The Importance of Strong Operations, Capital, Tax, Debt Service and Insurance Reserves

As investors the attraction of keeping cash in our pocket can seem irresistible. When our property is performing well and the cash flow is strong, we are tempted to believe that with so much available cash each month that reserves are not necessary. We can convince ourselves that the risk is not worth the worry or the cost. However, protecting the asset is as important as making the cash flow. Because of this, strong reserves are critical.

The temptation to take reserves and enjoy the cash is strong. Reserves can hold $10,000 or $100,000 or even $1,000,000 captive on relatively small investments. When large sums such as this are involved the temptation to make other use of these funds is strong.

However, a tax lien, the catastrophic loss of a building, the failure to make needed capital improvements can be much more damaging. The failure to fund reserves results in potential catastrophic asset loss and eroded asset value.

In many cases, if taxes are not paid, a property could face a tax foreclosure in a matter of less than 6 months. Tax reserves are a critical to protecting the investors' asset. Immediately behind tax liens, a well run property should maintain reserves to assure insurance is maintained, to guarantee that if occupancy drops or income wanes that interest and principal payments will be kept current, and to assure that needed improvements to the project will go forward.

The purpose of debt cost reserves is obvious in the same way that tax and insurance reserves are easy to understand.

Capital and operations reserves are more easily skipped. Over the course of time, these decisions will insidiously undermine income pushing the potential income of the property downward. If the situation persists long enough and serious enough improvements are not made the property can become unrentable. All at once a quality asset becomes a burden and a loss to the investors. Additionally, if capital reserves are kept steadily, strong the owners and management will have the opportunity to make good choices that instead of preventing value erosion will lead consistent asset appreciation. Truly, the result creates reinforcing positive results just as not funding creates consistently damaging results.

Value focused owners will see to adequate tax and income reserves, well planned debt cost reserves, and steady strong capital reserves. Making this choice protects invest capital and offers the potential of steadily appreciating total asset value - the preferred goal of any serious investor.