Reserve line on a five room house: per room, per square foot, or a slice of gross

Question

Re-underwriting three room-rented houses for a partner and the reserve line is the softest number in every one of them. I can defend rent, I can defend taxes and insurance within a few hundred, and then I get to reserves and I'm picking a convention rather than calculating anything.

Middle house, so the numbers are concrete: 1,900 square feet, five rooms, gross 3,700 a month at full occupancy.

At 8% of gross I'm holding $296 a month. At $65 per occupied room per month I'm holding $325. At $1.25 per square foot per year on the structure I'm holding $198.

Those spread by more than $1,500 a year, which on a house like this is a real chunk of the levered return.

The argument for per room is that the wear is people-driven. Five adults with five schedules put five times the load on one kitchen and two showers, and the turn frequency scales with headcount rather than with the building. Room turns, paint, door hardware, furniture replacement, all of it tracks bodies.

The argument for per square foot is that the expensive items don't care how many people live there. Roof, siding, the two HVAC systems, the water heater, sewer lateral. A 1,900 square foot house eats the same roof whether one family or five strangers live in it, and a percent-of-gross convention badly underfunds that in a high-rent market and overfunds it in a cheap one.

I've been running one blended number for years and I think it's been wrong in both directions on different houses. Interested in what the operators here actually hold.

renee_dubois · Accepted Answer

Two lines, and hollow's roof is the reason.

Building line: I set it by square foot and age, not by rent. On a 1,900 foot house with average bones I use $1.30 to $1.60 a foot a year depending on what's already been replaced, so somewhere around $210 to $255 a month for your middle house. If the roof and both HVAC units are under eight years old I'll sit at the bottom of that. If they're original I'm above it, and I'll also write down the year each major component was installed so the number has something behind it.

Wear line: this is the one that's genuinely different from whole-unit leasing, and I fund it per occupied room. Across my small multifamily and two room-rented houses the pattern is that the shared spaces consume the money and the bedrooms barely move. Kitchen surfaces, bathroom fixtures, interior doors, hallway paint, the washer. My per-room number lands at $45 to $55 a month on top of the building line, and it runs higher in the first eighteen months of a new house because the previous owner's finishes weren't chosen for this use.

So you'd be holding roughly $240 building plus $250 wear at five rooms. That's above all three of your conventions and I think all three of them are light.

The assumption it hangs on is turn frequency. At a room turn every fourteen months the wear line covers it. At every seven months, which is what a student-heavy house does, the wear line is a fantasy and you should be budgeting turns as an operating expense with a real dollar cost per turn rather than pretending they're capital. Pull your own move-out dates for the last three years before you set the number. That history is the only input in the whole model you actually own.

laurenkim53 · Answer

Percent of gross is the one that breaks worst at my price points. My rooms go for 380 to 450 in small towns. Eight percent of a $2,100 gross is $168 a month, and the roof I put on last fall was $9,400. That's four and a half years of the entire reserve for one line item, before anything else in the house asks for money.

The roof costs what it costs whether the rooms rent for 400 or 800. Tying the reserve to rent means the cheapest houses, which are usually the oldest ones, get the smallest reserve. Backwards.

I hold a flat building number by square foot and then a separate turn budget I fund out of each move-out, which is not a real reserve I suppose, more of a habit.

Reserve line on a five room house: per room, per square foot, or a slice of gross

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