Capital Reserve

A capital reserve is a cash buffer held inside the property's entity to cover big, irregular costs: a new roof, a boiler, a foundation repair, a long vacancy. Routine maintenance comes out of the operating budget each month. Capital items are too large and too lumpy for that, so they are pre-funded. The reserve is usually built two ways. An initial amount is raised with the purchase, often 2 to 5% of the property price, and sits in the entity's account from day one. Then a small share of rent, commonly 5 to 10%, tops it up each month until it reaches a target.

Every dollar into the reserve is a dollar not distributed, so a property contributing 8% of rent to reserves pays a lower yield than an identical one contributing nothing. The second property is not better. It is deferring a cost that will arrive anyway, and when it does the distributions stop until it is paid. The initial reserve also affects the price per share. A $500,000 house raised as $525,000 of shares, with $25,000 held in reserve, means part of your investment is cash rather than property. That cash is still yours, and it comes back at the sale if unused, but it does not earn rent.

Look for the reserve in the sources and uses table of the offering, where the raise is broken into purchase price, closing costs, fees and reserves. A raise with no reserve on an older property is a warning sign. So is a reserve that looks large enough to flatter the yield by hiding a known repair. Once a property is running, the sponsor's updates should show the reserve balance. A balance that keeps falling without a corresponding repair means the operating budget is short and the reserve is quietly covering it.