Why build a reserve fund for your commercial property investment?

If you’ve partnered with a commercial property investor before, you may have seen the section of the Information Memorandum (IM) which outlines the investment’s reserve fund. Putting returns and forecasts aside, this is perhaps the most underrated item discussed by investors, new and old. It’s how we prepare against unexpected events and safeguard investor capital.

What is a reserve fund?

A reserve fund is a sum of capital that investors might put aside for their investment – in addition to the purchase price and costs – to cater for both expected and unexpected events related to the smooth functioning of the investment and the assurance of continued cash flow into their pocket.

Some investors question the importance of a reserve fund. Just like some people have questioned the importance of seatbelts and helmets – especially if they’ve never needed to use any of them. You might not see a reason why anything could go wrong with your commercial real estate investment. And that’s more reason to build an appropriate reserve to cater for the unknown.

A reserve fund, with enough capital to service even the most unlikely event, will give you peace of mind that your investment will withstand anything Murphy’s Law might throw at it.

What are some of the items you might need a reserve fund?

Future Capital Expenditure

After you or your investment partner has completed the due diligence on the asset – and I hope it was a thorough one – you should be able to capture the potential capital expenditure necessary to maintain good working order of your premises.

It might cover things like the building structure, air conditioning units, lift equipment (if one is installed), and any of the endless minor capex items that might appear in your tenure as landlord.

Future lease expiries

If a tenant’s (or tenants’) lease is due to expire soon, you’ll want to consider the potential vacancy triggered by the occupant exiting the premises in the wake of the expiry. No matter how likely they are to renew their occupancy, it’s crucial you’re prepared for any surprise.

Ensure you have enough in your reserve fund to cater for:

• Potential rental downtime
• Leasing agency commissions (when finding a replacement tenant)
• Tenant incentives
• Any capex required to re-let the potential vacancy

Loss of outgoings

In the unlikely event of a vacancy, you should factor in the ongoing ownership and upkeep costs of the asset, such as land tax, council rates, water rates, repairs & maintenance, and insurances. All of these are usually paid for by the tenant (adding to the beauty of an occupied commercial property investment) but will be yours to pay for if they vacate.

Also consider a small provision to cover a portion of bank interest—just in case.

Base reserve

This amount is raised purely as buffer for unknown or unexpected expense items of any description. They might include:

• Insurance excesses
• Interest rate hedging instruments
• Essential independent reports
• Banking covenant protection
• Legal fees

A well-managed property mightn’t run into too many issues, and certainly, completing a solid due diligence investigation before you invest will help avoid or prepare for nasty surprises during your ownership. But you can’t account for every possible event. We’re at the tail end of a pandemic… Surely that’s proof enough.

In commercial property, anything that can go wrong, will go wrong – unless you have adequate funds to cater for it.

Beat the crowd to our next investment

Our next property investment opportunity isn’t far away. Want exclusive access to the Information Memorandum (IM) and the chance to invest first? Then subscribe for investment updates. We’ll keep you in the loop a week or so ahead of the investment launch, giving you the opportunity to invest before the investment is offered publicly.