It's better to have and not need, than need and not have. When it comes to owning investment property, it's not a matter of if something unexpected will happen—it's a matter of when.
"If the pandemic taught us anything, it's to be prepared for things to shift at a moment's notice," said Cory Hensley, manager of the specialty assets group at BOK Financial®. "In terms of real estate investment property, preparation means having cash reserves."
A recent study of 597,000 small businesses found that 25% of small businesses had fewer than 13 cash buffer days in their reserve; 47% of small business respondents admitted they would have to use personal funds to support their business through a rough patch.
He said cash reserves provide liquidity for replacement of capital items and other unexpected costs.
"As we have seen over the past year, things can change quickly, and having a cash reserve to offset unexpected vacancies, added cleaning protocols and safety measures, or needed improvements at your property can help you more easily navigate through the issues," he said. "Essentially, it's protection from being put in a position of having to incur debt against your asset."
"The pandemic is as good an example as any of the value of saving for a rainy day," said Dan Bartell, president of Bartell and Company Real Estate Wealth Management. "Whether it be a reduction in rent collections, increase in tenant defaults, or uncertainty around what the office market might look like post-COVID—we've seen in real time how having reserve cash can be 'make or break' for a business."
It won't always be a pandemic, but there will always be something, he added. "The recession of 2007 to 2009 caused an abrupt halt to sales of one of my office-flex condo projects. Fortunately, though, I had extra equity which allowed me to weather the storm, reduce loan payments, pay my share of operating expenses and capital improvements, and enjoy the resurgent market that arose in 2010."
How much is enough?
When it comes to determining how much to save, there are a number of factors to consider.
Most experts suggest having enough cash reserve to cover three to six months of operating expenses at a minimum.
"It's just a starting point," said Brad Nelson, specialty asset manager for BOK Financial. "You don't hear of businesses regretting having a rainy day fund or wishing they had saved less money for an emergency."
"Determining the right amount of reserves depends on many factors, including your general liquid assets position and the condition of your property," Bartell said.
"For example, can your property's infrastructure condition stand on its own today, or do you anticipate problems in the near to mid-term?
"These details should be assessed in tandem with your wealth manager and real estate advisor," he said.
How to get started
When it comes to getting started creating a cash reserve for your business, Hensley offered the following tips:
- Determine a savings goal.
- Create a plan for allocating funds—whether it's a weekly percentage or all revenue from a specific income stream.
- If you dip into your reserves, be sure to replenish it.
"Unfortunately, I have seen situations where adequate reserves were not put into place, and when the need arose, the only option was to liquidate due to poor financial planning and reserve analysis on the front end," said Nelson.
"When it comes to real estate investments, there are numerous variables at play. You hope nothing will happen that will compromise your assets, but it's better to be safe than sorry."