Afford Anything - Ask Paula - I'd Like to Airbnb a Yurt. Should I?

Episode Date: March 26, 2018

#122: Tony lives in Chicago, where the returns on rental properties are so-so. He's thinking about investing in Indianapolis, where he consistently finds rental properties with cap rates that are greater than 8 percent. Should he invest locally, so that he can get a primary residence mortgage and keep a closer eye on the space? Or should he invest out-of-state, where the returns are stronger? Dan lives in California. He's curious: where should he look for rental properties? And when should he buy? Dan holds $150,000 in a savings account and carries a mortgage and car loan with less-than-2-percent interest rates. Should he continue saving, or is he ready to take the plunge? Isaiah and his friends want to buy a plot of land and build two yurts, complete with internal bathrooms and kitchenettes. They estimate this will cost $120,000 and they can Airbnb the yurts for $100 per night. They'd like this to be a hybrid between an investment and a personal vacation spot. Should they do it? Evelyn lives in Brooklyn, where she's an Airbnb host within her primary residence. She'd like to sell her home and she expects to clear $1 million in equity. What should she do with this windfall? She holds $100,000 in a SEP-IRA and $10,000 in credit card debt, and she can't qualify for another mortgage. I tackle these questions on today's episode. Enjoy! For more information, visit the show notes at http://affordanything.com/episode122 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 for your money, but also your time, focus, energy, attention, anything in your life that's a scarce or limited resource. And so the questions become twofold. Number one, what's most important to you? And number two, how do you align 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'm the founder of Afford Anything.com and the host of the Afford Anything podcast. Every other week I do an interview and on the weeks in between, I answer questions that come in from you, the listeners. Of these episodes in which I answer questions, I alternate between general personal finance questions and real estate questions. So every fourth episode is one in which I answer real estate related questions that come from you. And this happens to be that one in four episode. So if you're interested in real estate investing, stick around. And if not, don't worry, 75% of our episodes are not about this topic. So check out some of those.

If you are into real estate investing, then you'll probably be interested in this first question about where to buy a property. It comes from Tony. Hey, Paula, this is Tony calling from Chicago. I'm trying to decide between going into real estate in Chicago or Indianapolis. And what I'm finding is in Chicago, it's pretty hard to get a cap rate of April. percent or higher, whereas in Indianapolis, I'm consistently finding places that would give me a cap rate of 8.8 to 10 percent. My question is, what am I missing in these two instances? Is it just that Indianapolis is just not going to be appreciating as fast as Chicago, or is it just because Chicago is a bigger city, so prices are inflated? At this point, I'm not really sure which one I should go into.

the pro for Chicago is that I live here and I can move into the actual unit I purchase, whereas in Indianapolis, I would be managing it or hiring a management company to manage it from, obviously, remotely, because I would still live in Chicago. So I just wanted to pick your brain on the situation, see what you think. Obviously, this is a pretty big investment, and I want to make sure that I know what I'm getting myself into before sinking some capital in it. So I'd appreciate it if you answered. Just give me your thoughts and your concerns about my situation. Thank you. Tony, that's a great question. Thank you for asking. So there are a couple of different ways that I want to approach this. And let's start by talking broadly about the framework of why some

properties are more expensive in some areas than they are in others and why the price to rent ratio in different areas is different. First of all, when you buy a property, and let's ignore condos for a second, because they're kind of a different animal, let's assume that you're looking at either a single-family home or a multi-unit, like a duplex or triplex or four-plex. When you buy that property, you're actually buying two different components. You're buying the underlying land as well as the building or the structure. Now, broadly speaking, buildings depreciate over time, while underlying land either stays

the same or generally speaking rises in value. So from the point of view of somebody who is making an appreciation play, you want that underlying land because that's the thing that actually becomes more valuable over time while the building depreciates and needs to be repaired. From the point of view of somebody who is investing for cash flow, however, it's the opposite. If you're investing for cash flow or for rental returns, the underlying land is just overhead, whereas the building is the thing that produces an income stream. That's one of the reasons why, from the perspective of a rental property investor, a multi-unit can be a good deal because you consolidate multiple units onto the same piece of underlying land. And since from the point of view of a rental

investor, a cash flow investor, underlying land is overhead, then the more you can consolidate that overhead, the better your income stream is. By contrast, if you are making an appreciation play, then in that case a single family home might be a better option because, number one, you've got more of the underlying land, and number two, you'd be more likely to sell to a retail investor, an owner-occupant, who makes their decisions not based on investment criteria, but rather based on human emotion, i.e., they're willing to spend more. So when you look at markets like Chicago versus Indianapolis, all else being equal, one-eighth of an acre of bare land in Chicago will most likely cost more than one-eighth of an acre of bare land in Indianapolis.

And that means that you're paying a premium just to get into the game. Now, different cities and different neighborhoods, broadly speaking, will have different price-to-rent ratios. And the way to calculate a price-to-rent ratio, and it's simple back-of-the-envelope math, look at the price of a property divided by the annual rent. So if a property is $300,000 and it rents for $1,500 per month, which is $18,000 a year, then the price divided by the annual rent would be $16.1.4. six in this example. So what that means is that very, very broadly speaking, different neighborhoods

are just going to have different price to rent averages. And due to the cost of the underlying land, as well as other factors like labor costs in the area and so forth, it's likely that the average price to rent ratio in Indianapolis is going to be lower than the average price to rent ratio in Chicago. Now, with that being said, all real estate is local. And when When I say local, I don't just mean city. I also mean neighborhood by neighborhood often block by block. And I think one of the advantages of real estate investing is that you don't have to just hug the averages. You can find the outliers.

Or you can create the outliers by, for example, buying a fixer upper. But broadly speaking, an area where you get lower price to rent ratios is going to be broadly a better place to own. And what that means is that Indianapolis, based on what you're saying, it sounds like Indianapolis will generally be better than Chicago. Now, that being said, you mentioned that if you were to buy in Chicago, you would move into the unit. I'm assuming what that means is that you are looking at multi-unit properties where you would move into one of the units and rent out the others. If that's the case, then there is an argument for buying in Chicago because you would be able to get financing for that property as a primary residence if you were to do that. As long as you buy a multi-unit

property that has four or fewer units and you live in it for a minimum of one year, you would qualify for a primary resident mortgage. And that means that you'll have to put down a lower down payment. You'll get the best interest rates on the market. Like the best possible financing that you can get is a primary resident mortgage. And that's a very compelling argument for buying in Chicago, since for many people, the financing is the limiting factor. And then once you have that first property,

you can later borrow against the equity in that property, do a cash out refi, use that to purchase your next investor, property and so on and so forth. So that would be the argument for buying in Chicago. I would not, personally, I would not choose Chicago over Indianapolis for appreciation related purposes. I would choose Chicago over Indianapolis if Chicago gives you the best financing options and if that level of financing is necessary to be able to get the home. On the other hand, though, all else being equal, assuming financing isn't an issue, I would choose personally, I would choose Indianapolis because that's where the better cap rates are. And it makes sense to go where the money is. I mean,

you're in this for the sake of getting returns. You're in this for the sake of getting a good cap rate. So go where the good cap rate is. Now, you mentioned that in Indianapolis, you would have to hire a property manager. That should be equal regardless of where you are looking. So when you run the analysis, analyze both properties as though you are outsourcing the property management, even if you, in Chicago, to do it yourself, you still always want to run the math in an identity agnostic way, meaning that you cannot value the time and expense of a property manager in Indianapolis and yet value your own time in Chicago at zero and call that an apples to apples comparison. For math to be math, it must be consistent regardless of the identity of the person who is

performing the task. That way, if you were to ever move away from Chicago, let's say that you got a great job offer in Southern California, you decided to move there, you could do so, and the numbers would still stay the same. Finally, the last thing I would say is I want to explain a little bit about why I would not make a decision based on potential future appreciation. There are two ways that a property can appreciate in value. One is called market appreciation and the other is called forced appreciation. Forced appreciation is the type of value that grows as a result of something that you directly have done. So, for example, if you buy a fixer-upper and renovate it, adding value to that property in excess of what you have paid for the renovation,

then you've created forced appreciation. If you buy a multi-unit property and you manage it in a better way than the previous owner did, let's say you create greater efficiencies within the management. You take better photos so that it rents more quickly. You stage it for showing so that rents more quickly. You do all of these management-related tasks that lower the vacancy and improve the ultimate returns. Well, in that case, you've also forced appreciation by adding value through something that you've directly done. Forced appreciation is awesome, and that can happen anywhere. But the other type of appreciation, the one that most people tend to think about first, is market appreciation. And that's the type of appreciation that comes from the broader market, just

rising in value. I think people, we tend to think about this because it feels good, right? It's something for nothing. The whole area went up in value. You didn't have to do anything and money just got created out of thin air. It's a very compelling idea, but it is unreliable. We have no idea whether or not a particular city or neighborhood will appreciate at greater than the rate of inflation. And, more importantly, we have no control over whether or not it does. And when you're making an investing decision, make decisions around factors that are within your control. There's this great concept in the book Seven Habits of Highly Effective People by Stephen Covey, where he talks about the circle of concern and the circle of influence.

Inside of your circle of concern is everything that you could potentially be concerned about, such as market appreciation and nuclear war and the colonization of Mars and whether or not your socks match. Right. And then within your circle of influence are, those areas of concern that you yourself can directly influence, such as forced appreciation and whether or not your socks match. In order to be maximally effective, focus on the factors that are inside of your circle of influence. And counterintuitively, the more you do so, the more that circle of influence over time grows. So applying this framework to rental properties, focus on the areas that you can directly influence, such as running an efficient property with streamlined management and good customer service, focus on forced appreciation through renovations, focus on buying properties at slightly less than retail value so that there's instant equity at the closing table. Those are all factors that are within your circle of influence. But market appreciation is not. And I like to say that appreciation of speculation, we just don't know what's going to happen in the future. And we just don't know what's going to happen in the future.

We can't control it, so don't make six-figure decisions based around it. So I hope that helps, and I hope that gives you a number of factors to think about. Good luck with the property hunt. Our next question comes from Dan, and Dan actually has two questions. So we'll start with one out of two. Hey, Paula, Dan here from California. So I'm in the mortgage industry, and to be honest, investing anywhere in the San Francisco Bay Area as far as rental properties are concerned just doesn't make sense as far as a return on

investment. What areas throughout the United States do you feel are currently good areas to invest as far as a buy and hold strategy? Been looking at Phoenix, Arizona area or parts of the Midwest, but what areas, if any, would you recommend our good buy and hold investments right now? or do you think it's tough to get a return on investment no matter where you would look at rental properties? Hey, Dan, that question fits in perfectly with the last one. So this is by no means a comprehensive list. And of course, I want to emphasize all real estate is local. But just as a broad overview, a couple places. So in the Western United States, Phoenix, Tucson, Mesa, Arizona, Las Vegas definitely has some great deals here. Port Angeles in Washington State. The outlying counties outside. of Boise. Boise itself is kind of expensive, but Gem County and Canyon County in Idaho have some really good deals. I've got some friends who invest there. In the Midwest and in the eastern U.S., I would say Cleveland, Buffalo, Pittsburgh, some parts of Philadelphia, Memphis, Toledo, Ohio,

Cincinnati, Dayton, Louisville. And then towards the middle of the country, Corpus Christi, Houston, some parts of Houston, depends. Birmingham. Birmingham is, in fact, pretty much everywhere all over Alabama, there's really excellent deals for rental property investors. The outer suburbs of Metro Atlanta outside of the perimeter, Lincoln, Nebraska, Oklahoma City, and that's by no means a comprehensive list, but those are just some ideas to get you started. And bear in mind, what I have just named are larger cities. There are also plenty of places in more rural areas that also have really fantastic rental property deals. I know Las Vegas has good deals. I've never really really looked at Carson City or Reno or even the more far-flung, like very sparsely populated

counties of Nevada. But those all fit the criteria of places where the underlying land value is not going to be that expensive. Now, that doesn't necessarily mean that the rental property deals there are good, but it at least means that it meets the minimum threshold of conditions for which there may be good deals. Now, of course, once you go very rural, you encounter the issue of, well, you know, how many property management companies are there, how many contractors are there, will you be able to create a strong team in a place that is sparsely populated? So for those reasons, I think I like the far-flung outer suburbs in the metro areas of inland cities and towns, you know, places where there's enough of a population that you'll get services, but not so

much of a population that land is at a premium. So hope that gives you a good starting point, and now let's move to your next question. So my wife and I currently have about $150,000 liquid in our savings account, getting about one and a quarter percent, very small amount of other debt besides our mortgage and our cars, which are both below 2%. We really want to invest in buy and hold investment properties long term, but we feel like we don't know when it'll be a good time to buy, especially. in California, where it's really difficult to cash flow on any buy-and-hold rental properties. Would you recommend continuing to suck away money in a savings account to be able to pull the

trigger when a buy-and-hold investment property makes sense, or would you go a different route? Really look forward to your response, and we love the show. Thank you so much. So this is a great question. When is it a good time to buy a rental property? And I'm glad that you gave me a financial snapshot of your current situation because the question of when is it a good time to buy a rental property can be answered in two ways. There's when is it a good time personally and when is it a good time within the context of the markets and the economy. So in your situation, it sounds like personally it's a great time for you to buy a rental property because you have almost no debt except for a less than 2% interest rate, which is fantastic. And you've got plenty of cash savings, so you certainly have enough money to get you through an emergency. So all of the personal finance boxes are checked, which means that you are at a personal level

in a very good position to buy a rental property. So now the question becomes, in terms of the markets, when is it good? And what I would say here is don't speculate on what may or may not happen in the future. It's very easy to get caught up in the, well, geez, are we headed for another crash? might prices go down in the future or might they keep rising? Like, it's very easy to get caught up in the speculation of what may or may not happen. And that's true, not just for real estate, but also for stocks. You see a lot of people right now who are sitting on the sidelines thinking that another recession is imminent. And that may or may not be the case. So what I would say is to follow the Warren Buffett approach of not trying to time the market. The Warren Buffett approach is that he never buys at the very bottom, nor does he sell at the very bottom. Nor does he sell at the very top. He simply buys when he encounters a good deal and he sells when the deal is no longer good. And consistently doing that gets him good returns. And that is the attitude that I would encourage you to have towards rental properties. Don't worry about what might happen in the future. Just look at this very moment, be here now. At this moment, is this particular property that you are

looking at a good deal or not. If it is, buy it. If it's not, pass on it. And so like the caller who came before you, Tony, Tony found some properties that have greater than 8% cap rates. And remember, a cap rate is the expression of the income stream on an investment. It's not an expression of the total return. So if a property has a cap rate of 8%, and it also appreciates at the level of inflation and no more, which historically is 3%, then that means the total return on that is 11%. That's a pretty good deal. And so if you find something like that, get it. And don't worry about whether or not it might be a better deal in the future.

There's this concept of maximizers versus satisfacers, right? Maximizers are people who try to maximize and optimize everything, whereas satisfacers are people who say, you know what, this is good enough. I'm happy with it and I'm going to stick with it. And that concept doesn't just apply to investments. It applies to anything in life. Buying a pair of pants. Are you trying to find the absolute best pair of pants at the best price? Or are you trying to find just a pair of pants that are good enough at a price that's good enough. That's the difference between a maximizer and a satisfacer. And over time, maximizers end up spending way too much of their life energy, pursuing deals. And then second-guessing themselves constantly.

Satisfisers tend to get really good deals and are happy with it. So I would encourage you to take that attitude towards finding a property. Just find something that's good and get it. And don't worry about the rest. Now, you mentioned that in California, it's hard to find deals that are cash flow positive. It's hard to find deals that have good cap rates. In that case, go where the money is. Check out Nevada.

Check out Arizona. Check out Washington State or Idaho. There are plenty of places that do have good reasons. returns. And if you're going to put your money somewhere, it makes sense to put your money in the place where you're going to get a good cap rate relative to the level of risk that you're exposed to. So I hope that helps and best of luck with your property search. We'll come back to the show in just a second, but first, take a guess. What do you think is the national average interest rate on a checking account? Well, according to the FDIC as of February 7, 2018,

the national average interest that you could earn in a checking account is 0.04% APY. That is not a very high number. If you're looking for a higher interest rate, check out Radius Bank. Their radius hybrid checking account offers a 0.85% APY on balances of $2,500 and up. That's 12 times greater than the national average. And that rate doesn't expire. A lot of other banks have these flashy, introductory rates that expire after six to 12 months, but that rate is not going to expire,

and it's not going to get capped on the maximum balance that you can have in there. Radius hybrid checking is a free high-interest checking account. It combines the high-interest earning power of savings with the flexibility of checking. And it doesn't kill you with fees. There's no monthly maintenance fee. There's no minimum balance requirement. Your first order of checks is free. And you can use free ATMs worldwide.

To open an account, go to radiusbank.com slash Paula. That's Radius Bank, R-A-D-I-U-S, Bank.com slash Paula. Again, to open an account, check out radiusbank.com slash Paula. Do you enjoy audiobooks? If so, check out Audible. They have a huge selection of books, including Rich Dad Poor Dad, the Four-Hour Work Week, all of those books that help you improve your finances and your finances in your life. A few of the books that I've listened to through Audible include The Inevitable

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So whether you want to listen on your phone or in your car or at home through your Amazon Echo, you can pick up exactly where you left off through Audible. Start a 30-day trial and get your first audiobook free by going to Audible. slash afford anything. That's audible a-u-d-I-B-L-E dot com slash afford-anything. If you prefer to send a text message, you can also text the words afford-anything to 500-500. Again, you can text, afford-anything to 500-5-0-5-0. And both of those will allow you to get a 30-day trial with your first Audit. for free. Once again, go to audible.com slash afford anything or text afford anything to 500,500 to get

started. Our next question comes from Isaiah. Hi, Paula. My name's Isaiah. I'm planning on launching a kind of unique real estate venture with a few friends. We're planning on buying a piece of land and building a few yurts to use as short-term Airbnb vacation rentals. Our goal is to build a vacation property that generates income for us, but it is also a place that we'd like to use for our own vacations together. We think that we can acquire the land and build out and furnish two yurts with internal bathroom and kitchen ads, including plumbing, sewer, electrical, for around $120,000 total. And when they're all finished, we'll be able to rent out each unit for around $100 a night. If you find anything interesting in this plan to discuss on the show, from starting a business with close friends to building yurts versus traditional construction, to managing short-term vacation rentals and Airbnb properties, I'd be interested to hear you discussed on the show. Thanks. Oh, there's plenty of interesting about this. There's a lot to talk about. First of all, I like the way you think. Like, yurts are awesome. I love yurts. And I think that sounds like a really cool idea.

there are also a lot of red flags that I see. So let's, I don't mean to be a downer. I don't want to focus on the negative, but let's focus on the negative. All right. So first and foremost, let's start with your mental framework, right? So there are two different ways that you could be looking at this and I want to make sure that you are looking at it in the way that is most appropriate. What you've essentially said is, hey, I want this as an investment and also I want it for my personal enjoyment. And that is not a great framework because a thing can be, optimized for one or the other, but when you try to blend the two, it almost always has problems. An investment is something in which you maximize your returns relative to the risk

profile and the liquidity. And an investment is something that you choose based on spreadsheets and projections and rigorous mathematical analysis. Something that you're buying for personal enjoyment, whether it's your primary residence or this personal vacation spot, that's something that you choose based on personal preferences. And the overlap is almost never there. Now, that doesn't mean that you can't or shouldn't do it, not at all. What it means is that I want to check in with you to make sure that your attitude towards this is in line with the reality of the situation. So there are two attitudes that you could have, right? Attitude number one is, hey, this is something that we want to do for our own personal enjoyment. And we're going to

Airbnb in order to offset some of the costs. And if that's your attitude, you're going to be in order. then awesome, your head's in the right place. But on the other hand, if the attitude that you hold is, hey, we think that this is a good investment, that is where I would caution you. So you can have two actions that behaviorally are the same, but the mental framework, the attitude that you have when you go into it is what's going to make the difference, basically the expectations that you set around it is what's going to make the difference around whether you happy with it or disappointed with it. So if you do this, go into it with the attitude of this is just something that we're doing for ourselves and we're going to use Airbnb to defray some of the costs. But we're not going to think of this as an investment. Because if you want an investment, buy the best investment and then use the returns from that in order to pay for your personal vacation. So for example, I have rental properties in Atlanta and I could use the cash flow from those rentals in Atlanta to rent an apartment in Costa Rica and hang out on the beach in

Costa Rica for a while. And that is a very different scenario than buying an apartment in Costa Rica and renting it out when I'm not there. On the surface, the two may seem the same. In both cases, I own a piece of property which then gets rented out. But the setup is different. If I were to buy a property in Costa Rica and rent it out, I would be doing so not because I thought that it was the best investment, but because I just wanted to own that. And then by renting it out, I'm just defraying a few of the costs. So that's the first thing. The second thing is with regard to Airbnb, there's a lot of clutter that goes on there in terms of laws and licensing. The unfortunate truth about Airbnb is that the city or county can pass restrictions at any time.

I'll tell you a story about what happened in the city of Las Vegas. So I live in a condo. is located in the heart of downtown Las Vegas. Now, I bought this condo because I live here full-time. This is my full-time residence, so I did not buy it as an investment. But there are plenty of other people who own a unit within the same building who bought this specifically so that they could Airbnb it out. For a while, for several years, that worked well, and they made good money and everybody lived happily ever after. But this past summer, the city of Las Vegas passed a restriction that,

stated that only one property per every 660 feet could be licensed as a short-term rental. And the way that they measured that 660 feet was based on the ground footprint. So essentially what they did was they passed a law that stated that in any given condominium building, only one unit in the entire building could be permitted as a short-term rental, which means that in the building that I live in, there were dozens, like literally dozens upon dozens of Airbnb hosts who overnight got wiped out because only one unit, there are 250 units in this building and only one of them could get the permit. And everybody else was SOL. And I know that there are some of you who are listening to this who are thinking, well, yeah, but I can do it under the table. Nobody will catch me. But what many cities and counties are doing is they're actually searching Airbnb and VRBO. and all of those other short-term rental vacation websites, they're getting the lists, like they're getting really serious about enforcement. And in Las Vegas, the penalty is $500 per night if you are caught with an unlicensed Airbnb.

So the point of the story is that if you go into an investment with the idea that this will always be a short-term rental, the idea it'll always be an Airbnb, you're setting yourself up for potential trouble because it's always possible for the city to yank the rug out from under you. And granted, the example that I just gave was I'm talking about a condo, you're talking about a yurt on a lot of land, so something like a 660-foot distance waiver wouldn't apply in your case. But it's always possible that the county that it's located in will just pass a blanket law saying, no short-term rentals here. Or they'll pass, they could do anything, right?

They can pass any law that they want. So what I always tell people is that if you are buying a property, buy it with the assumption that you're going to rent it out on a long-term lease, at least a six to 12-month lease. And if you choose to Airbnb it out to make extra money, that's awesome. That's icing on the cake. But you're not going to rely on that in order for the investment to make sense. And that's essentially another way of saying that if you do plan on purchasing a property for the sake of Airbnb being it out, make sure that you have multiple exit strategies.

That's true for really any investment. want to have multiple exit strategies. And the reason that so many condo owners in my building ended up in such dire positions is because they didn't have a secondary exit strategy. Their idea was Airbnb or bust. And so they got busted. So that's the second thing I would say. If you're going to do this, make sure that the decision still makes sense even if you can't Airbnb it. And you end up putting these yurts on a six-month lease. The third thing that I want to talk about is occupancy and operating overhead. Now, I don't know. heard you say that you estimate that these can fetch about $100 per night, but I didn't hear you

mention any estimates of your occupancy rate or your operating overhead. Now, I understand, Isaiah, that you left a one-minute voicemail. So by the nature of the way that you communicated this, by the nature of leaving a voicemail, there are probably a lot of details that you couldn't include. But I'm saying this, not just for your sake, but also for the sake of everybody who's listening who's thinking about doing something like this. When you are considering any rental property, think about the operating overhead, and particularly when you're considering an Airbnb, think about the additional operating expenses that you will have that are above and beyond what a 12-month rental property owner would endure. And also think about your occupancy rates. For example,

let's say that this can fetch $100 per night, but the occupancy will be around 15 nights per month. That means that your gross income would be about $1,500 per month. Now, from that, you would have to subtract sales and occupancy tax. And that's an additional tax that's levied on Airbnb units that is in addition to the normal taxes that are assessed on all income. So let's say that this sales and occupancy tax is 10%. You're grossing $1,500 a month. That reduces it down to $1,350 per month. And then from that, you want to subtract the cost of property taxes and utilities and insurance. Sure, all landlords have to do that. But then you'll also have additional management costs because managing an Airbnb just costs more because there's so much more turnover and the work is done during turnover. And you'll

also have a bunch of additional house cleaning costs since you have to do a cleaning between every guest. Plus, you have to pay for some consumables, toilet paper, dish soap, sponges, all of the things that traditional 12-month landlords don't have to pay for. So after all of those expenses, the actual cash flow from that $1,500 per month gross might come to maybe $400 a month, $500 a month, And that's assuming that you pay cash for the whole deal. If you've got a mortgage on this, who knows what could happen? And the reason that I'm saying, I literally mean who knows, this might still be a good deal. I would want you, however, before you go into this, to really carefully run some spreadsheets that analyze how much you would actually end up walking away with at the end of the day after all of those expenses are paid and use a variety of different occupancy estimates.

because your second biggest risk factor as an Airbnb host is occupancy. There is nothing that is more expensive than vacancy. Of course, your biggest risk factors changes to the law, since that'll just shut down your business entirely. But your second biggest is occupancy, so make sure that you've accounted for that when you're running your numbers. So that is a third thing that I would say. And then the fourth and final thing, this relates to the fact that you're going in this as a partnership with some friends. And that raises a handful of red flags. So two risks that I'll talk about.

One is that you and your partners may have strategic differences in your philosophy and approach to this investment. You might want to put X amount of money into bringing this to a certain level of niceness, and your partners may want to put Y amount of money into bringing it to a different level. You may want to invest a little bit more in good customer service, put more effort into it to make sure that you get top-notch guest reviews. Your partners may feel differently. You may want to price it. price and occupancy exist in a dynamic tension, right? If your price is $1 per night, your occupancy might be 100%. If your price is a million dollars a night, your occupancy will be 0%. So price and occupancy exist on the seesaw. And as you are an Airbnb host, you'll be

figuring out the optimal balance of that seesaw. So it might be that you want to price it at X in order to improve your occupancy rates, but your co-hosts want to price it at Y and accept the occupancy trade-off. Those are all. of the decisions that you guys are going to have to make as you are building and then managing this property. And so that's one of the risk factors is that you just might not see eye to eye. Your philosophies and your management strategies might be very different. And furthermore, what happens if one person is done and wants to piece out of the game, but the others don't? Will the remaining partners be obligated to buy out? The departing partners share. And if so,

for how much and how is that value going to be assessed? And at what payment structure? And if the other partners aren't either ready or willing to buy out the other partner share, can the departing partner sell it to another random person? I mean, those are all of the factors you're going to have to figure out. And in addition to that, the second risk factor are what are known as the four Ds. So death, divorce, disability, and drug use. What happens if that befalls any partner? What happens if one of you gets a divorce and your interest in the property gets split between that partner and the divorced spouse? And then the divorced spouse wants to sell off his or her share. What happens then? Or what happens if one of the partners becomes so addicted to drugs or alcohol that they are unable to participate in managing it and they're unable to participate in making good decisions around it? Are the remaining partners able to force him or her out of the project? And if so, how is that done? What happens if one partner goes through a severe bout of clinical depression such that they can't really participate in this anymore? And that lasts for a year. Do you cover for them for a year? And then at what point do you kind of tell them that they're out? Those are all of the factors that you have to figure out when you have a partnership with other people. So generally, I don't recommend partnerships. I don't think they're a good idea because of all of the additional complexities that can happen in all of the ways that they can go wrong. It's much simpler when there's one owner and everybody else is a lender on the project or an employee slash contract laborer on the project. That's a much simpler setup. So If you do decide to go forth with a partnership, get a lawyer and hammer out all of these issues in writing ahead of time. Because you guys are probably really good friends and you don't want something like this to come between you.

And there's just a huge risk that that might happen. Business partnerships have ruined a lot of relationships, both friendships and family relationships. So be very cautious about that. Thank you for asking that question, Isaiah. And good luck with whatever you choose. We'll return to the show in just a moment. As creatives, we're in the business of turning our ideas into value for our customers.

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That's freshbooks.com slash p-a-u-l-a. And enter Afford Anything in the How Did You Hear About Us section. Our last question of the day comes from Evelyn. Hi, Paula. I am an all-time follow. of your blog. Thank you for doing everything you do. My name is Hevelin and I am over 50 years old. I am self-employed since I was 25 years old. I need to sell my New York Airbnb home, which is my primary residence and has also worked as my investment property. I have been doing Airbnb for over seven years. There is a possibility of clearing over a million dollars.

in equity. I can do a 1031 exchange for $1.2 million of it. And of course, I have the $250,000 capital exception. I'm single. I do need to live somewhere. Because of the 1031 exchange, I have to decide fairly quickly after the sale. Because I am self-employed, I don't show much income on my taxes, so I don't qualify for a personal mortgage without putting most of the down payment. I do qualify for business loans and things like that, which I've been talking to my mortgage broker about. I do have excellent credit above 800, and the only debt I have is about $10,000 in credit card. I just did windows on my house, which I will basically pay off once I sell the house.

I thought about buying another house in Brooklyn again, since I do need to live somewhere, but I also want to buy another investment properties in other places. I also only have about $100,000 in a step IRA, and I am over 50, so I'm thinking, what am I going to do? What will you do and what do you recommend for somebody this went full of money? and also the house was my business, so it will not be my business anymore. Any tips? Thank you for everything you do.

Evelyn, this is a really interesting situation. Now, first of all, congratulations on having so much equity. Congratulations on your upcoming windfall. That's fantastic. Now, what makes this interesting is that your property is both a personal residence and an investment property. And so you're talking about having the purpose. personal residence capital gains exemption, as well as doing a 1031 exchange. Now, what's kind of interesting slash tricky about this is that you cannot do a 1031 exchange on a personal residence.

You can only do a 1031 exchange on a business or investment property. And likewise, a personal residence is a personal residence. So you get the exemption on that, the capital gains exemption. The first thing that I would do if I were you, and I don't know, you may have already done this, but I'm just saying it in case you haven't, is talk to. a 1031 expert, talk to some accountants, get a handful of experts who are very well versed in 1031 law, and be absolutely sure that your understanding of what is exempt and what is not and what qualifies for a personal residence exemption and what qualifies for the 1031 exchange, be absolutely sure that your understanding of it is rock solid. So don't just talk to one person. spend the money getting multiple accountants and multiple 1031 experts, get multiple people

to weigh in on this because we're talking about a huge amount of money. And particularly with 1031 exchanges, it's incredibly important that every I is properly dotted, every T is properly crossed. So the first thing that I would say is do not be afraid to spend the extra money on getting multiple experts to look over your shoulder every step of the way and make sure that you are proceeding in the way that you are supposed to. Make sure that you get a first opinion, second opinion, third opinion, get a fourth opinion, all from people who are experts in this. Get a team behind you as you execute this. Now, in terms of what decision to make, if you can use this money to pay cash for a property, that is what I would do. As you said, you can't get a

mortgage because you're self-employed and you probably don't show a very high income on your tax returns, but you're clearing more than a million dollars in equity. So use that million to pay cash for something. And if you 1031 it, then the thing that you buy, you'll have to use as a business or as an investment property. But that'll be great because the cash flow that you'll be getting from that will be pretty significant since you won't have a mortgage on it. And then you can use the money that you're making from that property to start making more contributions into your SEP IRA. So yes, I do. want you to contribute more money to your SEP IRA, but I would not do that from the windfall that

you're getting from the sale. I would instead make as much of the windfall from this sale tax deferred or tax advantaged as possible. And then from the future earnings that come from the next property, use that money to contribute more to your SEP IRA. Now, as far as the $10,000 on the credit card goes, sure, pull money out to pay that off, but that's only $10,000. Even if you were to to pay taxes on that. It's not a very large amount of money. So wipe the credit card debt off just so you have it out of the way. Tax protect the equity gains that you get from the sale of the property and then use future earnings to contribute to your retirement accounts. That's my answer for your situation. And above all, spend as much money as it takes to get accountants and 1031 experts to give you, to really look over your shoulder on this one. Because the worst case scenario would be getting a tax bill on that million dollar infall. Finally, if you are buying a property in cash, that simplifies a lot of what you have to think about. There are time limits with the 1031 exchange. You have to buy the next property very quickly. So buying a property in cash will allow you to do that. You'll make a stronger offer when you present a

cash offer. You won't have the risk of the contract falling through because you weren't approved for financing. So anything that you're trying to do will be simplified and streamlined by virtue of the fact that you're paying cash for this next property. And that in addition to the additional income that you make that'll go into your retirement accounts will put you in a pretty solid position. So congratulations again. And thank you for calling in with that question. That is our show for today. Coming up on future episodes, we have next week, Vicki Robin, the author of Your Money or Your Life, which is the book that essentially started the financial independence movement. Vicky Robin is joining us on the show to talk about financial independence.

So we're going to be hearing straight from the OG of financial independence. And that is next week's show. So please go to your favorite podcast player, hit subscribe so that you can make sure to get that episode. And also if you go to podcast.organtanything.com, there's a big box right above the fold where you can put in your email address. And that will sign you up for the show notes. So you'll be able to get show notes for all of the upcoming episodes, including next week's episode with Vicki Robin. Also, coming up on future episodes, we have Morgan Houssel, a former writer for the Wall Street Journal and The Motley Fool, talking about how to make smart investing decisions. Thank you so much for listening.

Please don't forget to subscribe to the show in your favorite podcast player, Apple, Stitcher, Overcast, whatever it is that you use. And get the show notes emailed to you by signing up at podcast.offordanything.com. My name is Paula Pant. I am the host of the Afford Anything podcast. I'll catch you next week.