Replacement Reserves on a Multifamily Loan: Recording the Deposits, the Balance and the Draws

What are replacement reserves on a multifamily loan?

Replacement reserves are money set aside each month to replace the big parts of an apartment building, such as roofs, boilers and appliances. On many loans the lender collects and holds it.

The money is still the building's. The lender holds it so that when a roof or a boiler gives out, the cash to replace it is there. In the books it sits in 1210 Replacement reserve, held by the lender, next to the escrow the lender holds for tax and insurance. What the reserve may pay for, and how to draw on it, is written in your loan documents.

The deposit is one of the 4 parts of the monthly draft in recording a multifamily loan payment.

How much does a multifamily lender require for replacement reserves?

The amount is written in your loan documents, often as an amount per unit per year. Birch Way's is $1,050 a month for 50 units: $21 a unit a month, $252 a unit a year.

The Birch Way reserve deposit, invented data

Your own figure comes from your own loan documents. The lender sets it when the loan closes, and the documents say whether it can change.

How do you record a replacement reserve deposit on a multifamily loan?

Record it as an asset called lender-held replacement reserve. Cash goes down, the reserve goes up, and the P&L does not change. It is not an expense.

At Birch Way the $1,050 leaves the operating account inside the $41,050 lender draft. It lands in the reserve asset. No cost line moves.

The monthly deposit at Birch Way, invented data

Booked as an expense, the deposit would lower net operating income by $12,600 a year for money the building still owns. Some loan documents take the deposit out of income before measuring coverage, covered in debt service coverage ratio for an apartment building.

How do you request a draw from a multifamily replacement reserve?

Do the replacement work and keep the invoice. Send the lender a draw request with the invoice and proof of payment, in the form your loan documents name. Record the money when it arrives.

1. 1Do the replacement work and pay the invoice from the operating account. Birch Way paid Example Roofing $8,400 for a roof section.
2. 2Keep the invoice and the proof of payment, such as the cleared check or the bank line that shows it.
3. 3Send the lender a draw request in the form your loan documents name, with the invoice and the proof of payment attached.
4. 4When the lender pays, record the money the day it arrives: cash up, reserve asset down. It is not income.

Each lender has its own form, its own list of what counts as replacement work and its own timing. All 3 are in your loan documents, so read them before the work starts.

How do you record a replacement reserve draw in an apartment building's books?

When the lender pays the draw, cash goes up and the reserve asset goes down by the same amount. It is the building's own money coming back, so nothing is recorded as income.

There are 2 entries, on 2 different days. First Birch Way pays Example Roofing $8,400 for a roof section. Later the lender pays the draw. The work is recorded as its own project. The reserve only records the money.

The work is paid, Birch Way, invented data

The lender pays the draw, Birch Way, invented data

The $8,400 that comes back is the same $8,400 the building paid in over the months. Booked as income, it would show the roof as a profit. Tracking the work itself, unit by unit, is in renovating an apartment building.

How do you tie a multifamily replacement reserve to the lender statement?

Each month, take last month's reserve balance, add the deposit, subtract any draw, and compare the result with the lender statement. Birch Way: $25,200 plus $1,050 minus $8,400 is $17,850.

The month-end tie-out, Birch Way, invented data

When the result and the statement differ, the usual cause is a draw that the lender paid in a different month from the one the books used, or interest the lender added to the reserve that has not been recorded. The same month-end check is run on every account in bank reconciliation for an apartment building.

The reserve balance is one of the figures in the lender reporting package.

What is the difference between replacement reserves and capital expenses in an apartment building?

The reserve is the money set aside. A capital expense is the work it pays for. The reserve stays an asset in the books, and the work is recorded as its own project.

Whether a piece of work is a repair or an improvement is a question for your CPA. We record it where the CPA says, and the reserve stays an asset either way.

What if an apartment building keeps its own replacement reserve?

Record it the same way: an asset, kept apart from operating cash. Birch Way has $5,750 of its bank balance set aside as replacement reserve, so that cash is not free to spend.

Birch Way has $112,000 in the bank. $5,750 of it sits in 1030 Reserve account, the owner's own reserve for big repairs. That is a separate pot from the $17,850 the lender holds in 1210 Replacement reserve, held by the lender. The 2 never mix: the lender's balance must equal the lender statement, and the owner's stays in its own bank account so the operating balance never counts it as free cash.