“Help, my rental unit has an expensive problem and I don’t have the cash to get it fixed!!!”
NOTE: These notes and figures were created in the Memphis TN market in 2016 and may need to be adjusted for your housing market and the year.
Does this sound like you? Are you a new landlord? Have you run into this situation with your rental units or your own personal house (or car, or lawn mower)?
We all face this. There is a time when some expensive repairs are required for things we own, but we don’t have the money to fix the problem. Somehow we figure it out, we borrow the money, we use a credit card and then slowly but surely we dig our way out of debt, but isn’t there a better way? Going into debt is awfully hard on your blood pressure, and paying it back leads to strife and money problems, as well as arguments with your spouse, not to mention sleepless nights. What can you do to make your financial life easier with regards to your rental units that are supposed to be making you rich but instead, it often feels like all you do is pour money into them over and over again?
The answer is SIMPLE: a “Slush Fund”. Your money gurus have better names for this, but it is nothing more than a savings account set aside strictly for repairs of your rental units. We all know that these expenses will arise (at the least opportune moment, like December 20th) and when they do, it causes extreme stress especially if we aren’t prepared to take care of the problem quickly. We fret and fuss and yell, but none of that fixes the problem and often leads to sleeping on the couch.
HOW TO CREATE A SLUSH FUND:
This is hard to do during a cash flow cricis, so if you are reading this now and you don’t have a cash crunch problem at the moment, NOW is the time to start your Slush Fund.
- Open a NEW Slush Fund Account – either at a local bank or online, but make it a separate account from any account you currently have. This will help keep you from accidentally spending it, you will access it on purpose for a specific reason in the future.
- Now begin funding your Slush Fund. How much of your cash flow can you afford to live without right now? If you say, none, you are in trouble! If you only own a couple of rent houses, chances are, you have a day job, so put 100% of your cash flow into your Slush Fund to fund it quickly. If you use your cash flow as income, you’ll have to reduce your spending to afford to put some of your cash flow into your Slush Fund. Set aside a particular amount each month and set a total goal. Make a decision, deposit the money as soon as you receive it, not at the end of the month when the money will suddenly not be there anymore. PAY YOUR SLUSH FUND FIRST.
HOW MUCH DO I NEED IN MY SLUSH FUND?
This is probably the million dollar question. There are no easy answers here, but this is how I would evaluate it. I will run through a recent example to try to give some guidance, but ultimately only you know your own properties. My friends who own a bunch of units in Midtown which could be upwards of 100 years old may need more cash per unit, however, they are typically smaller units, so the numbers may still work out in the end. My units are newly constructed single family houses, so their maintenance, at least for the first 10 years should be minimal other than “tenant damage.”
EXAMPLE: You own a rent house, maybe 10-15 years old with no major maintenance issues. The HV/AC is in decent shape. The electrical systems are all up to par. The roof and carpets are all great. All the appliances work…for now.
How much do you need in a slush fund for this ONE house?
What is the worst case scenario? Tenant moves in and does great for 6 months straight, then one of them gets laid off at work. They’ve trashed the carpets (kids and Kool-aid) and because of the “getting laid off” they fight, the husband damages a few doors because he was mad. Because mom and dad are fighting, the toddler opens the dishwasher and stands on the door to reach the cookies…now the dishwasher door won’t close all the way, but they use it anyway and the leak damages the kitchen floors. Now, because they have no job and know they can’t pay rent, they move out in the middle of the night taking with them the stove, all the ceiling fans and leave you holding the bag for this month’s rent. They of course don’t leave you the keys, but DO leave you a semi-trailer amount of crap and a broken down swing set and trampoline in the back yard.
How much will this cost to repair and get ready to rent again? I know this does not happen every time you have a tenant move out, at least I hope not, but let’s explore some possible costs.
Carpet Replacement $1000
Plumber Labor $300
Vinyl in Kitchen $800
2 new Doors $60
Carpenter Labor $300
Locksmith (you have extra locks, so you change out the locks yourself)
“Got Junk” $500
Paint $1500 (they had painted all rooms a funky color)
Past-Due Rent $950 (or actual rent amount past due from tenants)
Lost Rent $950 or more (clean up time and finding new tenant)
TOTAL REPAIRS $6,860.00
These numbers may be off a little, but many MIG members with real life experience can tell you their actual numbers, some are true horror stories. Recently I had to rehab a house after 8 years of the same tenant. He had the NERVE to call me and tell me that it was all “clean” for his move-out inspection. The total cost of the rehab was $4,500 not counting lost rent. His $775 Security Deposit barely covered his past-due late fees much less the rehab on the building. He actually threatened to “take us to the court house” to try to get his $775 back, luckily we took pictures and have receipts. He didn’t try.
- We replaced all the carpets and had to paint the entire interior.
- We had to replace the HV/AC unit, (he didn’t tell us it wasn’t working… but it was fried), not that he was responsible for this, but it would have been nice to know.
- The disposal didn’t work and the kitchen sink was totally clogged, therefore the dishwasher couldn’t drain.
- He had apparently let sodas or beers “spew” in the great room so there was sticky goo on 2 of the 4 walls and no attempt had been made to dab up the spills, therefore, there were at least 3 hard, dried, sticky beverage “disks” stuck to the carpets.
- There was also a strange green stain on the carpets, like a green sharpie had lived under the sofa, bleeding its green blood onto the carpet until it finally died a slow and agonizing death.
- He had, at some point, overflowed the toilet and water got onto the carpets. At the time I offered him a cleaning option which included him doing the cleaning, (we don’t pay for overflowed toilets) and he opted to clean it by renting a machine. When he moved out, the entire master bedroom had black mold all over the carpets.
- He had smoked so much (in the non-smoking unit) that the windows were brown and had to be scraped clean with a razor blade!
- One bedroom’s closet had staples in the drywall, about 10,000 staples where posters or something had been affixed to the walls. There were torn corners of posters left and the painter charged us extra to remove all these staples.
- There was also extreme mowing required because he moved out on June 1st, but had not mowed the yard once that spring/summer.
- One exterior light was busted, had to replace it.
- One window was broken
- I had to re-key all the door locks as his room-mate wouldn’t return her keys.
If you add the lost rent to my $4,500, the total was now up to $6,050. BUT, he lived there for 8 years, so $756.25 per year (or about $63 per month) would be needed for my Slush Fund to fully fund itself for this unit if this is a fair assessment of what could happen on any given rent house. But if he had done this much damage in one year and moved out, I would be severely lacking in funds if $756 was all I had in my Slush Fund.
So in answer to the question, “How much Slush Fund” do I need for THIS house, the answer is $6,000 or more per house…depending on how many you own, but we’ll get to this later. Ideally you should have this on hand on day one. Hopefully every tenant doesn’t leave your house this bad (The bathroom walls alone; what DIED IN THERE!?!) but to save yourself a lot of stress and strife between you and your spouse/partner, you need to be prepared.
One way to fund your Slush Fund would be to set aside this much money as you buy the property. You know there will be closing costs, taxes, insurance, there will also be needed repairs and rehabs. COUNT THE COST and set aside this money immediately, the entire $6000 if you can, then you are good to go no matter what happens as a general rule.
But you tell me, I have 5 rental units, or 20, or 50. How much Slush Fund do I need? Do I just multiply $6,000 times the number of rental units? Twenty rent houses times $6,000 is $120,000! You could probably buy a few more rent houses for that amount of money! The question here is; how often do you need to rehab a house? Does every house need major renovations every time you change tenants? And, do all your tenants move out at the same time? The answer to both of these is, ‘no’. If you have been at MIG for long, you’ll know that getting good tenants by having a great screening process in place helps many times, just not always. Most tenants wants their security deposit back, so they will try to keep the unit well and clean it before they leave. Some landlords teach their tenants well and treat them fairly, so the tenant tends to want to keep the unit better. But some tenants will never understand what “clean” is, therefore will never be able to accomplish clean.
So, if you don’t have a lot of money to start with, you already own a bunch of rent houses and don’t have a Slush Fund, set a goal, $100 per month, or $500 per month. As stated above, use 100% of your cash flow if you only own a few properties and you still have a day-job so that you can fully fund your Slush Fund quickly and then live with peace of mind, once fully funded, you can begin to use your cash flow to acquire more properties, or go on vacation, but until you have a fully funded Slush Fund, don’t spend your cash flow.
Think about this, though; if you have 10 houses, you probably don’t need 10-times $6,000 ($60 grand). They won’t all need renovations at the same time. Also, there will be varying degrees of rehab required for individual units depending on the tenant. So, my suggestion is to save about 3-5 times your ideal “per house” Slush Fund and keep it in the special savings account. Then when you need to rehab one house, use some of the money ONLY if you can’t fund the rehab from your regular operating expenses account (this is actually the goal, to have a rehab line item in your normal budget). An easy clean up rehab (maid service, lawn mowing, carpet cleaning, touch-up paint) can generally be absorbed with regular funds, but one bad tenant may require additional funds from your Slush Fund. IF, at that point, you dip into your Slush Fund, your deposits to the Slush Fund need to be started back (or increased monthly) to re-fund it to get it back up to your total target (Ex. 5 x $6000 = $30,000 – Slush Fund Goal for someone who may own up to about 10 houses). If you use $5,000 out of your Slush Fund, then repay yourself over the next year ($416.66 monthly) or 2 years ($208.33 monthly) to fully re-fund your Slush Fund. If you always keep this Slush Fund funded, you should never have the stress of not having enough money, or having to find a loan, or maxing out your credit card and you’ll get all the cool horror stories without all the stress. If you own 140 houses, like some in our group, you should keep a slush fund for huge emergencies, but your business plan and annual budget should have a percentage set aside for rehabbing your properties. If you have 140 units, you have probably been at this game long enough to know exactly what you will spend in any given year for rehabs. But for you new investors, be SURE to count the cost before you invest every penny you have into your property and then don’t have more when things go bad.
Copyright: Janne Zaccagnino