Afford Anything - Ask Paula -- Get Ready for the Next Recession

Episode Date: January 1, 2018

#110: Happy New Years! We're kicking off this year on a bright and cheerful note -- with a conversation about the impending recession! Yay! The U.S. stock market is at a peak, continuing its 9-year bull run. The markets have been rising since March 2009 without any major corrections or pullbacks. We are living in one of the longest periods of economic expansion in our nation's market history. That's worrisome. Speculators with short memories are popping champagne corks thinking the good times will last forever, while those of us who are students of history know that what goes up must come down. Trying to guess WHEN the next recession will happen is a waste of time. A more efficient use of time is to prepare ourselves such that when it does happen -- whenever that may be -- we are ready. How can we prepare for a recession? That's one of the four topics I cover in today's episode. Specifically, here's what we chat about in this first episode of 2018: Thayne asks: 1) Broadly -- What are the best investments overall if you're going into a recession? 2) Specifically -- What's the most recession-proof type of real estate investment? Aaron from Portland, Oregon asks: In Episode 96, you discussed the benefits of real estate investing -- but you didn't mention the use of leverage, nor did you mention that real estate is an inefficient market. Why not? Anna from the San Francisco Bay Area asks: I've moved out of my condo, which I'm renting out. But the rent only covers the mortgage (PITI) and HOA. Should I sell the condo? If so, I could use $250,000 in equity for an alternate investment, such as buying rental properties out-of-state. Enjoy! _____ Resources Mentioned: How to Calculate Cap Rate and Cash-on-Cash Return -- http://affordanything.com/2012/01/25/income-property   Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything, but not everything. Every decision that you make is a trade-off against something else. And that's true of any limited resource in your life, whether it's money, time, energy, attention, focus, anything that you have to manage. So the questions are twofold. Number one, what do you prioritize the most? What's most important to you? And number two, how do you align your actions to reflect that? Answering these questions is a lifetime practice, and that's what this podcast is here to explore.

My name is Paula Pant. I'm the host of the Afford Anything podcast. Happy New Year. We are kicking off the new year on a bright and happy note talking about recessions. Woohoo. And to kick off this conversation about recessions, we'll start with a question that came to us from our listener, Thane. Today's episode is ostensibly about real estate, but we veer into a lot of other topics as well. Let's hear what Thane has to say. Hey, Paula, this is Thain out here in Salt Lake City, Utah. I've got a quick question for you. I am wondering what you believe to be the best real estate investment going into a recession, whether it's single-family home, multifamily, apartment complexes, whatever it may be. My personal situation, we're about to do a 1031 tax exchange. We have some land that I believe the value is going to go down if there is a recession, and I want to put it into something safer. I'm young. would like something like a multifamily apartment complex, but also looking around at maybe buying a few homes.

Let me know what you think. Also, I guess the question can be asked is what are the best investments overall, whether stocks or real estate, if you know that a recession is coming. So say this was early 2008, what are going to be the best investments to weather the storm of a recession? Hopefully this can be a nice topic for your show. Thanks so much. Fane, thanks for asking. First, just for the sake of everyone listening, I'm going to give a bit of context. The U.S. stock market is at a peak right now, soaring to new heights after a nine-year bull run. The market has been going up consistently since March of 2009 without any major corrections or pullbacks in that time. So we are living in one of the longest periods of economic expansion in our nation's market history. And that's worrisome. Valuations are high. The P-E ratio of the S&P 500 right now is well above average. which means stocks are expensive. Now, people with short memories are popping champagne corks, thinking the good times will last forever that happens in every bull market,

while those of us who are students of history know that what goes up must come down. And to a reasonable degree, it's, you know, it's reasonable to have a fear of heights. We know that we have a recession on the way. We just don't know when. trying to guess when the next recession will happen is a waste of time. A more efficient use of time is to prepare ourselves such that when it does happen, whenever that may be, we're ready. That's the context that we're currently in. Now, Thane, you had two questions.

Number one, broadly, you wanted to know what are the best investments overall if you're going into a recession. And number two, specifically, what are the best investments? real estate investments if you're going into a recession. I'm going to talk about both of those, but first let's talk about broader investing strategy. And when we talk about investing strategy at the high level, I want to divide this into two different time frames. What should you do in anticipation of a recession? And what should you actually do during the recession? Let's start with the latter. So during a recession, after the market's already tanked,

everything's cheap. So this is the ideal time to buy more. You're investing strategy during a recession, if I can summarize that strategy in one word, is more. You are able to pick up undervalued assets that are on sale. A recession is basically just a time when everything's on sale. And I'm sure you've heard that famous Warren Buffett quote, be greedy when others are fearful and fearful when others are greedy. That's absolutely correct. And we've seen this play out over the last 10 years. Back in 2009, 2010, everybody was afraid of the market when, in fact, that was the best time in the last decade to invest. Now, I should give a caveat. Like, I don't believe in market timing. But when I say that I don't believe in market timing, what I mean is that I don't believe in moving in and out of asset classes in anticipation of what may happen in the future. So I believe in the tried and true strategy of maintaining a broad, diversified portfolio that's in line with your age and your risk tolerance and holding to your asset allocation through sunshine and rain come hell or high water. I do, however, believe in

market timing in the context of making extra contributions that you otherwise wouldn't have made. Like, in other words, saving more so that you can buy more of the thing that's cheap. I absolutely support market timing if it drives you to invest even more during recessions than you normally do. As far as investing strategy goes, asset selection is less important than asset acquisition. And that's basically just a fancy way of saying what you buy is less important than how much you buy. We could talk all day about large cap versus midcap versus small cap versus real estate versus

commodities versus Bitcoin versus blah, blah, blah, blah, blah. Well, none of that matters if you're only investing in extra 500 bucks. Your contribution, the amount of money that you put into the market or into real estate or whatever you're putting that money into, that contribution is more important than any specific investment that you choose, I mean, within reason. Like, I'm assuming that you're sticking with major index funds and you're not venturing like way out into left field. All of that being said, recessions are a really good time to pick up equities.

If we are turning the conversation to, all right, we've established that during a recession, I should buy more, what should I buy? Recessions are really, they're fantastic for stocks because stocks are undervalued at that time. There are a lot of investors who during recession will look to bonds or to treasury notes because those avenues produce safety. They produce less volatility. and during our session, you'll see a lot of pension funds and other institutional investors going that route in search of safety. But you, Fane, you're an individual who's not burdened with needing to give quarterly reports in front of a board of directors wearing suits. You have time on your side and you're only answering to yourself, which means you can think and act like a long-term investor. So assuming that you have the risk tolerance for, assuming that you've got the stomach to endure the volumin.

volatility, then embrace that volatility, the volatility of equities investments. And by the way, in case anybody's wondering, when I say equities, I'm referring to stocks and stock funds as compared to other asset classes like bonds or treasury notes or any of those other things that are out there. Now, within that specific stocks, individual stocks, shares of Nike or Coca-Cola, those are a lot riskier. During recessions, as well as at all times, there's a lot of turnover in the market. A lot of companies get flushed out. And you don't know specifically which companies are going to make it and which companies are not. You don't know which ones will stagnate, which ones will be victorious. You don't know what's going to form. I mean, what's cool about recessions actually is that we see a lot of new companies start in the midst of recession. Recessions are sometimes these periods of amazing innovation. Like Airbnb started in 2008. Uber started in 2008. Uber started in 2008. And going back into history, IBM, Procter & Gamble, General Electric, FedEx, all of those are companies that started during downturns and, of course, have flourished ever since. But my broader point is that we don't know, either during a recession or at any time, we don't know what companies will succeed and we conversely don't know what companies are going to fail.

And because we don't have that information, index funds are, in my opinion, the way to go. because index funds give you exposure to the overall market and you will do generally as well as the overall economy. And that's pretty good over the long term, or at least it has been pretty good over the long term. As my friend J.L. Collins, he was a previous guest on this podcast, as he says, the market is self-correcting, which means bad companies will get flushed out, but good ones will take their place. and that's one of the many reasons why a broad market index fund is the way to go, in his view and in mind. So anyway, that's what to do during a recession. But what do you do in anticipation of a recession that might happen in the future?

A couple of tips here. Number one, and this isn't actually a do, this is a don't. Don't stop investing now because you think that there's going to. be a recession in the future. And the reason for that is that we have no idea when it's going to happen. There were many people back in 2014, 2015, who were saying, oh, my goodness, look at how high the market is. And they were reluctant to invest back in the year 2015 because they feared an impending crash. Of course, on one hand, they're correct. The market will have a pullback at some point. But in the meantime, they've missed out on the significant gains that we've had in 2016 and

2017. So this is just another piece of evidence that market timing is for the birds. Number two, don't retool your asset allocation. You have that allocation for a reason. Like, let's say that you're 80% stocks and 20% bonds, right? You chose it for a reason. So stand by your choice. Because the great thing about having a balanced portfolio, the great thing about having asset allocation is that that portfolio inherently forces you to make contrarian moves. In order to maintain your allocation, whatever it is, you have to periodically sell your winners and buy more of your losers. That's baked into the strategy, which means that you don't need to make any changes.

So now, with all of that being said, I want to move on to the next portion of your question, Thane, which is stocks versus real estate in the context. of a recession. Now, both of these are great, and the decision that you make about stocks versus real estate should not be recession-based. It should be based on, I mean, I won't go down that rabbit hole, but a huge variety of factors that ultimately lead to the question, do I want to be a real estate investor? And if so, how hardcore do I want to go? In the context of a recession, both of them are fantastic options. If you choose to invest in real estate, and this is absolutely key. Do not buy any properties based on future appreciation. Buy only for the income stream that it

produces and any future appreciation other than just keeping pace with inflation is icing on the cake. That's true at all times, not just during recessions. And here's why. I'm going to use a stock market analogy, right? So think about the way that stocks are priced. Stocks are valued in two ways. Number one, stocks are valued at a multiple of their earnings, and number two, stocks are also valued based on what people think that stock price might be in the future. Valuing a stock based on its earnings is pure investment. You're buying an asset for the income stream that it produces. But buying a stock based on what you think it might do in the future, is speculation. And so it is with real estate and with all other assets.

Buying an asset because you think it'll be worth more in the future is speculation because we don't have a crystal ball. We don't know what's happening. When it comes to real estate, there are two key phrases that I like to repeat. And one of those is appreciation is speculation. And it rhymes. So it must be true. And the other phrase that I like to repeat is, and I don't actually, I don't think I've ever said it on the show before, is that home values only matter at point of transaction. What I mean by that is that there are only three very specific points in time in which your home value actually matters when you buy, when you sell, and when you refinance. Outside of that, home values are purely theoretical.

So the rest is, it's noise. That's all it is. It's just noise. as a real estate investor, as a rental property buy and hold investor, I mean, home value matters in so far as it affects the rent, but it's not really the home value that matters. It's the rent. And specifically, it's the income stream that comes from the rent, the net income stream after expenses. That's what matters. The value itself is meaningless other than point of transaction. What that means, broadly, is that as long as you are investing in properties that have solid cap rates and assuming that you're not over leveraged, then it doesn't really matter if the value of your property drops or stagnates because that value, that number on an abstract piece of paper, that zestimate, that's not going to affect your day-to-day life. What affects your life is the cap rate and the cash flow that comes from the properties. So to answer your question of how do you approach real estate in a recession-proof way, don't buy properties for their value.

Buy for income. Now, Thane, finally, to your specific question, you asked, what are the best specific types of real estate investments if you're heading into a recession? A couple of points here. Number one, bare land investments tend to be the first to drop in the last year. cover. And the reason for that, and I want everyone to understand why that is, the reason for that is because bare land, if you think about it, is inherently speculative. There is, assuming that there's no commodity on that land, you know, there's no timber that could be mined or anything like that, the bare land itself is not income producing. It is purely a speculative holding. The only reason

that an investor would hold bare land is because he or she thinks that the value may be able to go up in the future. And that by definition is speculation. So it's no wonder that a speculative investments like land are the first to go down during a recession, which is why getting rid of that is a good move. Again, not just for recession proofing, but I think in my opinion, generally for having a more income-based investment strategy. Now, the other thing is condos. Condos during price pullbacks, condos tend to be the first to drop in the last to recover. The reason for that is because when you own a condo, you don't own a full interest in the underlying land. And in real estate, the building itself depreciates.

It's the land that holds, theoretically, you hope, holds or goes up in value. But the building itself depreciates over time. So with condos, you've got less there to work with in a manner of speaking. Condos are also risky buy and hold investments because you're subject to the whims of the HOA. And if the HOA ever decides that rentals aren't allowed in the building, well, guess what? Now your hands are tied. And if you can't rent out that condo, then you only have one exit strategy, which is to sell. And if you can help it, never want to be in a position where you only have one exit strategy.

So I would avoid bare land. I would avoid condos. The thing that I always favor is residential properties, which are single family homes and multifamilies that have four or fewer units. And I like those. I think those are particularly strong niches during recessions for two reasons. Number one, a single family home specifically, let's shell of the small multi unit for a moment. Single family home specifically are mostly purchased by owner occupants. Most of them are bought by retail buyers who aren't looking for an investment. They're simply looking for a place to live. And that means that the resale value of a single family home is literally irrational. Irrational meaning that it's not based on a price to earnings ratio, it's not based on a net operating income, it's determined by emotional factors and psychological factors, not mathematical ones. To an extent, of course. But to a greater extent than any other type of dwelling that would be purchased by investors, single family homes are unique in that regard, that they're bought by retail buyers. Now, on top of that, any residential property, so both single-family homes and multi-units with four or fewer, residential properties tend to have the easiest financing arrangements.

And what we've seen historically is that people tend to buy the properties that they can get financing to buy. So if financing is easiest for residential, then, again, you may have more of an exit strategy, more, quote-unquote, liquidity. if you will, with residential properties. And they tend to hold their values. Broadly speaking, they tend to hold their values decently well compared to some other asset types of real estate assets. Now, that being said, there is no quote unquote real estate market. I think that's important to note. There are only many, many, many sub markets or niche markets. Recessions affect different markets in vastly different ways. If we go back to 2008, I mean, look at the effect that the housing crash in 2008 had on markets like Las Vegas and Phoenix and Miami. It decimated huge parts of those markets. And by contrast, it didn't have a huge effect in markets like Cincinnati or Dayton, Ohio, or Boulder, Colorado. Those places did not get demolished in 2008 the way Vegas and Miami and Atlanta all did. And that be. And that said within each of those markets, there are many, like dozens if not hundreds of submarkets,

particular neighborhoods or sections of neighborhoods that performed the same better or worse than the overall city or the overall state or the overall nation. So never forget that one of the big competitive advantages that you have in real estate is your ability to become an expert in an extremely niche area and make decisions about that area, you are not beholden to what's happening in the overall nationwide market. And again, I'll cite Cincinnati as an example. I've been watching that market pretty closely. Cincinnati is, relatively speaking, a very stable market. It didn't go up very strongly in the good times and it didn't go down that sharply in the bad times. So if you're looking for a stable market,

you can always look to a place like that. You know what? You can liken this to different asset classes. There are simply some asset classes that have greater volatility, greater risk and potential greater reward. And there are other asset classes that have less volatility and they're more stable. And local markets in real estate are very much the same. And then the final idea that I want to leave here is that just because there's a pullback in the broader stock market does not necessarily mean that home values will plummet, as they did in 2008. It might mean that or it might not. It might simply mean that new construction slows down. It might mean that the number of permits that are being pulled for new construction and or renovations slow down,

which in turn means that fewer workers have jobs, which has effects on the overall economy. Certainly all of those things could happen. But a pullback in the stock market doesn't necessarily translate to lower housing prices or stagnant housing prices. It may, it may not. That's the thing about the future is we just don't know, which is why trying to time the market is a practice that's best avoided. So, all this being said, the TLDR of everything is, number one, don't be too worried about market timing. Number two, use recessions as an opportunity to buy more because you'll want to buy the most of something when it's on sale or when it's undervalued. And number three, if you choose to invest in real estate, make your decisions with a focus on income rather than property value.

Because the value of the property is purely theoretical other than point of transaction. And the value of the property doesn't affect your day-to-day life. The cash flow does. Awesome. Thank you so much for asking that question. We'll come back to this episode in just a second. But first, question for you. Do you want to eat fresh, healthy, home-cooked food, but you're super busy?

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dot com slash p a u la and enter afford anything in the how did you hear about us section our next question comes from aaron paula paula paula this is aaron from portlandia i am so sorry i missed you when you were here i'm huge fan of the show and the blog i've got so many real estate questions here are just two of them so number one on episode 96 for the last caller you were outlining the strength of buy and hold rental property investing and you specifically did not mention use of leverage or the fact that real estate is an inefficient market so what am I missing why did you not name those two things am I missing something about this conversation question number two is how would a

buy and hold rental property investor such as yourself protect themselves or try and hedge themselves against recession or a housing bubble. All right. Thank you so much. Big fan. Take care. Woohoo. It's Recession Day at the Afford Anything podcast.

Well, I covered the recession and the last question. So I'll burn on the actual cash that you yourself put into the deal. That's the type of example that is commonly heard in real estate investing circles. And if we want to move away from all of this talk about market appreciation, you could use that same argument when discussing income streams that come from real estate as well. So let's say you have a rental property, you buy it for $200,000. It rents for $2,000 a month, which is $24,000 a year. And after paying all of the operating overhead, you end up pocketing a net operating income of, let's just say, $10,000. Now, the cap rate on that would be 5%, because that's $10,000 relative to a $200,000

house, that's 5% that you're getting as a dividend as your cap rate for that property. But if you think about this in the context of the money that you put down on the property, so again, in this example, you put $40,000 down, well, you're making a net operating income of $10,000 per year on that $40,000 investment. And even after subtracting out the financing costs from that net operating income, let's say, just say hypothetically you're left with four grand, well, that's $4,000 that is being produced from your $40,000. In other words, having $40,000 gives you an income stream of $4,000 a year that's cash in the bank, even after paying financing, in this hypothetical example,

which is a 10% return, which is awesome. So as context, that's the argument that you will typically hear a lot of real estate investors making when they talk about why real estate is so awesome. And what they're really doing here is they're espousing the virtues of leverage. I like to avoid this. I like to avoid citing leverage as one of the advantages of real estate investing for the following reasons. Number one, leverage is a lever. So it works both ways. It can make the gains a lot better, but it can also make the losses a lot steeper. And it is inherently inaccurate to compare unleveraged returns against leveraged returns because leverage inherently has risk and all returns need to be viewed in the context of risk. So in other words, that hypothetical in these examples, that $4,000 in cash flow that you're getting every year or that $20,000 in equity that came from the home value appreciating, those gains didn't appear in a vacuum.

they appeared in the context of the risk that you've also taken on. That's another way of saying you're not getting something for nothing when you take on leverage. The returns that you get are the compensation for that risk. Reason number two, and this is really the bigger reason, there's this formula, and Erin, I'm sure you know this, but I'm just going to explain it for the sake of everybody. There's this formula called cash on cash return. Many investors use this formula when they're making buying decisions. I think that's a huge mistake. Cash on cash return, the calculation is very simple. It's your cash flow divided by cash out of pocket.

So in that example that I just cited, your cash flow is $4,000, your cash out of pocket is $40,000, your cash on cash return is 10%. That sounds awesome. And so many investors will take that as a green light. They'll take that as a go ahead to buy a property with a terrible cap rate simply because they're getting a solid cash on cash return. I think that's a huge mistake because essentially what you're doing, if you buy a property based on your cash on cash return rather than your cap rate, is you're making the statement that this asset is not good enough to buy in cash. And the only thing that makes this a good deal is the fact that you can take out a loan for it. And that is inherently flawed logic. If you wouldn't hold something in cash, don't hold it with a loan. In other words, don't depend on financing in order to make a bad deal good or a mediocre deal good. In my view, the wiser approach is to first evaluate the asset itself to decide whether or not that particular asset, that particular property is worth holding.

Is this a good investment? Is it a good deal? And if it is, then look for good financing. But don't let the tail wag the dog. Choose the investment first, then look at your financing options. Because here's a thing. You could theoretically use leverage to buy a lot of things. You could take out a loan, a home equity line of credit, for example,

and use that money to buy stocks or to buy Bitcoin or to start an online clothing store or whatever it is that you wanted to do. That wouldn't necessarily be a good idea, but you could theoretically do that. And if you were to do that, you're already taking on a certain amount of inherent risk by virtue of having debt. You don't want to exacerbate it by using a formula such as cash on cash return that states, hey, this may not be a good enough investment to be worth owning in cash, but that's okay as long as I take out a loan for it. It just defies logic. So, I've been ranting about this for a little while, but for that reason, I really want to avoid discussion of leverage as a advantage in real estate because I think that too many real estate investors skew the topic towards leverage. And in the process of doing so, they cloud the decision-making process around the core question, the key question, which is, is the asset itself a good deal?

is the asset itself something that produces a strong dividend. And that is very much where I think that conversation needs to focus. So hopefully that answers your question about why I intentionally did not mention use of leverage as one of the advantages of real estate. Now, as for the other thing that you asked about, the fact that real estate is inherently inefficient, so again, I'm going to give some context here for the sake of everyone who's listening. There is a hypothesis known as the efficient market hypothesis, which states that everything about the stock market is publicly known and all of that publicly known information is priced into the value of a stock. So if you're looking at a share of Coca-Cola or Tesla or Amazon, what you are seeing is the same thing that everybody else in the world sees.

You're seeing its price at this particular moment in time. and that price is determined by all of the publicly available knowledge about that company. And you as an individual do not have any type of advantage. So this is known as the efficient market hypothesis. And with regard to stocks, it's controversial. There are some people who agree with it, some who disagree, some who believe that the stock market is inherently efficient, some who believe that it is inherently inefficient.

It should be worth noting that the Nobel Prize Committee in awarding Nobel Prizes for Economics have in the same year awarded prizes to both the person who came up with the efficient market hypothesis, as well as a person who came up with a very strong counterargument for it. So expert economists find validity to both the notion that the market is efficient and the notion that it isn't. Now, by contrast, real estate, I think most people can agree, is inherently inefficient. And what that means is that there's a lot of opportunity for insider knowledge and there's a lot of opportunity for investors to harness an informational advantage. For example, if you form a close relationship with a real estate agent, he or she might know of a property that has not yet been listed. and they might bring you that property before it's publicly listed on the MLS. Or likewise, if you work with wholesalers or you practice any of the tactics that many wholesalers use,

like driving for dollars, you will, again, find properties that are not publicly listed on the MLS. And this can be where you find very good deals in many cases. So real estate differs from stock market investing insofar as all of the information is not publicly known, you can use that to your advantage. I, well, I'm not qualified enough to voice an opinion on the efficient market hypothesis as it relates to the stock market. You know, that's something that even the field of economics has not agreed upon. So I will let the master economists debate about that at conferences. As far as real estate is concerned, however, the inherent inefficiency in the market,

is an advantage that people can harness. And the way that I like to express that is just by telling people, hey, your biggest advantage is becoming an expert in a particular niche. Because by being an expert in a very specific niche, such as a particular zip code, and even within that, certain blocks within that zip code, and within that three, two single family homes valued between X and why within those particular blocks. You know, if you narrow your expertise to that limited of an area, you are effectively eliminating the competition and gaining the informational advantage that comes from being a micro expert. That coupled with the fact that real estate allows you to practice a bit of a hybrid between running a business and having an investment.

You get to make decisions that directly influence the bottom line. That's, I think, where one of the big advantages in real estate exists. So, yeah, Aaron, I would agree. The real estate market is inefficient, and really, I think what that does is it affords you the opportunity to become an expert. Thanks for asking that question. The cash on cash return issue in particular in the use of leverage is something that I feel pretty strongly about.

I've been to a lot of investor meetups where there's a certain machismo around putting as little of your own money into the deal as possible. I went to this meetup once in Atlanta where this guy, he was, young, like early 20s. He walked in. He had just done his first deal. And he announced, oh, I only put $600 of my own money into it. And this other guy was like, who did you put in that much? And I was, I was just sitting there. I was also probably, you know, maybe 27 or 28 at the time. And I was just sitting there thinking like, wow, there are, there are no old over leveraged investors. There are no people who have been in the game

for decades who would not caution prudence in the love affair that real estate investors tend to have with leverage. Well, thanks again, Erin, and hope I get to meet up with you at some point. Regardless of whether or not you have debt, managing healthy credit is important. If you want to buy houses, whether it's a personal residence or an investment property, or if you want to open up new credit cards, if you want to lease a home in a different city for lots of other things, you need to manage your credit. So if you're interested in a website in which you can check your credit score for free,

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With your membership, you also get free identity theft insurance worth up to $50,000, which could be a lifesaver in the wake of the Equifax data breach. And if you need it, there's a live helpline where you can talk to identity restoration specialists, also for free. And you can check your credit score for free. So check them out. It's great to know your credit score and to get personalized educational content. They're creditcesamy.com. Creditcesmy.com. Our final question today comes from Anna.

Hi, Paula. This is Anna. First, a big thank you to you and your team. Your blog and podcasts are really changing people's lives. Here is our situation. We live into San Francisco Bay Area, where property prices is extremely high. We own our current condo with mortgage

and recently purchased a new place and plan to move in soon. My question is, should we sell our current condo and invest in out-of-state rentals? If we rent out our current condo, the rent will be just covering our mortgage, HOA, tax, and insurance. However, there is more upside potential and an appreciation. If we sell it, we can pull out about $250K in cash to invest in out-of-state rentals. In summary, should we sell our Bay Area condo and invest in out-of-state rentals or keep it. Our goal is to reach financial freedom in about 10 years. Thank you so much for your help.

Anna, this is a fantastic question. And actually, it's one that I've thought a lot about, personally, because I myself live in a condo. And if I were to move out, which I have no plans to do, but if I were to, I would be in the same situation as you. My personal residence would be a terrible investment property. And so I've often wondered, theoretically, if I ever were to move out, what would I do with it? Because mine would have the same numbers as yours. I could rent this place out for enough to cover expenses but no more, which means that really I would be losing money once you account for repairs, maintenance, vacancies,

all of the other expenses beyond just the mortgage and HOA that come with owning a condo. So here are a couple of questions that you should consider. Number one, is there any possibility that in the future you would want to move back to your original condo. If there's a likelihood that you might want to live somewhere else for a year or two, and then let's say that you decide that you don't like your new neighborhood or you just, you miss your old place for whatever reason. If there's any chance of that happening, hold on to your old condo because that's a decision that you're making based on personal enjoyment as opposed to an investment. And because the transaction costs of moving real

estate are so high. You don't want to sell the condo now and then re-buy it or re-buy something very similar to it a couple of years later. So if you think you might move back, hold on to it. Otherwise, if you're looking at it purely from an investment point of view, in terms of cash flow, it's just not a good investment. And that's fine. You didn't buy it as an investment property. You bought it as a personal residence. And the vast majority of personal residences, yours and mine included are terrible investment properties. Those are two different types of properties that are bought with two very different sets of criteria in mind. So an apple is not meant to be a Kiwi.

As long as you leave your money parked in that old condo, that money likely will be underperforming relative to what it could otherwise be doing elsewhere. And if your money is going to underperform, then the only reason to justify that, That would be if you had some type of strong personal motivation, like moving back in. Without that, then it doesn't really make sense to keep your money in an underperforming asset. And now, I say that knowing that we have no idea what's going to happen with valuations in the future. So there's a chance that if you sold that condo and then property values skyrocketed, you would be very, very mad at me. And that's entirely possible. That could happen.

It's also likely that you would hold on to the property or sell it or whatever that regardless of what you did with the property, the underlying value would maybe experience some slow growth or maybe stagnate. Literally anything is possible. There are five possibilities. There's rapid growth. There's moderate growth. There's stagnation. There's moderate decline. And there's rapid decline.

Those are the five possibilities. We don't know which of them is going to happen. And any attempts to figure it out is really nothing more than fancy guesswork. Another one of my key phrases that I like to say is that projection is just a fancy word for guess. Now, with that being said, I don't know the specifics of that particular neighborhood. If you have reason to believe that that neighborhood will, you know, be the next best thing, like I said, all real estate is local. So if there is some knowledge that you have about that neighborhood that would drive your decision to hold, on to the property, then only you know that because that is so neighborhood specific that

only a person who was intimately familiar with that particular neighborhood would be able to make that assessment. But speaking in broad generalities, if value is the only reason that you're holding on to the property, then that sounds like a speculative bet. And if you have any doubts about this, you can calculate the cap rate on your property. If you run that equation, and I'll put an article in the show notes, which is at afford anything. slash episode 110. I'll put an article there that walks you through how to calculate the cap rate and the cash on cash return. But if you run the equation and the cap rate turns out to be maybe

2%, well, then, you know, at that point I think your answer would be fairly clear. Because if the cap rate is analogous to a dividend payout, then you're getting a dividend of 2%. And if the appreciation is, I don't know, maybe a little bit better than the rate of inflation, we'll say it's 4%, then the total return that you're getting is around 6%, which, you know, if your mortgage has an interest rate of 4 or 5%, then the spread between what you're paying on that mortgage and the total return, including value appreciation, is within a margin of error of each other. The spread is virtually non-existent. So you just wouldn't be getting as good of a return on that money as you could be getting

elsewhere. You know, you've got $250,000 and given that your goal is financial independence, it makes a lot of sense to put it where it will serve you in a more income producing way. Now, finally, Anna, that doesn't necessarily mean that you should put that $250,000 towards out-of-state real estate investments. You could do that. That's one of many options. You could also put it in index funds. There are a lot of things that you could do with that money. I think real estate is fantastic for creating passive income that leads to financial independence, but it is not the only route. If it's something that excites you, if that's a route that you want to go down, awesome, do it. But I guess I would just want to be clear that there are many, many paths to

financial independence and real estate is an option, but it's not necessary. Well, thank you so much for asking that question, Anna, and thank you to everybody who has called in with a question. We've got around a three to four month turnaround time on the questions that we're getting right now, but we are working through it. So if you've called in, thank you. And we are, we're getting there. The show notes for this episode, like I mentioned, are available at afford anything.com slash episode 110. Coming up in future weeks, we have an interview with Tanya and Mark. They are the bloggers at Our Next Life.

They have retired at the age of 38 and 41, respectively. So they're going to talk about how they retired in their late 30s, early 40s. My own future plans for the year 2018, I am, I'm got to finish this course. I will describe the process of building it and putting it together. I'll describe all of that sometime later. But needless to say, it's been quite a task. It's been a lot more than I had ever anticipated. But I'm hopefully rounding the last, what's the baseball analogy?

in the last inning, rounding the final base. So hopefully that will be, that will certainly be ready at some point this year. I don't know when, but at some point this year, and my goal is the spring, but we will see. So the real estate course is coming 2018. Similarly, the shop is also underway, which all proceeds from that are going to go to Charity Water. That is also underway. And of course, you can find me here on this podcast every Monday. I've set a few other goals for myself in 2018. I'd like to publish on the blog more. I've been neglecting the blog for the past, really for the past two years. I've not been posting very much as I've just been distracted with other things. So, you know, I'm one of my intentions is to hopefully start publishing articles on that again with some degree of more consistency or more frequency. I'd like to start creating YouTube videos, creating more of those. I know I talk a lot about having a goal-free existence and being.

committed to action rather than outcome. But for the lack of a better term, you know, those are my goals or my intentions or whatever semantic twist you want to call them for the year 2018 at a business level. And at a personal level, I'd like to just focus on getting healthier, exercise more, eat better. There's such a massive link between your physical health and your mental and emotional health and your success in business and finances in life. I mean, I'm absorbed. more and more that the way that I treat my body has a massive effect on my mental clarity and energy. So one of my major intentions for 2018 is to make that a much bigger priority. And in service of that, I would like to travel less.

2017 got a little out of hand with just how much traveling I was doing. And eventually it got to the point where I was traveling so much that I just wasn't appreciating the trips that I was taking. plus all of that travel was interfering with some of my other goals, particularly health-related goals. So that is another one of my 2018 intentions is to be at home more and to create strong routines in a strong space and to just focus on getting healthy and producing really excellent things of value. I constantly have more projects in my mind than I am able to execute in any sort of timely manner. And I guess that's both the blessing and the curse of being a creative entrepreneur and being financially independent. You know, with freedom comes responsibility. And with responsibility comes a lot of self-directed pressure.

So I just keep reminding myself that success, in whatever way that you define it, success is built one day at a time. It is not something that happens overnight. It's not something that happens out of nowhere. It is simply, to paraphrase a quote from Jim Rohn, it is simply a series of habits that are practiced every day that slowly over time add up to something substantial. So whatever your goals for 2018 are, whatever your intentions are, just remember it's less about the big things and more about the habits that you form and the actions that you take. the things that you do every once in a while matter less than the things that you do every day. So I will leave you with that note. My name is Paula Pant.

You can find me on Instagram at Paula Pant. One of my intentions for this year is to post on there at least once a day and hopefully share something insightful in doing so. Thank you so much for tuning in. This is the Afford Anything podcast. I'll catch you next week.