Reserves are cash you set aside, outside your operating account, to cover the costs a rental throws at you on no schedule: vacancy between tenants, repairs, and big-ticket capital replacements. They are not profit and they are not an expense on your books; they are money you have already decided not to spend until one of those events arrives.
In practice
Reserves are usually sized as a number of months of total housing cost per door, or as a flat figure per unit. Say you own a duplex. Each side rents for $1,400, and the full mortgage payment with taxes and insurance is $1,650 a month. A common target is six months of that payment in the bank before you count the property as stable. Six times $1,650 is $9,900, so you would hold roughly $9,900 set aside for this one building.
Some landlords prefer a per-door rule instead. At $250 per unit per month, a duplex builds reserves at $500 a month, or $6,000 a year. That figure is meant to absorb the replacements you know are coming but cannot date: a $7,000 roof, a $5,500 furnace, a $1,200 water heater. If you set nothing aside and the furnace fails in January, the duplex did not lose money that month so much as you never funded the bill.
Why it matters to a small landlord
Reserves are the difference between a bad month and a forced sale. A single-property landlord with no cushion who hits a long vacancy and a failed appliance in the same quarter ends up paying the mortgage from a paycheck, then resenting the whole thing. Lenders know this, which is why underwriting on rental loans often asks you to show several months of payments in reserve at closing. Holding the cash is also the only honest way to read your returns: a property that looks like it cash flows $300 a month is not really clearing $300 if it owes $250 a door to a replacement fund you never funded. Build the reserve line into the same routine you use to close your books each month, and decide your per-door number deliberately rather than after the fact; there is a fuller treatment of how much to hold per door if you want the ranges.
Reserves sit next to a few ideas worth knowing in the same breath. The replacements they pay for are capital expenditures, which is why they never show up in your operating expenses or your monthly cash flow until you actually spend them. And the single biggest reason a reserve gets drained is a stretch of empty units, so your assumed vacancy rate should drive how deep you decide to fund it.