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Our years in real estate have taught us some things. One of them is: Investors don’t pay attention to replacement reserves. When they do, they don’t develop the right plan.
Investment goals should drive the plan. Yet goals seem to get lost in the shuffle most of the time. That results in mistaken analyses. Those mistakes lead to erroneous assumptions about returns. In other words, bad plans lead to bad decisions.
First, we talked to clients about reserves. Then we wrote articles. Then we made a simple Reserve Estimator model. It became part of our Apartment Expense Report. This book brings all that work together. It gives us the room we need to tell the whole story. It gives you the tools you need to walk away with a solid plan: a plan based on your investment goals.
Buildings wear out. Investors know that’s true. So they budget for it, setting up a reserve to take care of future capital costs. For most, this replacement reserve is fiction. They don’t really set aside dollars. That’s okay some of the time, but not all of the time. The problem is investors usually don’t budget enough. That may feel good in the pocketbook now, but it hurts later, and ultimately costs money at the time of sale.
Most budgets we see are less than $350 a unit a year. Investors who budget that much think they are being careful. Well, here’s a shocker: you need twice that to cover capital costs over the long term. That’s if you start with a new property and increase reserves every year as costs rise. If you buy an older property, your reserve budget may need to be higher. Or, it may need to be lower. It depends on two things: the condition of your property, and your investment strategy.
That's where the Reserve Estimator model helps investors. It lets you customize a replacement reserve plan based on your property's condition as well as your investment strategy. Plus, the model lets you test any number of"what if" scenarios, to make sure your strategy isn't too risky.
The rest of this article discusses this issue in more detail.
