One of the biggest challenges REIs have with rentals is keeping up with expenses, especially unpredictable ones. Anything can happen at any time, and landlords must always be prepared for contingencies. A rental maintenance account could help, as well as other methods of funding repairs. However, there could be tax implications for contingency plans, so it is important to learn their proper set-up and upkeep.
Situations like unforeseen repairs, rent default, preparation costs for re-rental, and longer-than-usual vacancy periods are common and can make property ownership a nightmare. They’ll also drain your finances if you have insufficient available cash to address them immediately, especially if there’s no quick fix in sight.
“There is such a high risk of unexpected expenses for landlords,” says Brian Davis of Spark Rental, a REI who owns 15 rental properties. “Defaulting tenants can require lengthy, expensive evictions while you must continue paying the mortgage,” he continues.
In addition to costly repairs to roofs, furnaces, or other major systems, Davis reminds REIs that “tenants may file lawsuits, which are expensive to defend even if the landlord is 100 percent right.”
It’s impossible for a landlord to anticipate all of the many things that can go wrong, which is why it’s so important for landlords to have a well-funded rental maintenance account.
“Maintaining adequate reserves places you in the best possible position to address concerns as they arise,” says Gene Clark, president and chief legal officer of 5 Arch Funding. “Not only are you preparing for the unknown but relatively inevitable repair, but you are also sending a message to your tenants and lending partners that you are concerned about them as well. This pays off in higher rents and better borrowing rates.”
Being Ready is a Landlord’s Best Financial Defense
It’s not a matter of if but when you’ll need the funds in your rental maintenance account, so it is important to set these up at property purchase. Without them, the financial consequences could be serious. “Lack of adequate funds for maintenance, repairs, and improvements can lead to reduced property value,” explains Keith Schroeder, an enrolled tax agent for more than 30 years, as well as a former REI and owner of The Wealthy Accountant. His blog features advice on personal finance, retirement planning, and investing from his three-decade career helping clients manage (or watching them mismanage) their money.
“Deferred maintenance and repairs frequently increase project costs considerably and can cause building code violations,” adds Schroeder, who once managed 176 family-owned properties and focuses today on helping REIs avoid tax issues with their own properties.
REIs should put maintenance funds in savings accounts for each unit; how much depends on how many properties they own, as well as each unit’s age and condition. Davis’ recommendation: “Landlords should keep at least $2,500 in a rental maintenance account, with easy access to more money for sudden costs.”
Owning more properties represents more risk, but in lieu of holding more than $5,000-$10,000 in cash in a savings account, says Davis, “landlords should have sufficient money in easily liquidated investments in case of an emergency.”
Schroeder takes a percentage approach to funding these accounts. “In my opinion, you should save 7-8 percent of the real estate value if you own fewer than 10 units; 5-6 percent if you own 11-30 units; and 4-5 percent if you own more than 30 units,” he states.
Both agree you won’t pay taxes if the accounts earn little interest. Schroeder adds this about recordkeeping for the funds: “A simple line item for the maintenance fund listed under current assets should suffice, and recordkeeping should be by monthly bank reconciliation only.”
Don’t Think Credit Cards or Insurance Will Cover Your Assets
Some landlords may think they’ll just use credit cards or get insurance to fund emergency repairs, but that’s a poor strategy, say experts. In addition to the accrued interest, “It’s a rare contractor who accepts credit cards for their labor, and those who do usually charge a 3-5 percent convenience fee,” says Davis.
And insurance doesn’t cover most costs associated rental ownership like regular repairs, roof replacement, tenant defaults, eviction, and other legal actions, Schroeder adds. “Insurance only covers storm, fire, or similar damages, and there is still a deductible.”
Your best bet is a well-funded rental maintenance account backed by other liquid assets for big expenses. Failing that is a rookie mistake that could lead to business failure.
“When a rental hiccup comes along, landlords without cash available are in real trouble,” says Davis. “They either need to borrow the money quickly or risk their costs spiraling out of control.”
5 Arch Funding’s rental lending programs are designed to offer investors great rates and even greater flexibility. Whether you are looking to finance a single property or a whole portfolio of residential investments, you can count on a quick closing with 5 Arch Funding.
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