Afford Anything - Ask Paula: How Can I Retire in 10 Years with Rental Properties?

Episode Date: February 27, 2020

#243: Adam is 23 years old and wants to achieve financial independence as quickly as possible. However, he’s nervous about investing in the stock market and real estate. How can he overcome his fears? Paris, age 35, has a similar question. She earns $150,000 per year, is debt-free, and doesn’t own a home. How can she reach financial independence in less than 10 years? Paul wants to househack his first home, but none of the properties he's seen meet the one percent rule. He doesn’t want to rent forever. Does he need to compromise on his commute time, or wait until he finds an undervalued gem? Anonymous Househacker rents an apartment with three bedrooms, two of which he rents out on an inconsistent, short-term basis. They want to know: does the money they earn count as rental income if they aren’t making a profit on it? Ben is a real estate investor who’s curious about growing his portfolio from four units to 20 units. What’s the best approach to take? I answer these five listener questions in today’s episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode243 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything. You just can't afford everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to any limited resource that you need to manage, such as your time, your energy, and your attention. And that leads to two questions. Number one, what matters most in your life? Not what is the prescribed path that society has set out for you, but what is truly a value in your own life, even if it is unconventional? That's the first question, and the second question is,

how do you align your day-to-day decision-making and your daily actions in a way that reflects these values? Answering these two questions requires a lifetime of 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. Every other episode, I answer questions that come from you, the community. And today, we're going to tackle the following five questions.

Adam is 23 years old. He wants to achieve financial independence as quickly. as possible. He makes $41,000 a year. He's on track to pay off his student loans this year. What should he do? How can he get from the starting point to financial independence? Next up, Paris has a similar question, but her situation is different. She's 35 years old, and she makes $150,000 a year. She's debt-free, and she wants to reach financial independence in the next 10 years. What should she do? Paul lives in Northern Virginia. He wants to buy a two-bedroom condo, live in one of the bedrooms and rent out the other one. He's struggling to find a property that meets the dual criteria

of must be a close commute to work and also must be a great investment. What should he do? Meanwhile, an anonymous house hacker calls in to report that he's living Paul's dream. He rents a three-bedroom apartment, lives in one of the bedrooms, and he rents out the other two bedrooms as a short-term rental. What are the tax implications of his setup? Finally, Ben calls in with both a success story and a question. He moved from California to Cincinnati, my hometown, bought a fourplex for $48,000, fixed it up, rented it out, and now makes great passive income and is semi-retired. He wants to grow his portfolio from four units to 20 units. What should he do to get there? We're going to tackle all of these questions right now, starting with Adam.

Hi, Paula. This is Adam from St. Louis. I am 23 years old, and I am a music teacher. slash bartender on the weekends for my side hustle. I currently make about $41,000 a year, and then I save as much as I can for my bartending job. I am on track to pay off my student loans this year. I have two months of savings in my emergency fund, a little over $4,000, and I started my Roth IRA investments last year, and I contribute $300 each month. My question is, what can I do to speed up the process towards financial independence at a young age? I'm nervous to invest in the stark market or anything like that because it is all very new to me and I've always been told not to invest in something that you do not know much about. In addition, I feel like I'm a little

young to invest in real estate, which again, I need a little more information on before I start investing in that. Any advice to help me move faster at a young age would be great. Thanks. Love your podcast. You're incredibly inspiring. I'm looking forward to listening to more in the future. Adam, first of all, congratulations on being on track. Let's pause to reflect on how impressive your numbers are. You mentioned that your emergency fund represents two months' worth of expenses and it's a little over $4,000. So you're living on about $2,000 a month, $24,000 a year, yet you're making $41,000 a year plus bartending income.

So you're living on 60% of your pre-tax full-time income, not even including your bartending income. I don't know how much you make as a bartender, but once we lump that into the equation, your savings rate is significant. Again, ignoring your bartending income, if we just look at your full-time income alone, you're living on 60% of it. That's impressive for anyone who does it, but it's particularly remarkable

when you're in the lower half of the five-figure income zone. I know what that is like. As someone who has herself spent many years in the trenches being super scrappy, I totally get how much hustle and drive and gumption you need to get you through. And you've got it and you're doing it. You sound as though you're debt-free other than a student loan and that student loan is going to be wiped out by the end of the year. And you've already got retirement savings.

So what should you do next? All right. Now, for my answer, I am assuming that you do not have a 403B or other comparable workplace retirement plan. that includes a company match. I'm assuming that that offer is not available to you. If it is, then duh, you know exactly what my answer is going to be, which is drop everything you're doing and go get that full company match right away. Make that priority number one.

Like literally don't do anything else before that happens. Don't brush your teeth before that happens. Don't go to the bathroom before that happens. Do that first, then live your life. So assuming, because I know you're smart enough to know that already, So assuming that that's not an option, then here's a more reasonable ranking of priorities. All right. So priority number one is to max out your Roth IRA.

And I would advocate doing this even before paying off your student loans. Right now you're contributing $300 a month to your Roth IRA. The contribution limit in the year 2020 for people who are ages 49 and under is $6,000 per year, maximum, which is $500 a month. So boost your Roth IRA contributions from your current 300 up to 500 so that you can max out this year's contribution. The reason for that is because the contribution limit is use it or lose it. Any unused portion of that limit doesn't roll over. Once the window is closed, it's closed. And a Roth IRA is basically the ultimate account.

if you need to, you can withdraw the principal portion of your Roth IRA contributions penalty-free. Now, I don't advocate doing that in most cases, but you have that option there as a backup. So when money's in a Roth IRA, you simultaneously get the benefits of having money that grows tax-exempt throughout its entire investment duration. And you're 23. If that money is in the account for 40 years or 50 years, all of the capital gains, all of the dividends, all of the appreciation, all of that will be completely tax exempt. And when you think about how much money that can grow to, tax exemption on Roth accounts are one of the greatest gifts the IRS has ever given to us. And when you have that benefit paired with the liquidity, and I'm using liquidity kind of in air quotes, because I don't,

want to encourage a mindset of tapping the principle. But when you combine it with the reality that that principle is accessible, penalty-free, I mean, that just makes it the have-your-cake-and-eat-2 account. So max out your Roth IRA first and foremost, even if this means that it takes you a little bit longer to pay off the student loans. And I imagine it's not going to take you that much longer. Maybe it means that rather than the student loans being paid off in December of this year, maybe they'll be paid off by February, March, April of next year. You'll still. You'll still have those student loans wiped out within a margin of error of plus minus a few months. And in the meantime, you'll have the benefit of the Roth contributions. So, priority number one,

max out your Roth IRA. Priority number two, pay off your student loan. And then after that, priority number three, boost your emergency fund up to the point where it represents between three to six months of your living expenses. Get that a little bit higher. After you have finished those three things, then any money that's remaining split between two buckets. One bucket is if your school does offer some type of retirement accounts, such as a 403B, maybe they don't offer a company match, but if they do offer some other retirement savings vehicle, then start contributing to that as well so that you can have money set aside in multiple retirement accounts, a 403B and a Roth IRA. That's one of the two things. The other is to start saving for a down payment. And you can use this down payment for either your personal residence or for a future investment property.

You don't have to make that decision right now. But keep some money set aside in a taxable brokerage account or depending on when you plan to tap the money, even in a high yield savings account or a money market account or in Ginny Mays, you know, have that block of cash that's set aside in relatively low risk, low volatility, highly liquid assets. that way, when you are ready to purchase a home, regardless of whether it's a personal residence or an investment property, you'll have a block of money that's set aside for that, that you can easily access without complication. And so that leads us to the latter half of your question, which is, how do you invest money once it's in the appropriate buckets? You know, once you put that money in your Roth IRA or in a 403B, well, it can't just sit there in cash. I mean, it can, but I wouldn't recommend it. So you'll want to invest it, but how? And similarly, as you grapple with the decision as to whether or not to buy a rental property at some point in the future,

how do you even start to feel out whether or not that's a good idea for you? Here are a few tips. First, let's talk about investing in the stock market. If you want the simple answer, the simplest, cleanest 80-20 good enough are Vanguard-Target target-de- date index funds. A target date retirement fund is one fund that consists of a basket of holdings that are optimized for a specific timeline to retirement. So if you plan on retiring in the year 2016, then the holdings inside of that fund, the asset allocation between equities and bonds will be adjusted periodically as the timeline approaches retirement. You'll have higher

equity's exposure now, higher bond exposure later, and you don't have to worry about it. You don't have to do anything. Now, most target date retirement funds are a rip-off because most brokerages charge insane expense ratios for them, but Vanguard does not. And so if you can access Vanguard's target date retirement funds, there's are one of the few that are actually a good deal. So what I would recommend doing when you're getting started and you're not sure what else to do is in the interim, park your money there as you're learning. Just do it as a temporary stopgap measure so that your money isn't sitting in cash. After you've done that, in order to start learning about the stock market, two resources. One is afford anything.com slash episode 31.

That's our interview with Jim Collins. He's the author of A Simple Path to Wealth. and he explains in very simple beginner-friendly terms the benefits of index fund investing as compared to buying actively managed funds. He discusses the historical outputs of the stock market over the last 100 years and why we shouldn't be as irrationally afraid of variance as we tend to be. He breaks all of it down in very, very simple terms. So afford anything.com slash episode 31, our interview with Jim Collins. That's one of the two resources. And the second resource is his book, A Simple Path to Wealth.

We'll put a link to it in the show notes for this episode. Those show notes will be available at afford anything.com slash episode 243. Adam, you are absolutely correct in that you should not invest in something that you do not understand. And the more specific the investment is, the more important it is to know exactly what the strengths, weaknesses, opportunities, threats, and financial snapshot quarterly earnings balance sheets. If you're buying an individual stock, you want an in-depth level of knowledge about that particular individual stock, because individual stock investing is incredibly risky. But as you zoom out into broader and broader asset categories, you relieve yourself from the need to know about the specifics inside of it. you can hold an S&P 500 index fund without needing a nuanced understanding of each of the companies that are represented by the S&P 500.

And the reason for that is because broad indices are self-cleaning. If there are a few bad or underperforming companies in there, they will eventually fizzle, close up shop, and newer, younger, scrappier companies will rise up to take their place. And some of those will succeed and some of those won't. but all of that happens within the ecosystem of an index fund. And so as long as you understand how the ecosystem as a whole operates, you don't have to burden yourself with understanding each inhabitant within that ecosystem. Let's take that same concept or framework and apply it to this question of rental properties. Because rental properties in the context of buy and hold investing are incredibly specific.

There is no such thing as, quote, unquote, the real estate market. There is simply the performance of the market in the 3034 zip code or the 45231 zip code or whatever zip code you're looking at. And inside of that, there's maybe a cluster of a few blocks where you understand at a very detailed level what all of the transactions are that have been happening in this limited geographic area. And if inside that area you find a house that is selling at a reasonable price and that will give you, a great cap rate, which is essentially a dividend, then that's your play. But you find that play in real estate very much by doing the opposite of what you do when you learn about broad market index fund investing. In the equities and stock index world, you're intentionally not learning about specifics. You're simply learning at a macro level how everything operates and leaving that

is good enough. In real estate, you're doing the opposite. You're learning specifically about each property, down to the level of detail of how many years of life do you think are left on the roof? And so to zoom out and answer, I think your bigger question of which should you prioritize, that's going to boil down to which are you more interested in. You mentioned that you are afraid that you might be too young to invest in real estate. Everybody thinks that. Or to amend, everyone thinks some variation of that, because I'm too young is a way of expressing imposter syndrome and everybody feels imposter syndrome. Some people will justify that anxiety by thinking that they're too young. Others will think that they're too bad with money or they're too inexperienced or

they're not handy or oh my goodness, there are so many agents and contractors out there and those people are professionals. So what makes me think that I could do better than them, right? Like those are all examples of the ways in which we justify imposter syndrome. So don't let that stop you. And I get it. I was 27 when I became a landlord. And I felt like a pip squeak. Like, you imagine me, like I'm a 27-year-old five-foot-one girl opening the front door to greet these potential tenants who are coming to tour the home who are in their 50s. And I'm standing there like, hi, I'm your landlord. I felt ridiculous. I felt ridiculous calling myself a landlord at the age of 27. And I was a renter when I bought my first rental property. Like I owned rental properties for five years before I ever owned a personal

primary residence for myself. And so being simultaneously a renter and a landlord, I felt even more like an imposter, not to mention the fact that I was 27. But you just do it. You get through it. So if you want to invest in real estate, don't let the fear of being too young stop you. The operative question is, what are you most interested in learning? If you follow your curiosity, where does that lead you? Does your curiosity lead you down the rental path? Or does your curiosity lead you down the equities path? Follow your curiosity, and that's where you will have the highest likelihood of having the most success.

So thank you, Adam, for asking that question. And best of luck. We'll come back to this episode after this word from our sponsors. Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the FinTech Hustle that got them named one of America's most innovative companies by Fortune magazine. That's what being a fifth third better is all about.

It's about not being just one thing, but many things for our customers. Big Bank Muscle, FinTech Hustle. That's your commercial payments. A fifth-third bedder. The holidays are right around the corner, and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need serveware and cookware. And, of course, holiday decor, all the stuff to make your home a great place to host during the holidays.

You can get up to 70% off during Wayfair's Black Friday sale. Wayfair has Can't Miss Black Friday deals all month long. I use Wayfair to get lots of storage type of items for my home, so I got tons of shelving that's in the entryway, in the bathroom, very space saving. I have a daybed from them that's multi-purpose. You can use it as a couch, but you can sleep on it as a bed. It's got shelving. It's got drawers underneath for storage. But you can get whatever it is you want. No matter your style, no matter your budget, Wayfair has something for everyone. Plus they have a loyalty program 5% back on every item across Wayfair's family of brands. Free shipping, members-only sales,

and more. Terms apply. Don't miss out on early Black Friday deals. Head to Wayfair Now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-F-A-I-R.com. Sale ends December 7th. Our next question comes from Paris. Hi, Paula. I'm hoping you can help me out with a planning question. So I am 35 years old, completely debt-free and do not own a home.

And I've just started a new job making 150K per year, which I'm really excited about and I've sort of been reading about the fire movement and somehow just continuing to work and say for another 10 years feels like the longest possible time. And so I'm curious if you were in my shoes, what is the shortest route to financial independence that you would map out? I would love to hear your thoughts. Thanks so much. Paris, first of all, congratulations on being in such an awesome position. You're 35. You make $150,000 a year. You're debt free. And your worst case scenario is reaching financial independence in a decade. Your question, the premise of your question is, hey, 10 years seems kind of like a long time from now.

How can I reach financial independence sooner? So the fact that being financially independent by age 45 is the worst case scenario that you're trying to prevent, I mean, that is a good position to be in. So congrats on everything that you've done to get you up to this point. Now, the structure of your question is really interesting because you asked how to reach FI faster. And within this answer, we'll define FI. We'll use as the working definition, the point at which your passive income, typically through investments, is enough to cover your basic costs of living. Now, what's interesting about framing the question as what's the fastest road to get there is that the fastest road is also either low probability or or high risk.

So if you imagine that you've got some sort of a machine, you're tinkering with different dials, speed, probability, and risk are these interrelated concepts and you can't affect one without impacting the other. So, for example, the fastest way to reach FI, the act that could make you FI within the next six months to a year would be the intellectual property path. it would be to produce some type of work, write some sort of software, some type of book, music, create some form of intellectual property for which you hold copyright or trademark, and that is successful enough that it produces royalty income or residual income. Now, is that the fastest way to get there? Sure. Is it likely? I mean, for some people depending on their skill set and experience, that's more likely than others, but it's certainly not something that you could bank on. speed is high, probability is low. The second fastest way to get there, the path that could get you there within two to four years, is not a path that I would recommend because it is so fraught with risk. I do know people who have done it, but I would not recommend what I'm about to say next.

But that path would be to leverage hard into a bunch of rental properties, as many as you possibly can. We're talking rack up 20 properties or 20 units within the next year. And assuming that housing remains in an up market, and that is the crux of this strategy, housing must rise and ideally rise rapidly, assuming that that happens, then after about two years, once the equity in your homes have risen, you sell half your holdings, use that money to pay off the other half, and boom, now you have 10 units in cash in the span of two or three or four years. Now, will that get you there quickly? If everything goes according to plan, yes. Do I

recommend it? Absolutely not. The level of risk within that plan, because of all of the leverage that that requires, the risk is just far too great. That plan, which people have used and people have become financially independent within two or three years doing that, those people got lucky. Those people had timing all work out for them. And the problem with that plan is that when you're that highly leveraged, you don't have wiggle room for anything to go wrong. If you have multiple prolonged vacancies, if your capital expenditures are far higher than you anticipated, if the market, the broad economic forces outside of your control cause the market to stagnate, any of those factors could throw a big enough wrench in the plan that you may not be able to keep up with the

payments and then you lose the housing that you've acquired. So again, when we talk about what's the fastest way to get there, I mean, I share that as an example of a fast way to get there, but I share that not to recommend that path, but rather to illustrate how speed is inseparable from risk and probability. And so that brings us to pathways to reach FI. that have relatively greater levels of security, higher probability, and less debt and less risk. And that's where we get to the two classic examples, one of which is the real estate example and the other of which is the market investing example. In the real estate example, the beauty of using rental properties in order to reach financial independence is that you can essentially base your projections. off of what would be analogous to a 6% withdrawal rate rather than a 4% withdrawal rate.

The reason for that is because if you hold a property that has what's called a 6% cap rate or capitalization rate, that's analogous to that property getting a 6% dividend relative to the value of the asset. So if that property is producing a 6% dividend and the property itself is keeping pace with inflation, which is approximately 3% a year, then that property, may have a total return of 9%, which might be similar to what you would get in a total stock market index fund. But the difference is that that property's returns are biased in the form of dividends. They're biased in the form of passive income.

And so assuming that you have your investments tied up in the form of rental properties that you hold in cash, well, if you need $40,000 per year as annual income in order to be financially independent, $700,000 of rental properties at a 6% dividend will get you that $42,000 per year. In comparison, $1 million in a stock market index fund at a 4% withdrawal rate would get you that same $40,000 per year. So choosing the rental property route will get you there faster because you can estimate those returns, or specifically you can estimate the passive income that you will receive. from your returns at a 6% rate rather than a 4% rate. And notice in the example that I just gave, we are not basing this rental property strategy on a ton of leverage or a ton of risk, right?

In the example that I just gave, if you hold $700,000 worth of rental properties in cash, if you have that free and clear, well, those $700,000 worth of rentals at a 6% dividend, bring you that $42,000 in annual income. And the reason that I make that comparison is because if we are comparing a basket of rentals that we're holding in cash to a basket of total stock market index fund that we're holding in cash because you're not going to use margin to buy index funds, well then you make the most fair comparison when you compare a cash holding to a cash holding. It's more apples to apples that way because that way you're directly comparing the assets themselves rather than the financing that clouds it. So, assuming all cash positions, a million dollars worth of index funds will get you the same level of passive income as $700,000 worth of rental properties. And as a result, rentals will get you to financial independence faster. The drawback, or not exactly the drawback, but the factor that's going to slow you down is that in this example that I just gave, you still need $700,000 worth of rentals.

and you'll be acquiring that $700,000 the old-fashioned way, which is by saving it. You mentioned that you make $150,000 a year. I don't know what your cost of living is. And of course, that $150K is pre-tax income. But if you can save, say, $70,000 per year. Now, on the surface, it might sound as though that would take you 10 years, $70,000 per year times 10 years would be $700,000. But once you start acquiring properties, let's say that, Every year you acquire a single-family home that costs $70,000 and you get that home in cash.

Well, all of the free cash flow, all of the rental income from that property, then gets reinvested. So if you save $70,000 per year from your day job, plus you save and reinvest all of the cash flow that's coming from your properties as you acquire them, then using this model, you could reach financial independence in less than a decade. It would take maybe seven or eight years, which is still a long time, right? we're talking about maybe shaving two years off of a 10-year goal. And that's certainly something, right? That's shaving off 20% of the time that it takes, but it's also still the case that you've got to stick with the plan for eight years. But that's going to be true regardless of which strategy you take,

because if you take the index fund strategy, you're going to have to stick with that for significantly longer. There is a very popular post on Mr. Money Mustache's website. It's called The Shockingly Thubstaff. simple math to early retirement, he shows how many years you would have to work before you reach financial independence, assuming a starting point of zero, assuming that you earn 5% returns after inflation, so total returns of about 8%, and assuming a 4% withdrawal rate. So with those assumptions, in order to reach financial independence in seven years, you would need

a 75% savings rate. Again, that's assuming 8% total returns and a 4% withdrawal rate and a starting point of zero. So a 75% savings rate in order to reach financial independence in seven years, that means that you would be living on $37,500 a year of income from your day job, and that is the pre-tax figure. So you would be living on the equivalent of $37,500 minus taxes. I don't know specifically what your tax rate is, and you're going to have various deductions that play into that. But the long and short of it is you'd have to be living on about 30 grand a year in order to hit that 75% savings rate and reach FI in seven years. Or if you wanted a more moderate approach, at a 65% savings rate, you would reach FI in 10.5 years. So again, you can see how this path, I mean, the benefit to such a path is that you're probably,

assuming behavioral compliance, your probability of success is significantly higher. And I think that's the appeal of the index fund approach or the buying many rental properties in cash approach. As long as you do it, as long as you keep putting in your reps, your shot at success is pretty darn good and you don't take on too much debt or leverage risk along the way. But even with, quote-unquote extreme measures, even with a lifestyle in which you are saving $70,000 per year and buying one new house in cash per year, located probably in a different state in a low cost of living area, right? Even with an approach like that, or even with an approach in which you're living on 65% of your income and putting everything else into an index fund, even with those approaches, it's still going to take a decade, or at best maybe seven or eight years. Because realistically, you've got to live on something, so I don't see your savings rate getting higher than 75%.

You've got to, you need at least 30 grand in order to live. And so FI is a decade project. And sure, you can try to throw a Hail Mary and build some type of a business, have some type of royalty income. create some epic software that brings you that residual income that gets you there a heck of a lot faster. And there's certainly nothing wrong with trying that route simultaneously as you are also on a more assured path. But the fastest ways to get there are the paths that rely on having a handful of big winners and a lot of people who are trying. So by comparison, the decade-long

approach, the approach of just put in your reps, that one at least at a minimum, you know that barring any type of major unexpected calamity, you're on the path and you'll get there in a decade. Assuming that the next decade produces returns that are similar to what historic returns have looked like, you know that you have a pretty good shot of getting there. And so that's the landscape that you're dealing with. And that's my answer to your question of how do I get there faster? Well, thank you for asking that question, Paris. Regardless of which route you choose or which combination of routes you attempt,

stay consistent because that consistency, more than anything, is going to get you through. By the way, if you want two resources about this, number one, we did an interview with a guy named Rich Carey. He purchased 20 houses in cash, and he made all of these investments from outside of the country. So his holdings are all in Alabama. and at the time in which he bought them, he was in the military, so he was stationed in Germany and then in South Korea. So from overseas, he was an overseas landlord purchasing houses in cash. He racked up 20 homes, reached financial independence very quickly doing that. And you can hear that interview with him.

It's a perfect case study of a lot of what we've talked about. That's afford anything.com slash episode 136. Again, afford anything.com slash episode 136. So that is one resource I would recommend. The other resource we will link to this in the show notes is that page, the shockingly simple math to early retirement that's posted on the Mr. Money Mustache website in which he presents that table that I referenced, the table that illustrates that if you save 75% of your income, you'll reach financial independence within seven years. We'll link to that in the show notes. Show notes are available at Affordainthing.com slash episode 243. And thank you, Paris, for asking that question.

Our next question comes from Paul. Hi, Paula. Greetings from a long-time listener in Washington, D.C. I'm seeking to buy my first home in Northern Virginia, specifically a two-bedroom condo in which I can live in one room and rent out the other. My first question is whether I should apply the 1% test in this case, because none of the homes in my price range within a reasonable commuting distance come close to passing the 1% test.

And if it does apply, do I keep searching for that, value gem or will I just have to compromise on something like my commute? I mean, I don't want to rent forever. And my second question is about the increased potential for capital gains, given that Amazon is building HQ2 in the area. How much should I consider? How much wage should I give to this potential upside? Prices have already increased since the HQ2 announcement,

so I'm afraid it'll only get more expensive to buy if I wait any longer. Thank you so much for considering my question. Paul, you have unwittingly hit upon an incredibly important concept that I want to illustrate, which is the difference between buying a property as a pure investment versus buying a property as a hybrid between an investment and something that you are using for personal purposes. Now, in your case, because you are house hacking and because you live in northern Virginia, which is one of the most expensive parts of the country, you need or you are searching for a property that fits two widely disparate sets of criteria. When you're looking for an investment, let's pause and imagine that, just hypothetically, imagine that you weren't house hacking. Imagine that you are purely looking for an investment.

A pure investment, like an investor looking for an investment, that situation is property agnostic. And what I mean by that is that if an investor is looking for an investment, and that investment is purely meant to be an asset that performs as well as it possibly can within its risk-reward context, then the investor is going to be agnostic about which property it is. So assuming a comparison of two or more properties that have a similar age, similar condition, similar risk-reward profile with regard to the neighborhood, with regard to all other risk-reward profiles, and similar price, like assuming a comparison of those two properties, the investor would be agnostic about which one he or she chooses.

Imagine if you were purchasing a stock or an index fund, right? Stock A and stock B, imagine hypothetically that their numbers were identical. Same industry, same future prospects, same quality of leadership, same quarterly earning, same PE ratio. just imagine that everything between stock A and stock B was neck in neck, that their data were so similar that they could practically be interchangeable. Well, in that situation, an investor would not have a strong preference between stock A and stock B because they're basically the same thing. And the same is true when buying houses in a situation in which an investor is buying

something that is purely meant to be an investment. Now, where this gets complicated is when a person is, when a person is buying something that's meant to not only be an investment, but also satisfy their personal requirements. Because there is no aspect of an investment that is meant to or supposed to or needs to satisfy your own personal needs and wants in your personal residence. You most likely want a residence that is a reasonable commute from work and in a neighborhood in which you feel comfortable living, right? Even if we're not getting fancy, even if we don't care about what it looks like or how it feels

or like the enjoyment of living there, even if assuming you don't care about that at all, you at a minimum need something that is reasonable commuting distance from work and that level of geographic constraint impedes your ability to find a good investment. Because now what you're demanding from a property is that it satisfy a hybrid of needs, that it satisfy both your personal needs as well as your investment criteria. And so to your first question, your first question was, should I expand the parameters of my commute? Should I be willing to commute further? And the answer is yes, absolutely. There are so many, like in the course that I teach, your first rental property, I've had so many students who have

coming to office hours and they've said, hey, look, I have made my, I've turned my life into the moustachian ideal. I live a bicycling distance from work and I buy all of my groceries at the farmer's market unless I'm growing them in my own backyard. And my home is completely insulated to the point where my utility bills are almost nothing. Like I've, I've turned my entire life into this perfect moustachian ideal. But now I want to buy an investment property. I want a house hack. and the neighborhoods in which I find properties that meet the 1% rule are not the moustachean ideal neighborhoods. And like, duh, of course they're not. That moustache and ideal that make your life as wonderfully, beautifully efficient as possible,

like that is written specifically for retail homebuyers with high levels of education, high incomes, and the ability to live in safer neighborhoods that are commuting distance to work because their workplace is in a safe neighborhood. I share that story to illustrate how the criteria that goes into selecting a home when you are a retail home buyer looking for a personal residence is apples and oranges to the criteria that goes into a home as an investor. If you are trying to live commuting distance from work and you're a software engineer who works in an office park that's located in a suburb, well, guess what? The neighborhood that you live in is probably one of those Panera bread Lulu Lemon neighborhoods. That's where rich people live. They don't put a Panera bread in a Class C neighborhood. So if you want to find an amazing investment.

property, then yes, absolutely, expand your commute parameters and be willing to live in areas that you previously would not have considered. You don't have to live there forever. You just need to live there for one year. The beauty of house hacking is that if you live there for one year, you get the benefit of a 30-year mortgage of a primary residence homeowner, one year of living there and then 29 additional years of holding onto that primary residence mortgage. But the trade-off is for that one year that you're living there, it's not going to be the home that you want. It's not going to be bicycling distance to the farmer's market. And it might be located so far away that your commute is going to suck.

I mean, at a certain point, you have to ask yourself, are you willing to make that trade-off for one year? Are you willing to commute an hour each way to work for a year? That's a lifestyle question. I can't answer that question for you. You live in Northern Virginia. So I don't even know if within, I don't know that area. I don't know if you would even find viable properties within a one-hour commute to work. Maybe, maybe not.

In Atlanta, I know you certainly can. I've got plenty of friends and students in the course who work in Atlanta neighborhoods like Sandy Springs. And as it currently stands, there are a five-minute commute from work. And they have this very hyper-efficient life, but they're not going to find a good rental property in Sandy Springs because it's this nice suburban, green, leafy-green type of neighborhood. It's a Lulu Lemon-Panra-Bred neighborhood. You're not going to find good rental properties there. But if they move out to Douglasville or if they move south of the airport, yeah, they can househack into a property that meets the 1% rule there. But then they're commuting from Douglasville or from south of the airport to their.

office job in Sandy Springs, and that in Atlanta traffic is a rip your brains out commute. And so then it really becomes a question of, are you willing to accept that tradeoff for one year? And that's a personal question that you can only answer for yourself. But there's one other thing that I'll say to this also. I would invite you to ask yourself, if you are looking for an investment property or if you are looking for a personal property and you want to defray some of your out-of-pocket costs for that personal property. Because if what you're looking for first and foremost is a personal residence and you want to take in a roommate in order to offset some of the costs of having a

personal residence, well, then you're not buying an investment. You're buying a personal residence and you're just offsetting some of the costs by taking in a roommate. And if That's the case, then buy the thing that you want because that's the purpose of what you're doing. You're buying a personal residence. So everything that I've said up to this point about expanding your commute parameters, everything that I've said with regard to that expansion of commute parameters is based on the assumption that what you're looking for is an investment. Because if you're looking for an investment, then you have to consider whether or not you're willing to make that lifestyle trade off. But again, looking for an investment is very different than looking for a personal residence and renting out one of the bedrooms in that personal residence in order to offset its costs.

And on the surface, those two actions may look the same, right? On the surface, under both sets of circumstances, you are purchasing a property, living in one of the rooms, and then renting out the other room to a tenant. right? So the actions appear identical, but the motivation behind buying something as a personal residence versus buying something as an investment, that's going to be the distinguishing factor in the property that you select. Okay. Now, final, final thing I'll say before signing off, you mentioned Amazon, the Amazon HQ2 announcement. I would not put too much weight. into broad market speculation or predictions as a result of that. First of all, the announcement is already publicly known and has been for a long time.

So the impact of that announcement on pricing has already permeated the market. And a lot of that initial impact is speculation in the first place. Housing prices that get driven up by irrational exuberance from people thinking that this will result in enough of a population boom that demand will exceed supply. And that idea sometimes can get priced into the housing markets early, right? The speculation that in the future demand may exceed supply gets priced in early before that ever happens, thus negating the effect if it ever actually does happen. That's often what happens when there's an initial surge of excitement after there's some big headline-dominating announcement.

But the reason that I would not speculate about what may or may not happen in the future is because, yeah, sure, new jobs are coming to the area. But there are also going to be new construction permits, renovations of existing properties. There's also going to be an increase in housing supply. And so in the long term, how will that shake out? Like, will housing supply and demand stay constant? or will one exceed the other? And if so, which one? I mean, you can start tracking the number of permits that the county issues per month. And you can look at the month-over-month data of renovation permits and of new housing starts. You can try tracking that data to see what patterns are emerging month-over-month. And then you can compare the number of new housing starts to the level of population growth month over month. I mean, there are certainly many, many people who that's how they make predictions about local housing markets. As they look at that data, they gather that data, they look at the number of permits that are being issued.

They look at vehicle registration or voter registration in order to try to get a better sense or more accurate sense of population growth in the area. You know, there's certainly many people who are in the business of trying to create these predictive models, but even the people who do this full time are often wrong. So I certainly would not play armchair demographer and try to make guesses about whether or not the cost of housing will rapidly increase or outpace inflation. And if so, by how much and for how long. The minute that you try to get into that broad macroeconomic guessing game, the more that that can lead to trouble. And I'm an optimist. I'm fairly confident housing prices will continue to rise, but I don't know that. And first and foremost, I have to always acknowledge that I know that I do not know

the degree to which real estate prices will arise over the span of the next one, two, three, four years. So, thank you, Paul, for asking that question. Best of luck with whatever you decide. We'll come back to the show in just a second, but first, our next question. comes from an anonymous house hacker. Hi, Paula. I'm a fan of the show and also of the fire movement in general. I have a question.

I am currently renting an apartment that has three bedrooms. The total rent for the whole apartment is $690. I also have expenses including internet and utilities that generally come out to somewhere around $100. a month. I was previously living with a roommate who moved out, and I was going to be living with two friends, but both of them had issues and thus are no longer living with me. Being a fan of the podcast and of the fire movement, I thought it would be wise to start a house hack. I now have roommates coming in and staying with me on a monthly basis. I charge them $500 in rent. On average, I have

one a month. Sometimes I have two a month. Other times I have none, but it has been averaging out to one a month. My question is, would I need to pay taxes on this rental income? Or, as I am not making a profit on it, would this not be considered rental income? Thank you so much. Anonymous. I'm so glad that you're a fan of the show and of the fire movement. And congratulations on your setup. You're paying $690 a month in rent,

and you're on average renting out one of the bedrooms for $500 a month. So you're out-of-pocket costs for rent for yourself are about $190 a month, the rent, you know, not including utilities and such. I mean, that's awesome. You've done a great job of getting your own out-of-pocket housing costs to be super low. And that means that your ability to save money, your ability to take the money that you otherwise would have spent on rent and put it towards whatever else you think is more important is turbocharged. So huge congratulations to you for doing that. Now, to answer your question, yes, you.

You do have to declare rental income. So any time that you make money, regardless of whether it is net profitable or not, you must declare all income that you receive. Now, the good news is you'll also be able to declare expenses, right? The flip side of declaring income is that you also get to write off or deduct some expenses that will offset that income and make what your enterprise on paper even less profitable. But there's a third point, that throws kind of an interesting wrench in this.

And that's the fact that this is a unit that you yourself are inhabiting and you are also renting out a portion of it. And so what that means is that a portion of your domicile is personal use and a different portion of your domicile is used as a business, is used as the place from which you earn income and, deduct expenses. And so the expenses that you pay that cover the entire domicile, you don't write off the entire amount of that because a portion of that benefits you. So when you declare expenses for this rental property that you have, you will be declaring

a proportion of your expenses that is relative to the proportion of your expenses that is relative to the proportion of the domicile that's being used as a business, that's being used as a rental business. So, for example, you pay utilities. A portion of that utility payment is an expense within your rental business, but a portion of that utility payment is your own personal spending. So when you go to file your taxes, you aren't going to write off the entire $100 per month that you spend on utilities. You'll write it off proportionately based on how. much of your domicile you are using as the investment portion of the property. I would strongly recommend hiring a tax professional who can help you with this so that you can

accurately calculate those percentages and report everything, report your expenses with the greater degree of accuracy. So I would recommend that you hire a tax professional who can help you file your taxes. But in order to answer your question, yes, this is rental income, regardless of whether or not you're making a net profit on it, and you always have to declare all income that you receive. Hiding income from the IRS is a go-to-jail-level offense. So make sure that any income that you receive, make sure that you report it. There's a difference between reporting income to the IRS versus having that income be taxable. The fact that it's a fact that

it's not profitable, means that, yeah, you'll report income, but you'll also offset it with expenses, so you're not going to have a tax burden on it. Just because you report income doesn't mean that you pay taxes on that income, but you do always have to report the income. Otherwise, otherwise you're hiding information from the IRS, and that is a huge no-no. One last thing, I recommend for the sake of bookkeeping, that you create a separate business account that is purely for the rental business that you're running. So create a business bank account in which all of your rental income is deposited and from which all of your rental-related expenses are paid. So have a separate business bank account that's not commingled with your personal

spending. Your rent checks go there, your utility payments come out of there. That way, everything is consolidated into one bank statement. everything is clean and organized and in one place and not commingled with your personal finances. It makes the bookkeeping and record keeping a lot easier. And then, again, with those utility payments that I mentioned, your tax professional will adjust the amount of it that gets written off based on personal versus investment, based on usage of the property. But you can make that entire payment from the business bank account. That's fine. You don't have to split the payment into two separate payments.

So you can make the full payment from business banking, and then when it comes time to prepare your taxes, just let your tax pro know that they'll have to make adjustments based on usage of the property. So that is the rundown. And again, congratulations on offsetting most of your housing costs through having roommates. that's such a great way to manage your money. The three biggest expenses that a person has are housing, transportation, and food. So the fact that you've been able to get your housing costs down to $190 a month on average,

that's epic. That's super big. So huge congratulations to you for that. We're going to close out today with a comment. This is kind of interesting. It's sort of a hybrid between a comment and a question. It's a comment with a question at the end. And I am a huge fan of this person who called in to leave this comment because they now live in my hometown, Cincinnati.

So here is our commenter from Cincinnati. His name is Ben and he is going to share a success story about how he reached financial independence through rental properties. Here's Ben. Hey, Paula, Van, Ben here, Cincinnati. Long time listener, first time caller. I am calling because I've been wanting to show gratitude for everything you've done. Then listening to you since it was the money podcast five years ago, there was a home invasion and I had a gun pulled on me and went off inches away from my head.

My light flashed before my eyes and realized I was not happy with what I was doing, which was property management for a nationwide company. kind of reoriented myself and a long story short move from California to Cincinnati, your hometown, and bought a 4plex for 48,000, put 100,000 into it, did all the work myself, rehabbed it, got a cash out re-five for 266, so I got 200K out of that, and now I'm level 5 financially independent, and, you know, semi-retired. I have investors in looking to repeat the process with my second property here and I just really feel a connection to you.

Also go to a Burning Man every other year, as that's where I fell in love with my now wife, opposed to her, and had kind of a mock wedding there. Yeah, I just wanted to say thank you for everything you do. And if you got any tips on growing a real estate investment business from four units to to 20, I'd love to hear about it. Thanks so much. Ben, what an amazing story. First of all, I'm sorry that you went through such a scary experience, the incident with the gun that you described, but I'm glad that everything worked out. You're okay. You're safe. You're healthy. And it inspired these huge changes in your life that have brought such amazing things to your life.

You know, now you're financially independent, you're semi-retired, you're living a great life. So thank you for sharing your story because I think that that's inspiring to a lot of the people who are listening to this, to hear that example and to know that not only can it be done, but people like you are doing it. You're living it every single day right now. To the last thing that you said in your question, any advice about growing from four units to 20, I'll refer back to. to the answer that I gave to Paris earlier in today's episode when Paris asked about the fastest way to reach financial independence. There is a trade-off between the speed at which you acquire properties or acquire units and the amount of leverage that you take out. So if you want to grow from four to 20 using leverage, well, you can do that with relatively,

few headaches or hassles. You can look to an institutional lender in order to buy a few more fourplexes. And ultimately, when institutional lending runs out, there are lots of creative financing options, private loans, and other forms of creative financing that you can use in order to get you to those last few units. But the decision that you need to make before you start down that path is what is your ideal debt-to-equity ratio across your entire portfolio of properties. What is your ideal aggregate debt to equity ratio? And that's a different question from what ratio do the lenders require? Because it might be the case that you would prefer to have a ratio that is different than the one that's required by your bank or your credit union. You know,

it might be the case that for every $1 in equity that you hold across your aggregate basket of portfolios for every dollar of equity, you're comfortable having a dollar of debt, right? Maybe that 50-50 balance feels right for you. Or maybe you're cool with a 70-30 flipped in either direction. I mean, like, that's a fundamental question that you need to ask yourself before you go down that road because that way at the outset, you'll know what your personal guideposts are. The other thing that I would say, I'm curious why you have a goal of 20 units.

it strikes me that if the goal is financial independence, which I know you are already FI, but maybe your goal is to pad financial independence, maybe it's to be fat fire. If the goal is FI, then it strikes me that a goal related to the amount of passive income that you're pulling in might be more relevant than the number of units that you hold. And so if your goal is related to the number, the amount of passive income that you're pulling in every month or every year, then that becomes a separate question because you can either grow rapidly, get 20 units, but only be cash flowing $100 a door from each of those units. or you could grow a little bit more slowly, get eight units or 10 units, but be cash flowing heavily from those. And so really, to answer your question of, you know, what advice would I have about growing from four units to 20 units? Broadly speaking, my advice is to think about aggregate debt to equity across your entire portfolio.

think about whether your goal is number of units or your goal is cash flow slash passive income and think about the trade-off between the speed at which you grow versus the level of risk that you take on. And in each of those arenas set a clear vision and clear parameters and boundaries and guidelines for where you want to be. Because once you demarcate that, then you have a roadmap, right? then you have essentially an investor policy statement or a guiding statement that shows you, this is the plan. And that plan is much more specific. It's much more concrete than simply wanting to accumulate more units.

So that would be my recommendation. But again, it sounds like you're doing an amazing job. You know, you've done a fantastic job with this fourplex. You've forced depreciation through renovations. You've cash out refied it. You've built some great passive income, so huge congratulations for everything that you've done. And I'm excited to see where you end up in another year or two. Where the path leads next, because I'm sure it's going to be somewhere great.

That is our show for today. Thank you so much for tuning in. If you enjoyed today's episode, please do three things. Number one, share it with a friend or a family member. Number two, make sure that you subscribe in whatever app you're using to listen to this podcast. And number three, leave us a review. As of the time of this recording, we have 2,157 reviews on Apple Podcasts, formerly known as iTunes, and I want to give a shout out to Pauly Tess for her amazing review.

She said, quote, as a single woman in her 30s, I find Afford Anything Podcast to be a highly resourceful tool to building a sturdy financial foundation for myself and my future family. This year, I increased my net worth by over $250,000, simply by saving and investing, a significant chunk of my paycheck, and avoiding lifestyle creep. Thank you, Paula, for keeping me financially engaged and enlightened. Keep up the great work. Wow, congratulations to you for increasing your net worth by $250,000 in one year. That's huge. In fact, Steve, can we get a sound effect? Big congratulations to you for increasing your net worth by a quarter of a million dollars.

You're the one who did that. You know, you took the action. You deserve all the credit for that. So huge, huge, huge congratulations to you. If you want to discuss today's episode with other people in the community, if you want to bounce ideas off of people or talk to people about specific topics like side hustles or debt payoff or rental properties, join our community. We have more than 1,500 awesome people. in the Afford Anything community. It's totally free. Everybody's there, exchanging ideas, offering encouragement, growing and learning

and being inspired together. There's a new discussion posted every day and a huge span of topics ranging from everything from personal finance to self-improvement to health and business.

So afford-anything.com slash community is where you can go to join in our community. There's a ton of activity going on there, and I think you're going to have a lot of fun.

So afford-anything. dot com slash community totally free and a great place to just share ideas and get inspired and learn more. If you are interested in rental property investing, we have a free seven-day email series that walks you through the basics, like the 101 introduction to rental property investing. It talks about everything from how to find properties, including if you have to look out of state, how to build a team, how to think about the math. on a rental property. So for a seven-day introductory email series to that, head to Afford Anything.com slash VIP list.

That's Affordanithing.com slash VIP list. We also offer a course. We offer it twice a year. We have a spring semester and a fall semester. The dates of the spring semester are to be determined. But we will be announcing that to the VIP list first. So be first in line to get that information at afford anything.com slash VIP list. Thank you again for tuning in. I want to say a shout out to the sponsors of today's

episode, FreshBooks, Beta Brand, Blinkist, and Gusto. If you want a complete list of all of our sponsors and the discounts and the deals that they offer, you can go to afford anything.com slash sponsors. It's got all of our promo codes, coupon codes, deals and discounts everywhere. So Affordanithing.com slash sponsors. Thanks again for tuning in. My name is Paula Pant. This is the Afford Anything podcast. And I will catch you next. week. So my lawyer says I'm supposed to give you a disclaimer. So here we go. This is for entertainment purposes only. This is not intended to be advice. And please do not consider me to be an expert or a grown-up or in any way worthy of even really being considered an adult. I'm just some random person

who has access to the internet. So anything I say is purely for the sake of entertainment, you can just think of this as the least funny comedy show that you've ever heard. This is the Afford Anything Unfunny Comedy Hour. Before you make any financial moves, please check with a real grown-up and a real expert. That means check with a financial planner. Check with a tax advisor. Check with an attorney. Check with somebody who actually has credentials and who knows what they're talking about.

Because that's not me. So please, give me the same level of respect that you would give, meh, maybe a house cat? And please regard this entire show as nothing more than your source of entertainment. All right, you've been warned.