As real estate investors, your emergency funds are a critical line of defense against unexpected costs. It prevents you from dipping into your budget to handle them.
But what should you really use an emergency fund for? And how much money should you keep in your safety net? Here’s everything you need to know.
But first, I am a big believer in having a “no-big-deal” fund. What is the difference? Mindset. Investing is not gambling. You are not identifying money you can afford to lose and spending a few hours on the slots and tables.
What to Use Your “No-Big-Deal” Fund For
SFR investors should have access to capital and a no-big-deal fund before buying their first property. That’s not a rule, but it is a suggestion from an experienced investor. Planning to fund a no-big-deal fund from monthly rental revenue is not a recipe for avoiding disaster—it is a disaster.
Have your funds in place. Here are three good ways to use that money.
1. Covering temporary gaps in income
Every real estate investor knows that vacancies are expensive. While we would hope that residents renew their leases and stay put more often than not, that doesn’t always happen. People move on, and sometimes unexpectedly.
Use your safety net to anticipate and cover costs during these times. While you don’t want to rely on emergency funds to substitute income, they can help you cover mortgage payments, insurance costs, and property taxes in the interim.
2. Dealing with emergency repairs
Regular maintenance tasks are one thing—significant repairs are another. Your emergency fund covers these incidents. When this money is set aside and designated, you can quickly address things that adversely affect property value and cash flow.
3. Paying insurance deductibles
Insurance itself is another form of safety net. However, insurance claims almost always involve a deductible. For the investor, having cash set aside to take care of issues, even when insurance is involved, helps the process move forward.
What Not to Use the Fund For
Such a fund is not to be used for just anything, however. Here are three no-nos in how to spend this money.
1. Cosmetic renovations
Technically, you can use your no-big-deal funds for anything. There’s no rule against it. However, we would advise against using emergency money for purely cosmetic renovations.
Renovations can (and do) increase equity in a property by forcing appreciation, but not all upgrades are impactful in this way. If you dip into your precious savings, be sure it’s worth your while.
2. Personal expenses
Keeping your business/investment finances separate from personal finances is always wise. The emergency funds you set aside for your SFRs are not to be used for your personal bills.
3. Debt repayment
Investors need a separate debt management strategy in place. While you can dip into the coffers to cover debts in a pinch (such as mortgage payments during a vacancy), it shouldn’t become a habit. Doing so will deplete your resources, potentially leaving you high and dry when it counts.
Where Should Investors Keep Their Safety Net?
Now that you know what to spend your emergency fund on (and not spend it on), where should you keep it? Here are three suggestions.
1. Traditional savings account
Depending on your business structure, you can open a savings account to complement your existing business checking account. The key here is to keep investment emergency funds separate from your personal finances.
2. High-yield savings account
This type of account offers higher interest rates than traditional savings accounts, providing a decent level of growth while keeping funds easily accessible. High-yield savings accounts are FDIC-insured, making them a safe choice for your safety net funds.
3. Money market account
Money market accounts combine the features of savings and checking accounts, offering higher interest rates than regular savings accounts and providing check-writing capabilities. They also typically come with FDIC insurance or are backed by government securities, making them a relatively safe option.
While some may suggest putting your emergency funds in bonds, CDs, or other low-risk investments, these can pose a problem. CDs, for example, require a lock-in period that can prevent you from accessing funds for months—sometimes years. Bonds are safe investments and relatively liquid, but they demand a few extra steps to access cash.
How Much Money Do I Need in My Emergency Fund?
No one amount fits everyone’s needs. The best rule of thumb is this: at least three to six months of expenses for each property you own. This includes mortgage payments, property taxes, insurance premiums, maintenance costs, and other recurring expenses.
Then, set aside your net rental income after mortgage, insurance, and management, and add it to your existing no-big-deal fund until you reach the target amount for each property. For me, this has been as high as 12 months of expenses when I started out, and I now land around six to eight months as a highly comfortable, no-worries dollar amount I like to have.
Because the amounts will change over time between portfolio growth, changes in costs, and goal adjustments, you’ll want to revisit your target. Periodically review your financial situation and tweak your no-big-deal fund goal as needed.
For example, if you have followed this advice, you will start off from a very strong position and only get stronger. Then, you can dip your NBD fund back down to three to six months per property and reward yourself for a job well done! Your choice on the reward, but make sure you celebrate all wins—even the ability to maintain a no-big-deal fund over time.
Need a rock-solid passive investment strategy? Your REI Nation advisor is waiting for your call!
This article is presented by REI Nation
Ready to add turnkey real estate to your portfolio in 2024? If so, now’s the time to invest with REI Nation. Where you invest, and they handle the rest.
Discover stress-free real estate investing with the largest family-owned turnkey investment company, REI Nation. Whether you’re a seasoned investor or just starting, they are dedicated to helping you achieve your financial goals in the world of real estate investing. Visit our website to start your turnkey real estate journey, where your success is their commitment.
Some financial advice doesn’t work anymore. Read here to find out which principles are better left in the past!
Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
Discussion about this post