Afford Anything - Ask Paula -- How Should I Invest $100K in Real Estate?

Episode Date: January 29, 2018

#114: This week, I answer four questions about real estate investing from the audience. Joelle asks: I own a home outright on the West Coast. I’m thinking about taking out $100,000 from my home equity, and using this money to buy a rental property. I found a community out east where I can buy a property outright in cash for $100,000 in a good neighborhood. Should I pay cash for one house (via the home equity loan)? Or should I split this $100,000 into multiple down payments on many homes? Yasin asks: My wife and I are living on one income and investing the other. We save $60,000 per year. We’re looking at duplexes in Minnesota that cost $160,000 to $180,000. Our plan is to purchase a duplex, move into one unit, rent out the other, and aggressively pay off the mortgage in about 1.5 years. We’d move out and repeat this process until we have $7,000 per month in passive income, at which point we’d be financially independent. Should we pursue this plan? Or should are we playing it too safe? Should we buy more properties upfront, rather than waiting for two years between each purchase? Anonymous asks: I own four rental properties, each of which have an average rent of $1,350 per month. I purchased all of my properties within the past 24 months, and each one has been recently renovated. My goal is to own 20 rental properties. I’d like to make sure that I have adequate cash reserves, in case of emergencies. Each of my properties have insurance with a $5,000 deductible. How much money should I keep in cash reserves? What factors should I consider? Kim asks: I own one rental property. I recently moved into a single-family home in Scottsdale, Arizona, with the intention to live here for one year and then make this my second rental property. My mortgage is $1,500 per month, and I could collect rent of $2,250 per month – or more, if I Airbnb it. The neighborhood is booming; the housing here is appreciating at an astronomical rate. However, I’m concerned about the longevity of the plumbing in my current home, which was built in 1960s. I may have an expensive repair on the horizon. Here’s my question: Should I hold onto this property, despite the looming repair bills, and turn this into my second rental property? Or should I live in this home for two years and then sell it, cash out, and repay all my student loan and consumer debt? I hold a $60,000 student loan, $7,000 in vehicle loans, and $5,000 on a credit card. My goal to own many cash-flowing properties. Anonymous asks: A year ago, I relocated to Silicon Valley. I’m thinking about buying a townhouse-condo hybrid. I like the neighborhood and it suits my family’s needs. The property will become a rental in 5-7 years. It’s in a distressed area and could see a lot of potential appreciation. What loan should I consider, given that this property will become a rental within 5-7 years? I’m debating between a 7/1 ARM or a 30-year fixed rate mortgage. Also, should I redirect most of my income to paying off the principal as quickly as possible? There are two schools of thought on this: (1) build equity and use a HELOC to buy another property in 5-7 years, or (2) make only the minimum payments on your mortgage. What do you think? Tune in for the answers! 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, not just of your money, but also your time, your energy, your focus, your attention, anything in your life that's a scarce or limited resource. And so the questions become twofold. Number one, what is most important to you? What do you value most above all else? And number two, how do you actually align your behaviors, your day-to-day actions to reflect that? Answering these two questions is a lifetime practice, and that is what this podcast is here to explore.

My name is Paula Pant. I am the host of the Afford Anything podcast. Every other week, I answer questions that come from you, the audience. And today, the focus of those questions is going to be on real estate. So if you are interested in real estate investing, stick around and listen. And if that's not your cup of tea, check out some of the other episodes. Our first question comes from Joelle. Hi, Paula.

I have a question. I own a home outright on the West Coast. I'm considering taking out some of the equity in that home so that I can get into real estate investing. I'm thinking about taking out about $100,000. I've looked into a community out east, which I can buy a home outright for $100,000 or so in a good area, some properties that I've checked out. But then I started wondering if using that equity to buy a home, home to invest in outright would be worth it or if I should use that money to buy several

properties and put a good down payment on them using that money. I was hoping that you could help me kind of walk through the pros and cons. I'm really not sure. I love what you do. I can't wait to hear what you say. Thank you. I love this question because I think about this all the time myself. I won't tell you what to do, but let's walk through the pros and cons of each. So first of all, advantages to paying in cash, number one, in no particular order. Number one, you can buy the property. You may be able to buy the investment property at a cheaper price. And the reason for that is because imagine that you're a seller.

You're trying to get rid of your home and you get multiple offers. But one of the offers is, say, $10,000 or $15,000 higher, but it has a bunch of contingencies, including a financing contingency, a home sale contingency. It's got all of that baggage weighted with it. And you're not sure if the deal will go through. The other offer that you as a seller receive is a super clean offer from a buyer who is willing to pay cash for your property and can close quickly. And it's $10,000 less, but you know that this deal is going to go through.

Now, what would you as a seller choose? Well, it depends on, of course, your priorities. If as a seller your priority is to get the highest possible price and you have the ability to wait for that, then you might go with the higher offer that's choked with contingencies. But if as a seller you're highly motivated to sell as fast as possible, then you might choose the offer that's a bit lower, but that does not have any financing contingencies. And so for that reason, if you are a buyer who has the ability to make a cash offer on a property, it is often the case that you could buy a property for a cheaper price. This is a competitive advantage that you have when you're trying to purchase a home. So that in no particular order is advantage number one. And closely related, advantage number two is that you may be able to purchase the property, the rental property, faster.

either because there are more sellers who are willing to accept your offer or because you can close more quickly or a combination of those. And of course, the faster that you purchase the property, the sooner that you can get a renter in there and start collecting that rental income. Now, that being said, don't go to this strategy just because you can buy it faster and certainly don't artificially speed up the home buying process in order to get a renter in there and start getting income right away because it's better to, you know, it's better to, take your time and buy the right house than it is to hurry up and buy the wrong one. But all else being equal, you with cash, may be able to purchase the home a bit faster. Advantage number three of buying just one house in cash with this is simplicity, because there will be less paperwork, less underwriting. You're not going to have to spend loads of evenings and weekends gathering document after document, sending it all to the underwriters, then getting an email saying that they

need even more stuff, and then just you spend all your time dotting eyes and crossing T's, particularly if you're like me and you're just the type of person who is not good with paperwork and not good with details, reducing the number of times that you have to go through the underwriting process, for me, that's a huge motivator. So, you know, in your case, you're going to have to go through the loan application and underwriting process when you borrow against the equity that's in your home. But if you, then you, then you, you, that money to purchase a house and cash, you at least won't have to go through it twice. So it's just simpler. It's easier. It's less time consuming to buy a house and cash, to make a

cash offer. Advantage number four, fewer closing costs. Again, the fewer loans that you take out, the less closing costs you have to pay. And advantage number five, and this is the big one, is that you'll have stronger cash flow. So everything that I've talked about up until this point, the last four points, they're icing on the cake, you know, they're marginal benefits. But the big, I think, decider benefit for this question, if you were to decide to pay cash, use this $100,000 to just buy one property is the fact that you will have much stronger cash flow, because you'll be repaying just one loan, which is the equity loan against your primary home, rather than paying for multiple loans.

So let's walk through the numbers. Let's say that you purchase a home outright for $100,000. It rents for $1,000 a month, repairs, maintenance, management, vacancies, property taxes, insurance, etc., etc. Let's say all of those add up to $400 a month on average. So that is your operating overhead, which means that your net operating income is $600 a month. or 7,200 per year. Now, of that $7,200 per year in net operating income, which by the way would give you a 7.2% cap rate, which is very good, of that you will need to use some portion of it to pay off the $100,000 equity loan that you borrowed from your primary residence. But you won't have to also make principal and interest payments on an additional loan. And so what that means is that you have more. more cash in your pocket at the end of the day. And there's a huge advantage to that. You can use it to build an emergency fund. You can use it to save up for the down payment on a different rental

property. You can use it to invest in the stock market. I mean, cash is cash, right? You can do anything you want with it. And that's the big advantage is you'll have more wiggle room and less stress through the fact that you are in a stronger cash position. So those are the advantages to taking that $100,000 and buying just one property in cash with it. Now, what are the advantages to splitting up that $100,000? There's a few. Number one is that if you were to do this, and I don't know how much you have set aside for emergency fund.

I'm talking about an emergency fund for the rental property in addition to your own personal emergency fund. So I don't know how much you have set aside for that, if anything. But the advantage to splitting this up and, taking out a loan is that, number one, you may, if you did that, have more money left over as reserves, as emergency reserves for your rental properties. So again, as an example, let's say that you take this $100,000 and you split it into three buckets. You split it 40, 40, 20, 20, 20, 20, 20, 20,000, with 40% down payments on each property, getting an investor loan on

each of those two properties, right? And then you keep the other $20,000 around as an emergency fund for your rental properties. In this example, you wouldn't be too over leveraged. I mean, it's not like you're taking the $100,000 and trying to go, trying to buy 10 properties with it, with 10% down payments on each. You know, you still have a reasonable amount of equity in the properties that you've purchased. You've got a very healthy down payment that would easily qualify you, I'd say, with most lenders when you're applying for investor loans. And you would have the other 20,000 set aside as an emergency fund right from day one. So if you were to divide this $100,000 up into separate buckets that would purchase multiple properties, if it were me,

I would take an approach like that. I wouldn't try to break it up into four down payments of $25,000 each. I would probably, me personally, I would go a little bit more conservative and break it up into buying two properties or maybe three. Now, here's the other advantage to breaking up this $100,000 and putting it into multiple properties is, and this is the advantage that I think a lot of other real estate investors are going to emphasize. This is where my philosophy diverges from that of a lot of the other real estate investors who you will interact with on investing forums. So the other advantage is that you'll have better. are cash on cash returns. Here's what I mean by that. Let's say that you put $40,000 down on a

$100,000 property. And then that $100,000 property rises in value by 10%, which is $10,000. In that scenario, you've earned $10,000 on your initial cash investment of $40,000, which means that you've earned a 25% return on your cash. Contrast to that with purchasing one property for $100,000, that property goes up by 10%, which is 10K, in that scenario, you would have earned a 10% return on your cash. So by virtue of leveraging more, if the markets do well, if the markets continue to go up, you will earn a higher return on your cash outlay. And that is the major reason that many real estate investors are so leverage happy. In the world of real estate investing, among many people, there is this idea that you should leverage as much as possible because the less cash that you can put into a deal, the better. And not everyone thinks that, and I certainly don't, but you will meet, if you start mingling with real estate investors, you will meet people who think that.

I have walked into investor networking meetings like investor networking cocktail hours where it just seems like everybody's having a pissing contest over who put the least amount of cash into the deal. Well, I only put 10% down. Well, I only put 5% down. Oh, yeah, well, I only put in 600 bucks. And the reason for that is that a lot of people think, hey, put as little down as possible, buy as many properties as possible over time. They'll go up and you'll have major returns on your cash outlay, which are known as. cash on cash returns. That works if everything goes according to plan.

Yeah, man, if Plan A is executed flawlessly, then you'll be doing really well. But what about Plan B and Plan C and Plan D? So my approach is to take the concept of cash on cash return with a giant grain of salt. Like take it with a salt shaker. In fact, just leverage yourself into buying a salt mine. And remember that leverage can work both. ways. It's a lever, which means it can catapult you up a lot faster or it could catapult you down a lot faster. And here's another thing that I would say. So a lot of people would argue,

oh, why wouldn't you want to buy as many properties as possible? The benefit to dividing up that $100,000 into multiple down payments is that you could own more houses than you otherwise would, which is true? Before you do that, I want you to ask yourself, is that your goal, is your goal to own as many properties as possible, or is your goal to maximize cash flow with the minimum number of properties? Many people ask, oh, how many properties do you own as a proxy for, oh, how well are you doing? If you think about it, do you want to own 20 properties with 20 roofs, 20 kitchens, 40 bathrooms, 40 toilets, 60 bedrooms with 60 closet doors. Do you want to own 20 properties, each of which produce a net cash flow of $300 a month,

which would give you a total of $3,600 a year per property times 20 properties, which is $72,000 per year? Is that your goal? Or, alternately, would you be happy owning 10 properties with half the number of roofs and half the number of bathrooms, half the number of toilets. You'd have 10 properties, each of which cash flow $600 a month, which also gives you that same $72,000 per year. I think that there can be wisdom to having fewer properties that cash flow better. Now, if your strategy is highly based on appreciation, then, sure, owning more is better, because the less cash that you put into a deal and the more that the property appreciates,

the more your assets are worth and the higher your net worth, absolutely. But if your goal is financial independence, then you would want maximum cash flow for minimum hassle. And maximum cash flow for minimum risk exposure. It's not even so much that it's a hassle. It's just that the more stuff you own, the more that things can go wrong with that stuff. So those are some of the factors that I want you to consider when you're making this decision. And again, there are a lot of real estate investors who think that I am too conservative. There are a lot of real estate investors who are probably listening to this yelling at their radio right now going, well, if you hate risk that much, just invest in a CD.

I don't want to tell you what to do. It's clear you can probably tell through the lens and the filter and the bias of my answer, which one I lean towards. But again, there are advantages in both directions. Certainly, if you were to break up that 100,000 into down payments on multiple properties, then you would achieve some of the other benefits of owning multiple properties as well. There are certain economies of scale that happen when you own multiple properties. If you're paying for an accountant and you're paying for bookkeeping software, well, then you're going to pay more or less the same fee regardless of whether you have one property or three properties. So sure, that's another advantage to breaking up that money and buying multiple properties with it. Is that enough of an advantage that it would be a decider? I mean,

that's up to you. But I hope I've walked you through some of the considerations for this. Thank you so much for asking that question. It's a really excellent one. And it's certainly one that I have had to face and grapple with many times. Our next question is kind of related. It comes from Yassin. Hello, Paula. We really want to thank you for this opportunity to get your advice. I'm calling today because me and my wife, our goal is to have financial independence through our rental properties. And so my wife and I both are going to live off one income and save about 60K a year. And we want to do is buy properties with that. So we were looking at Minnesota where we saw we can get a duplex for about 160 to 180k a year. So our goal is to live in one side of the duplex. We rent it out,

rent out the other side. And then pretty much there are all the money that we have at the duplex. So our goal is spent a year and a half to pay off about 160K. worth of a duplex and keep repeating that process until we reach about a $7,000 a month of rental income. I wanted to get your advice if that was a good idea or if you should just us go not trying to be so safe, but buying more properties in that time instead of trying to pay it all off, each one off as quickly as possible. So I just kind of want to get your idea.

Thank you so much. Appreciate your time. And I appreciate your advice at the time. Thank you. Bye. That's an excellent question. Now, before I answer, for the sake of everybody who's listening, I want to go over why I think this is such a fantastic plan. So your goal is $7,000 per month in passive income from the properties.

Let's assume you mentioned that the price of each duplex is going to be between $160 to $180,000. I'll take the higher end of that range, $180,000. And I'm going to assume, just for the sake of example, that the duplexes will do slightly better than the 1% rule of thumb. So I'm going to assume that each duplex has a gross income of $2,000 per month total between both units. Right. So let's start with those assumptions. I don't know if that's actually what the deal is for you. But I just kind of want to illustrate to everybody who's listening why this is such a great way to reach financial independence.

So each duplex will assume has a gross income of $2,000 per month in total. Because duplexes have certain economies of scale, you've got, you know, one roof per every two. units. You've got one yard per every two units, one set of gutters, one set of siding. Because of those economies of scale, the operating overhead could be slightly lower than it would be on two single family homes, two comparable single family homes. So let's say that your operating overhead, we'll just conservatively say it's 40% of your gross income, which means that after paying for that operating overhead, the net income is $1,200 per month per duplex. If that is how the number shake out, then you would need six properties, six duplexes in order to reach

$7,000 per month, which means that if you pay off each duplex over the course of 1.5 to 2 years, then this is a 10-year to 12-year plan. Starting from zero today, you could reach financial independence in between 10 to 12 years following this plan. And you could actually reach financial independence even faster if you were to use the free cash flow from each previous property to rapidly pay off the next one. So in other words, that first property might take you one and a half to two years to pay off. But then when you move into the second property, you have all of the income that you're saving from your day jobs plus the cash flow from property number one. So that speeds up the payoff of property number two. And then when you move into property number three,

you've got your day job income plus the passive income from properties number one and two. And so the flywheel starts spinning faster and faster, which could turn this into something as short as a seven or eight year plan. And that is why this plan I think is so fantastic. And the other thing to add, the other advantage that you have with this plan is that inflation is your friend because over the course of the seven, eight, nine years that it takes you to reach financial independence following the strategy, the rents will arrive. at the rate of inflation, but assuming that you have a fixed rate mortgage, the principal and interest portion of that mortgage payment will stay the same, which means that over time you would be generating

more free cash flow. So those are all of the many reasons why I think this is such a great strategy for achieving financial independence in less than 10 years. So I think you're absolutely on the right track. Now, to answer your specific question, Let's talk about both the advantages and the disadvantages of the plan as you have outlined, which is move into a duplex, pay it off as rapidly as possible, and then buy the next one. So the advantage to that is that if you were to do that, you could buy each new property with a primary resident mortgage. By doing so, you'll have the best interest rates on the market. Primary residents get better interest rates than investors do or even second homes. So you'll have the best interest rates that are available. to you at the time. You'll be able to make lower down payments. And just generally, the approval process for a primary residence is much easier than the approval process for an investor loan. So that's one of the advantages that you have with the strategy as you've outlined it is you'll be able to fuel it with primary resident mortgages. Other advantages of the plan as you've outlined

it are that you'll have strong cash flow. It is a relatively safe approach. You'll have good flexibility. And another advantage is that if I know selling is not part of your strategy, and I wholeheartedly agree with that, but it's always nice to know that you have escape hatches or that you have Plan B, Plan C, Plan D. And if you were to choose to sell any duplex for any reason, since you will have lived there for two years as a primary resident, you won't have to pay capital gains tax. If a rental property was your primary residence for two out of the past five years, then if you were to sell it, you may qualify for the capital gains tax exclusion. So that's another advantage, too. And that being said, I know that you don't plan on selling it and also

never make decisions based on tax strategy because that would be letting the tail wag the dog. But I'm just throwing that out there as one of the many feathers in your cap of an icing on the cake type of a thing. So those are all the benefits to the strategy that you've just outlined. Now, there are a couple of disadvantages as well. Number one, if housing prices continue to to rise, then your next several houses could be more expensive. And depending on the relative rates at which housing prices and rents rise, the price to rent ratios on the properties that you buy may or may not be as good as they are today. So that is a potential disadvantage. It's very speculative because, you know, we don't know if housing prices will continue to rise. If they do,

We don't know at what percentage they will continue to rise. Will it simply be the rate of inflation or will it be more than that? We don't know how rents will rise in your area in correlation with the housing prices if rents will rise, if they won't. We basically, we don't know what's going to happen in the future. And I generally avoid speculating on what's going to happen in the future because, you know, future is unknown and appreciation of speculation. and making decisions based on what may or may not happen due to broader economic forces that are outside of our control is the very definition of speculation. So as a principle, I think it is generally not prudent to make six-figure decisions based on guesses about what may or may not happen in the future. That being said, of course, we've witnessed the last 10 years. Home prices have risen steadily.

And this time there's no indication of a housing bubble. And again, I want to hedge that by saying, let's not make guesses about the future because we just don't know what's going to happen. But TLDR, the disadvantage with the plan that you've outlined is that you might be buying into more and more expensive properties over time. And there are two ways to look at that. You could look at that as an impetus to buy more now. or you could see the increased price of houses in the future as the price that you pay for being able to have this slow and steady approach. An approach that's going to give you good cash flow and good flexibility and the ability to sleep at night, sometimes that's a price worth paying. Beyond housing prices, the other disadvantage with the strategy that you've outlined is that over the course of 8 to 10 to 12 years,

however long it takes you to execute the strategy, it's possible that you'll lose steam. You know, sticking to a plan for eight years is hard. I mean, how many people have been able to successfully stick to fitness goals over the course of eight years? Not that many. You know, how many people have been able to successfully stick to goals related to writing or learning a new skill? I mean, just sticking to something for eight years is very, very difficult.

And so there is something to be said for diving in at the beginning when your motivation is high, as it is right now. Sometimes sprinting can be easier than a marathon. And so that is the other disadvantage to the approach that you've outlined. But that being said, I think the approach that you've outlined is fantastic. But again, you know, there are pros and cons to both sides. Those are some of the pros and some of the cons. Thanks so much for calling about that question. And best of luck with that. I'm really excited for you.

We'll come back to the show in just a second. But first, are you happy with your bank? Are you getting the most from your money? Look, it's 2018. If your bank isn't making you money or providing an incentive for your business, it's time to find one that will. Leading personal finance site Go Banking Rates is back for the sixth year in a row, ranking the best banks.

These rankings cover five categories. best online bank, best national bank, best checking account, best savings account, and best CD account. There are also editors picks for categories like bonus offer, high yield checking, and much more. Now, these are totally unbiased rankings, absolutely no bank, paid to be included or paid for any specific placement. So if you want to know which bank was voted best savings account or best credit card rewards, You can go online today to go banking rates.com slash Paula to see the winners and sort through the categories to find out which bank is best for your needs. Again, that's go banking rates.com slash paula to check out these rankings. Go banking rates has created these categories around high value banking features and products in order to help you make the best decisions.

Go banking rates wants to help you choose a bank that can do the most for. your money on your terms. So bank smarter in 2018. Find the full rankings at go banking rates.com slash paula. Next question is from a listener who asked to remain anonymous. Hi, Paula. You have a wonderful podcast and a gift to explain things in easiest way possible.

My question today is regarding reserves for rental properties. I currently have four rental properties. The average rent is 1350 a month. I use leverage to purchase them and I want to continue to do so as I'm moving forward towards the goal of 20 rental properties between me and my wife. While I use leverage, I want to make sure that I have enough or rather more than enough funds for expenses. All my properties are purchased in last 24 months and they were rehabbed extensively when I purchased

system. All of my rental properties have insurance and have a deductible of $5,000. If you can please share your thoughts on cash reserves and factors to consider determining it, I would appreciate it very much. Thank you very much for your time. This is an excellent question and congratulations on buying your first four rental properties. A couple of things that you want to consider here. Now, first of all, in terms of cash reserves as a rule of thumb you want to keep around, six months worth of expenses. It's similar to creating a personal emergency fund in which you would want for a personal emergency fund, you'd want three to six months of your personal expenses. For a rental property, my rule of thumb that I always use is to keep around six months

worth of operating expenses. And there are two ways that you could calculate this. Option number one is that you could look at the profit and loss statements for your rental properties and calculate the average six-month cost that you have actually paid in the past for operating overhead. That's one way that you could do it. The drawback to, well, the advantage is that you're looking at actual numbers, so it might be a more realistic picture. The disadvantage is that because you are relatively new to owning rental properties, you've purchased all of them within the last 24 months, you will be looking at a small sample size of data. And as we all know, smaller sample sizes can sometimes be skewed. You know, there's no harm in, you know, it'll

take you probably less than an hour to look at your profit and law statements and calculate the average six-month actual operating overhead expense. So you may as well do that since there's no drawback to doing it. But in addition to that, the other way to calculate what six months of expenses are is to assume the rule of thumb is that 50% of gross rent goes towards operating expenses. And so if we use this rule of thumb of 50% of gross rent, what that means is that you would want to save 50% of that gross rent multiplied by six. So in your case, that would be 1350 per month divided by two times six, which is another way of saying 1350 per month times three, which is $4,000. And that $4,000 is the amount that you would want to have in reserves per property. So since you have four properties,

that would be $16,000 in reserves to cover six months of operating overhead for your entire basket of properties. That is the minimum amount that I would keep around. Now, if you want to be extra cautious, and this is totally optional, if you want to be additionally cautious, you could also save the principal and interest portion of the mortgage payment that you have on each property, so that that way you have saved six months of total expenses on each property. So as we've just discussed, that $16,000 that you would have in reserves would cover the operating overhead for all four properties for six months. I think that that's enough, but if you want to be additionally cautious, you could also save enough to cover your loan repayments as well for that six-month period. I think that's probably not necessary,

particularly given the fact that your properties are recently rehabbed and in good condition, that additional savings might be overkill. But that being said, if it helps you sleep more easily at night, then the better night's sleep is worth it. That is basically what I would say in terms of how much, you know, as a rule of thumb, like a prudent amount to keep around for reserves. Now, you mentioned that your properties, all have insurance with a $5,000 deductible. But remember, the reserves are there to cover more than just repairs and maintenance. They're also there to cover any extended vacancies that you might have on a property. Let's say you've got one property that sits vacant for two or three months,

while another property needs a $4,000 repair and a different property needs a $2,000 repair. You know, in a time like that, you know, those are some of the reasons that you would want reserves for more than just things that that landlord insurance or homeowner's insurance would cover. So, TLDR, in your situation, the minimum amount that I would keep in reserves are $16,000. And if you want to save more, that's fantastic. There could be some wisdom to doing that. But $16,000 minimum for your situation, four properties, each renting for $13.50 per month. More important than the answer, though, more important than that specific dollar amount that I answered.

I hope that I've clearly explained how I got there in terms of my reasoning. So thank you for asking that question. And congratulations on buying those first four properties. That's fantastic. And to have purchased all of those in the last two years, I mean, while you're balancing that on top of a day job, that's a good amount of work. Searching for properties is a lot of work. So congratulations on putting in all of that time and effort to reach your goals. That's great.

We'll return to the show in just a moment. Freelancers and small business owners, I feel for you. Tax season is here. And there's a good chance that many of you are trying to dig your way out from underneath a pile of receipts and spreadsheets. Do yourself a huge favor and stop digging. Before you completely disappear under that abyss of paperwork, go and check out Fresh Books cloud accounting software. Not only is it going to save you a ton of time and stress, it might actually change the way you feel about dealing with your taxes. Need to send your accountant a quick summary of the amount of tax you've

collected last year? How about pulling together a profit and loss summary? FreshBooks can generate these reports in seconds instead of the hours it would take you to do them manually. And FreshBooks is ridiculously easy to use. It's made especially for people who don't like dealing with numbers and dealing with their taxes. Right now, FreshBooks is offering a 30-day unrestricted free trial to my listeners. To claim it, just go to freshbooks.com slash paula. That's freshbooks.com slash p-a-u-l-a. And when they ask, how did you hear about us? Put in, afford anything. Again, that's freshbooks.com slash paula. And when they ask how you heard about them, mention afford anything. Are you interested in cutting back on the amount of times that you go to restaurants or

order takeout because there's nothing else to eat? Do you want to make more fresh home-cooked meals, but also you're busy? Check out Blue Apron. Blue Apron delivers fresh, pre-portioned ingredients and step-by-step recipes right to your door, and these recipes can be cooked in under 45 minutes. The menu changes every week based on what's in season. Blue Apron offers 12 new recipes each week, and you can pick two, three, or four recipes based on whatever fits best with your schedule.

And Blue Apron sends only non-GMO ingredients and meat. with no added hormones. They are the leading meal kit delivery service in the U.S. And while many people have heard about them, a lot of people don't necessarily know about the types of meals that you can eat when you cook with Blue Apron. They've got meals like strip steaks with potatoes and spicy maple collard greens, which is like a steakhouse favorite with a chili-infused maple syrup.

So they're really good chef-designed recipes. And one thing that I really like about them is that they have a lot of vegetarian recipes. They're at least three vegetarian recipes. every week that you can choose from. I'm not a vegetarian, but my husband is. So there are definitely weeks where I'm like, you know, we're going to get two vegetarian recipes so that you and I can eat together,

and then one that's just for me. I'm also learning a lot. I know recipes now, like meatloaf. I never knew how to make that. But I know it now because I had all the ingredients and the step-by-step instructions, and that's a great way to learn. If you want to give him a try,

Blue Apron is treating Afford- Anything listeners to $30 off your first order. if you visit blue apron.com slash afford a F-F-O-R-D. So check out this week's menu and get $30 off at blue apron.com slash afford. Blue Apron, it's a better way to cook. Our next question comes from Kim. Hi, Paula. My name's Kim. I love your show and love to get your advice.

In April of this year, my husband and I moved out of our four-bedroom townhouse in Scotso, Arizona. and converted that into a higher-end rental that rents for $2,000 a month. And then we bought a single family home in an up-and-coming neighborhood in Scottsdale with the intention of living in it for a year, then converting this one into a rental as well. Since we moved in and I've lived here for a few months now, we have some serious concerns about the longevity of some of the components of the house, particularly the plumbing.

So we could have some big expenses on our hands in the near future. It's an older home built in the 1960s. With that said, the neighborhood is booming, and many homes on our street have been renovated and sold for upwards of 80K more than what we bought our property for just a few months ago. So my question for you is, should we stay in the home for two years total to avoid paying taxes, and then sell it and cash out and pay off all my student loan debt and consumer debt and start from a clean slate? Or convert this property into a rental that could rent for around $2,250 per month or more if we made it into an Airbnb. be. All of this, if housing prices remain the same or increase in our neighborhood. Our current mortgage is $1,500 a month, but I have $60k in student loan debt, 5K in credit card debt, and about $7K left total in order to pay off both of our cars, an 06 Honda Pilot and

an 07 Honda Civic. We've got to love Hondas. We're having a hard time figuring out the best strategy for us. Our long-term goal is to own many cash-flowing properties, but should we cash out and delete the debt and start our rental property endeavors for a fresh financial plate or keep this property long term and take the cash flow instead. I realize this has many personal preference implications, but we would appreciate some help just to think this one through. Thanks so much. Hey Kim, fantastic question. Congratulations on having your first rental property under your belt, grossing 2K a month. That's no small piece of change. So awesome. A couple of kind of factors to consider. Now, first of all, the credit card debt, I would pay that off immediately.

Fortunately, that's only $5,000. And from the impression that I get, I don't think it'll take too long to pay that off. So make that the number one priority. That doesn't mean you need to sell the house in order to do it, but pay off the credit card as soon as you can. Now, as to the other two loans, the student debt and the car loans, with those debts, there are two factors to keep in mind. One is the interest rate and the other is the effect that that loan has on the cash flow within your budget. So student loans and car loans, I mean, I don't know what the interest rate on yours are. Generally, the interest rate on those can vary from at the lowest.

They can be at the rate of inflation or even less than inflation, in which case, if it doesn't have too big of an impact on the cash flow in your budget, you might as well hold on to them. On the other hand, if your student loan is at 7 or 8 percent and your car loan is also at 7 or 8 or 9 or 10 percent, then those become more concerning. So as a rule of thumb, I tell people to get rid of debts that are high interest and I define high interest as anything above about 7 or 8 percent. Depending on the interest rate, either try to refinance slash consolidate those loans in order to get the interest rate down or if that is not possible. If those are high interest rate loans, then yeah, I would sell the house, wipe out all of your debt and start from a clean slate. If however they are loans that are at 3%, I wouldn't be as worried about those, particularly given the fact that I get the impression that it doesn't

affect the cash flow in your budget too much. So that's the first thing that I would say. The second thing that I would say, you mentioned the possibility of Airbnb the house that you're currently living in. Check your city laws about whether or not you're allowed to Airbnb in many cities, including in Las Vegas. Only one property per every, in Las Vegas, the laws per every 660 feet is allowed to host short-term rental guests. What that means is that if I don't know what the laws are in Scottsdale, but, you know, your city may have restrictions and it's possible that even if Airbnbs are generally allowed within your city, there may or may not be a distance requirement that you would have to meet. And if there is, then it's possible that one of your

neighbors has already met it. And if they haven't, then you should go ahead. and get the permit so that you can be the one to meet it. Now, if Scottsdale does not yet have any restrictions on short-term rentals, then number one, consider yourself lucky because you'd be one of the few cities that doesn't have restrictions. And number two, get a permit for that. See if your city offers any type of permits for short-term renting. And if so, get any permit that your city offers because it could be the case that if later your city decides to pass a law, restrictions, short-term rentals, the current permit holders may or may not be grandfathered in. So in other words, getting a permit for a short-term rental gives you, quote-unquote, the insurance, so to speak,

that would protect you in the event that, or that could protect you, it may or may not, in the event that your city later decides to pass laws that restrict the use of residential properties as short-term rentals. The city of Las Vegas is going through this in a major way right now. You know, what we're seeing here are a lot of people who purchased properties with the intention of Airbnb being them. And now they're no longer legally allowed to do so. And that's one of the reasons why I constantly say, do not buy a rental property if you have to Airbnb it in order to make ends meet. Buy a rental property only if it makes sense as a long-term 12-month rental. And, hey, if you choose to Airbnb it out, that's icing on the cake. but don't ever rely on that as your primary way of making the investment work.

And that's for several reasons. It's not just because of city laws. It's also because you might not want to be an Airbnb host for that long. Being a real estate investor versus being an Airbnb host are two very different animals. One is the real estate industry and the other is the hospitality industry. Being an Airbnb host is a little bit more akin to running a small hotel or, you know, it's running a bed and breakfast. And that is very different than being a landlord. So you don't want to lock yourself into a 30-year mortgage in which the payoff of that mortgage relies on you refilling the toilet paper and the dish soap and replacing the kitchen sponges. All of those additional responsibilities that Airbnb hosts have or that they're delegates and the people that they manage have.

It's a very different basket of worms. Is that the expression? Can of worms? Basket of puppies? It's a very different thing than being a real estate investor, a rental property investor, a buy and hold, 12-month lease investor. The third thing I would say, with regard to the plumbing issue in the home that you currently live in, one possible way that you could conceptualize this, just in terms of a framework for decision making, is you could conceptualize that the additional cost of plumbing is part of the total. acquisition cost of your home. And so here's what I mean by that. When you're buying a rental property, the cost of buying a property is the price that you pay for the property plus the

upfront repairs that are needed to get it rent ready for the first tenant. Now, in your case, as a thinking exercise, you could conceptualize your current house as costing whatever you paid for it plus the cost of making those repairs as the total acquisition cost, the cost of getting that property rent-ready for the first tenant. For example, I don't know what you paid for your current home, but let's say that your current home cost $225,000, and let's say that the cost of these plumbing repairs that are needed will be another $20,000. You could conceptualize the cost of your current home as $245,000. And then from that starting point, you can then calculate the cap rate for the property, and I'll put a link in the show notes, which will be available at afford anything.

slash episode 114, you could calculate the cap rate for that property from the starting point of that property costing $245,000 in this example, in this hypothetical example. And then you can simply ask yourself, is this a good cap rate or not? Is this property worth holding on to? Given the fact that you do want to own multiple cash flowing properties, If you already have a property that has a 6% cap rate and it's in a good neighborhood, there would be a strong argument for holding on to that. After all, transaction costs in real estate are very expensive. Selling a home is going to require the cost of paying an agent, staging it, cleaning it, just getting it ready for that sale. So in real estate, the more that you can avoid those transaction costs, particularly if with a buy-and-hold long-term rent, strategy, the more that you can avoid those transaction costs, the better. Now, that doesn't mean that you should

hang on to an underperforming asset. But if your current home is going to be a strong performer, then that's certainly a reason to hold on to it. Again, assuming that your existing debts have a reasonable interest rate, all of this, everything that I'm saying goes out the window if your car loan has like a 12% interest rate and your student loans have 9 or 10% on them. If that's the case, then forget everything that I've just said, sell the house, pay off the loans, start from a fresh slate. So those are my thoughts. And finally, yeah, I love Hondas. There's fantastic cars. They're like, they're affordable. They're reliable. I love them. And I think they're really good looking too. Oh, oh, and PS, I can't believe I didn't say this earlier.

please, please tell me that you are saving up enough cash to be able to cover the big plumbing expense when it does occur. You've already got a rental property that is bringing in $2,000 a month. I don't know what the expenses on that are, but hopefully, hopefully fingers crossed, you've got enough free cash flow that you are able to just shovel money into a plumbing fund because you're probably going to need it. So if you do plan on hanging on to the house that you're living in right now, build a repair fund and build it big. All right, well, thank you so much for asking that question, Kim. Our final question today comes from a listener in Silicon Valley who has asked to remain anonymous. Hi, Paula. Thank you for all the hard work you put into this podcast. It's a wonderful

show I enjoy listening to. A year ago, I relocated from the East Coast to San Francisco Bay Area, known as the Silicon Valley. The rent and down payment prices are extremely expensive in this area. It's just ridiculously expensive. Nevertheless, I decided to buy into the property. I recently find the hybrid combination between the townhouse and condo in the area I like, and I'm considering this property for several reasons. First, I prefer to live in the better conditions that I currently live in. I have three years old daughter and my wife.

Frankly speaking, we don't have enough space currently in the unit that we rent. The property will become a rental unit. unit in five to seven years. It's currently in the current distressed area, which is going through a lot of gentrification and development in the South Bay area will result in the potential appreciation, but I'm not considering this as the main driver for my decision. The question I have, what loan program should I consider take into account that this unit will become a rental property in five to seven years? And I'm thinking between seven one arm and, and I'm thinking between seven one arm and 30 is fixed products.

And second question is, should I direct most of my income to killing the principal and decreasing the interest that I will pay no matter which product I will end up with? There are like two major school of thoughts. First, building up equity

and then use HELOC to buy a new property or refinancing or whatever down payment you want to take and keep this as a rental unit. And second school of thought, make your tenants pay the interest on the mortgage for the property that you own. Thank you so much. I look forward for the answers. Thanks. Have a good day. That's a great question. I'm going to answer your second question first. So your property, the one that you're going to move into, will become a rental in the next five to seven years.

And so I'm assuming that this means that in five to seven years from now, you're going to need money for the down payment on your next property, wherever you and your family are going to live next. If that's the case, then I would make the minimum payments on your existing mortgage, on the place that you will be living now, while simultaneously saving for the down payment on the next property that you purchase. Then you can buy the next property with a primary residence owner occupied mortgage, which is one of the easiest loans to obtain and has the most favorable interest rates. The reason I say that is because it doesn't make sense to me to rapidly pay off the mortgage for your current primary residence if you plan on taking out another mortgage within

at the lower end of the estimate five years and you know that you're going to need the down payment for that. You know that you're going to need the money for that. If your property does see appreciation within the next five to seven years due to the fact that the neighborhood is rising in value, then you'll be in a very strong position because theoretically you could do. do both. You would have money for saved for the down payment on your next primary residence, and you would also have enough equity that you could get a HELOC if you wanted to, if you wanted to tap it. But you're very wise not to depend on that price growth. If it happens, it's a bonus, and that's excellent. And that'll put you in an even stronger position that gives you more options.

but it's wiser not to rely on that just in case it doesn't happen. Don't make your whole future dependent upon market forces outside of your control. So your main way of buying your next home in five to seven years from now should be by focusing on saving for the down payment for that. I want to make a comment also on the concept of making your tenants pay the interest. Ultimately, you're the person paying one way or the other. either you are literally writing a check or you're paying in the form of opportunity cost because the rent money that's coming in from the tenants would be going to the bank rather than to you, which means that you're paying for it. You're paying the interest either in the form of reduced cash flow and missed opportunity or in the form of a literal payment that you make every month. So one way or another, it's not the tenants paying the interest. It's you. So I wouldn't make a a loan payoff decision based on the perception of who writes the checks. Now, finally, with regard to your question about taking out a 7-1 arm versus a 30-year fixed

mortgage, unless there is a very compelling reason to take out an arm, I almost always lean towards fixed-rate mortgages. And the reason for that is because with an arm, your interest rates could rise significantly. I've seen arms where the top interest payment that you might make, it could be as high as 10%. And given the fact that both 15 and 30 year fixed rate mortgages are at such low interest rates right now, why wouldn't you lock in a 4% rate rather than subjecting yourself to the risk of having a mortgage that could explode into a 10% rate or some other number that is draw-droppingly high? You know, why wouldn't you lock in one of the historically lowest mortgage rates that we've seen in our lifetimes? I mean, you've got the

opportunity to have that, so you may as well grab it. The justification that a lot of people use for taking out 7-1 arms is that the interest rate in the short term might be even lower than what you would get on a 15- or 30-year fixed, and people assume that they will be able to refinance out of that. But that's what people say. They're like, well, I'll take out a 5-1-arm or a 7-1 arm, and at the end of that time period, I will refinance it. So I'll take advantage of the lower interest rate while I can, and then after X amount of time, I'll refi and then I'll go into a different fixed rate mortgage. The problem with that plan is that that is a plan that hinges upon Plan A going according to plan. And again, I guess this is a theme that's kind of come up

time and again throughout today's episode is you always want to put yourself in a position where you have a Plan B, a Plan C, a Plan D. You always want to have multiple exit strategies, multiple fallback strategies, because plan A doesn't always work out. So in the absence of a very, very compelling reason to get into an adjustable rate mortgage, I always encourage people to take out either 15 or 30-year fixed-rate mortgages whenever possible. And the fact that you're going to turn this into a rental property, it doesn't change the math. It doesn't change the risk of the fact that your interest rate could go up, perhaps significantly so. All right.

Well, thank you so much for asking that question. Congratulations on moving to Silicon Valley and finding a home that you love. And also, congratulations on having the foresight to be planning five to seven years into the future. That's one thing that I love about this audience. That's one thing that I love about the people who self-select as the type of people who listen to something like the Afford Anything podcast. And I'm not like patting this particular podcast on the back specifically, but people who self-select as the type of people who listen to personal finance podcasts or money management or investing podcasts. are people who are thinking five to seven years into the future. And that is rare. Unfortunately, that is very rare. So congratulations to every single person who is doing that, who is thinking ahead. That is our show for today. A few announcements. Number one, we have decided to stop putting this show on YouTube. So if you are used to listening to this show through YouTube, then you're probably not listening to me say this because this episode is not on YouTube. YouTube. So I guess you won't be hearing this, which kind of makes this a moot point. But to,

but just, just FYI, we used to put all of the shows on YouTube. And we've decided to stop doing that because, I mean, for a number of reasons, but partially because YouTube is a visual medium. It's meant for video. And we want to use it for what it is meant for. So my hope is that we will be able to post more original videos to YouTube. We have one that we posted a couple of weeks ago, and one I think that we're posting this week. So we do have more original content coming out on YouTube, but we don't have any particular schedule for that. But we've got probably one or two videos a month that are kind of in the works.

So that's what you're going to find, YouTube.com slash afford anything to subscribe to our YouTube channel, but you will not be able to hear the podcast on that channel anymore. We are, however, on every major podcast player, Apple, Stitcher, Overcast, all of the above. So you can tune in through your favorite podcast playing app. And please do me a huge favor. Hit subscribe and leave us a review. Those reviews are incredibly, incredibly helpful. Coming up next week on the show, we have Rachel Cruz, Dave Ramsey's daughter, who talks about all of the money lessons that she learned in childhood as Dave Ramsey's daughter. She describes an incident when she overdrafted her checking. account. Hachtag embarrassing. And I asked her the question. I was like, hey, did you ever go through like a teenage rebellion stage where you just got really tempted to take out some debt? So you'll have to tune in for the answer. So that is coming up next week on the Afford Anything podcast. The show notes

are available at Afford Anything.com slash episode 114. That's episode 114. That's episode 114. And you can always find me on Instagram at Paula Pant, where I have set the goal. of posting at least once a day with some type of money-related, usually a money-related message or some sort of either fact or something motivational. I'm posting something every day. And that's where I hang out these days when I'm not in my podcast booth. So again, that's Instagram at Paula Pant, P-A-U-L-A, P-A-N-T. Thank you so much for tuning in.

My name is Paula Pant. I'm the host of the Afford- Anything podcast. I'll catch you next week.