Why property investors need a cash buffer

Piles of cash.

If you're a property investor, a cash buffer can save you from financial ruin.

If you've structured your property investment portfolio well, you should have a positive cash flow. But sometimes this cash flow isn't enough to cover some of the unexpected expenses that arise. That's why you need to build a healthy cash buffer.

Why you need a cash buffer

A cash buffer is helpful for a couple reasons. First, the cash flow from a property portfolio can fluctuate depending on circumstances. Right now you may be benefiting from regular rental income. However, if you suddenly find one of your properties untenanted or have a tenant who runs into hardship and can't make their rent payments, you could find this cash flow significantly reduced.

If you have a cash buffer built up you can weather periods when rental income reduces or dries up entirely. Even if your property is untenanted or your tenants aren't meeting their financial obligations, you'll still have to meet your investment home loan repayments. If you have a significant cash buffer built up it eases the pressure to rely on rental income to service your home loan and cover expenses.

Another reason to build up a cash buffer is to have a contingency plan in place in the event of unexpected repairs. If repairs have to be made as a result of damage to your property, you may be able to claim on your landlords insurance. But a cash buffer can help get repairs underway while you wait for a claim to be processed.

If repairs are the result of normal wear and tear, you'll likely be out of pocket. A cash buffer can ensure you're able to make repairs promptly.

A cash buffer also protects you in the event that your expenses rise. If interest rates rise substantially you could face higher home loan repayments and suddenly find your positive cash flow evaporating. A cash buffer helps you meet your higher repayments until you can adjust your rent accordingly.

How big of a buffer do you need?

Advice differs in terms of the size of cash buffer you need, but it's good to have a bare minimum of $5,000 on hand for each property in your portfolio. However, the size of your cash buffer can depend on the rental income you receive from your investment property compared to the expenses involved with maintaining it.

You can figure out a good buffer by subtracting the income you receive from your properties from the holding costs. So if you receive $700 a week in rent, your annual rental income would be $36,400. Now suppose the cost of holding the property, including your investment loan repayments, property management fees, insurance, council rates and repairs and maintenance, came to $45,000.

$45,000 – $36,400 = $8,600

So a cash buffer of $8,600 would be a good starting point for the example above.

However, you may want to build a cash buffer based on the assumption of loss of income. In the event you were to lose your personal income, you'd still have to meet your home loan repayments. It could be wise to set aside six months' income to safeguard against unexpected job loss.

How do you save a cash buffer?

Building up your cash buffer can be part of your regular savings plan, but saving enough to cover for emergencies can be difficult when you have the expense of maintaining an investment property and servicing a home loan. Instead, think about using the equity in your property to build your cash buffer. If you already have a home loan, you may look at refinancing and drawing equity out of your property.

Another option is to top up your cash buffer using your tax return. Most of the out-of-pocket expenses involved in owning an investment property can be deducted from your taxes, which can lead to a healthy refund at the end of the tax year. Save this refund to help form your cash buffer. Alternatively, you could apply for a PAYG withholding variation to increase your cash flow now and help build up your buffer.

A cash buffer is a crucial strategy for property investors. Whether you're cash flow positive or negatively geared, owning an investment property can be expensive. And when those expenses come unexpectedly, a good buffer can stand between you and being forced to sell your property sooner than you'd planned.

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Image: Shutterstock

Adam Smith

Adam has more than five years of experience writing about the Australian home loan market.

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