will be viewed.

Additionally, reserves can serve as a compensating factor that may help you secure a loan even if other areas of your financial profile are not as strong.

A Higher Standard for Real Estate Investors

While lenders set minimum reserve requirements to protect themselves, these requirements are usually the bare minimum.

As a prudent real estate investor, you should hold yourself to a higher standard.

We recommend maintaining six to twelve months of reserves for each property you own, even if the lender only requires two or three months.

This ensures you’re prepared for any financial challenges that arise, whether from vacancies, market fluctuations, or unexpected repairs.

By exceeding the minimum reserves required by lenders, you give yourself a stronger financial cushion, allowing you to handle unforeseen issues without jeopardizing your investments.

This conservative approach provides long-term stability and reduces your risk as you grow your real estate portfolio.

Using Reserves vs. Borrowing for Emergencies

Some real estate investors may consider borrowing money during emergencies rather than maintaining reserves.

The rationale behind this is that by keeping their capital fully invested, they can maximize returns.

In the event of an emergency, they plan to use debt to cover the shortfall, whether through a credit card, a home equity line of credit (HELOC), or even borrowing against retirement accounts.

While this approach may seem attractive to those wanting to keep their money working at all times, it introduces significant risks.

The Risks of Borrowing for Emergencies

Access to Borrowing Isn’t Guaranteed – In an emergency, your ability to borrow money is not guaranteed. Lenders may tighten credit requirements during economic downturns, or your financial situation might prevent you from qualifying for loans when you need them most. If your credit score drops or property values decline, you might find it more difficult to secure a loan.
Debt Comes with Interest – When you borrow for emergencies, you’ll need to pay interest on the borrowed amount, which adds an additional financial burden. Whether you use a credit card, HELOC, or borrow against retirement accounts, you’re essentially adding to your long-term costs, as these forms of debt need to be serviced with regular payments. Over time, this can erode any financial gains you made by keeping your capital invested.

A More Conservative Approach

Using reserves offers a safer alternative to borrowing.

While it may feel like your reserves are sitting idle, the peace of mind and financial flexibility they provide are invaluable.

In the event of an emergency, having reserves ensures you can cover unexpected costs without taking on new debt or being forced to sell assets at an inopportune time.

In the end, maintaining reserves is about reducing risk and protecting your investment.

By relying on cash reserves rather than borrowing during emergencies, you avoid interest payments, maintain control over your financial situation, and ensure your properties stay secure during challenging times.

Reserves for Insurance Deductibles

One important use of reserves is to cover insurance deductibles in case of an insured emergency.

Insurance deductibles are the portion of an insurance claim that the property owner is responsible for paying out of pocket before the insurance coverage kicks in. For example, if your deductible is $5,000 and the repair costs $50,000, you would pay $5,000 from your reserves, and the insurance would cover the remaining $45,000.

Having reserves to cover these deductibles ensures that you can address major emergencies without financial strain.

Example: House Fire

Consider a serious house fire that causes extensive damage to your rental property.

Let’s say the insurance deductible is $5,000. You would need to use $5,000 from your reserves to get the property back in working order before the insurance covers the rest of the repairs.

Without sufficient reserves, you might struggle to cover the deductible, which would delay repairs and impact your rental income.

Mortgage Payments During Rebuild

Even while your property is being rebuilt or repaired after an emergency, you’re still responsible for making mortgage payments.

And, in many cases, you’re not collecting rent during this period.

Your insurance may cover the repair costs, but your mortgage lender will still expect payments to be made on time.

This is where having reserves is critical—these funds ensure you can continue to make mortgage payments even if the property is temporarily uninhabitable.

Common Deductible Amounts

Insurance deductible amounts vary depending on the type of coverage and the specific risks your property faces.

You’ll want to ensure your reserves can cover these deductibles in the event of an emergency, as well as any additional costs you might encounter during repairs.

Here’s a breakdown of common deductible ranges for insured risks:

Fire – Deductibles typically range from $500 to $5,000, depending on your policy and location. Make sure you have enough in reserves to cover your specific deductible, especially since fire damage can often require immediate and extensive repairs.
Hurricane – Deductibles for hurricanes are usually calculated as a percentage of the property’s value, commonly between 2-5%. If you’re in a hurricane-prone area, this can mean significant out-of-pocket costs, so having larger reserves is key.
Flood – Flood insurance deductibles tend to range from $1,000 to $5,000. If your property is located in a flood zone, it’s essential to factor this in and ensure your reserves can handle the deductible if a flood occurs.
Hail – Hail deductibles are often higher than other risks, typically ranging between $1,000 and $10,000. If your property is in a region prone to hailstorms, you’ll want to account for this higher deductible when calculating your reserves.

Take a look at your actual insurance policies and compare the deductible amounts to your reserve funds.

Keep in mind that beyond the deductible, you may need to cover mortgage payments and other expenses while your property is being repaired.

If your reserves seem inadequate based on these deductibles and possible repair timelines, it’s a good idea to adjust them upward to ensure you’re fully prepared for potential emergencies.

Reserves for Measuring Risk

Measuring risk is an important part of being a successful real estate investor, and reserves are one of the many ways you can assess and mitigate that risk.

While there are several metrics to consider when evaluating your exposure, reserves offer one straightforward way to measure risk.

Common Ways to Measure Risk

Debt-To-Income (DTI) – This measures how much of your monthly income goes toward paying debt. A high DTI ratio means you’re more leveraged, which increases risk. Lenders often use this ratio to assess whether you can handle additional debt.
Debt Service Coverage Ratio (DSCR) – This ratio compares the income produced by your properties to the debt service (mortgage payments). A DSCR above 1.0 means your property generates enough income to cover its debt obligations. A higher DSCR indicates lower risk.
Debt-To-Net-Worth – This compares your total debt to your net worth, including the equity in your properties and other assets. A lower ratio indicates less leverage and lower risk, while a higher ratio suggests more exposure to financial challenges.
Debt-To-Liquidity – This compares your total debt to your liquid assets, such as cash, stocks, or bonds. Unlike Debt-To-Net-Worth, this ratio focuses only on assets you can quickly access in case of an emergency. Having higher liquidity reduces risk by providing readily available funds.

Using Reserves to Measure Risk

Another way to measure risk is by calculating the number of months of reserves you have.

When measuring risk with Months of Reserves, you can calculate your reserves on a per-property basis or across your entire portfolio.

For each property, divide your liquid cash by the monthly expenses for that property to determine how many months of reserves you have.

The higher this number, the less risky you are as an investor because you’ll have more liquidity to handle potential issues.

Here’s an example:

Let’s say your rental property costs $2,500 per month in total expenses (including mortgage, taxes, insurance, and maintenance), and you have $15,000 in liquid cash. Dividing $15,000 by $2,500, you have six months of reserves for that property.

If you have multiple properties, you can apply the same calculation to each or aggregate all your reserves and expenses across the portfolio.

The more months of reserves you have, the more protected you are against financial shocks.

While metrics like DTI, DSCR, and Debt-To-Liquidity give you additional, valuable insights into your financial health, reserves offer a clear, actionable way to measure your ability to manage unexpected events.

Check out our other resources for more on measuring and mitigating risks as a real estate investor.