Afford Anything - Ask Paula - Should I Invest in Index Funds or Rental Properties?

Episode Date: December 7, 2018

#165: Should Kim, an entrepreneur, invest in index funds or rental properties? Should Nick, an MBA student, househack into a more-expensive home with stronger cash flow, or a cheaper home with more budgetary wiggle room? Should Kelly, who is getting married soon, sell her current home and use the proceeds to buy multiple rentals? Or should she use her current home as a rental property? Should Trayci and her sister invest in rental properties or bare land? I answer these four questions in today’s episode. We’re a weekly show, but on the first Friday of the month, we air a bonus episode. This is our December 2018 First Friday Bonus Episode. Enjoy! More resources and be found at https://affordanything.com/episode165  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every yes to something is a no to something else. There's an implicit, explicit trade-off with everything. And this concept doesn't just apply to your money. It applies to your time, your focus, your energy, your attention. It applies to anything in your life. That is a limited resource, and that leads to two questions. Number one, what matters most to you?

Not what does society say ought to matter most, but what actually matters? in your life. And number two, how do you align your daily decisions in accordance? 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 host of the Afford Anything podcast. Normally, we're a weekly show.

We air every Monday morning. But once a month, on the first Friday of the month, we air a first Friday bonus episode. Welcome to the December 2018 first Friday. Friday bonus episode. Now, in three out of every four episodes, we talk about a wide range of topics from creating better habits to making smarter decisions to reaching financial independence. But in one out of every four episodes, we talk specifically about real estate investing. This is that one in four episode. And our first question on this topic comes from Kim. Hi, Paula. My husband and I were recently able to clear all of our consumer debt with the sale of one

our properties and also have more than six months of an emergency fund saved. We both are self-employed and are fortunate enough to have successful businesses and both be doing what we love. We are 27 and 28 and are planning on starting a family very soon here in Phoenix. We currently have one rental property that rents for $2,000 a month and now our goal going forward is to buy four more rentals with 50 to 100% down and have this be a significant source of income for us. We also want to offset at this with having a $1 million nest egg invested in index funds as well. At least this is the goal. We want to have both for financial independence purposes so we can have an option to choose our path in the future, since right now time is on our side. But we're having a really hard time

prioritizing in a logical way, which we should be doing first and when we should be buying properties. Should we save, save, save until we hit our savings goal in index funds first, then buy properties, or should we buy properties first and then save our excess funds plus the rental income into index funds? We aren't sure what should come first or if it should be a mix. We could really use some help. Thanks so much. Kim, first of all, congratulations on clearing all of your consumer debt and being self-employed in something that you love doing and in having a rental property that brings you $2,000 a month in passive income and achieving all. all of this by your late 20s, you are totally on track for an awesome future. So big congratulations

to you. So a couple of notes here. Number one, you mentioned that you want to buy these four additional rental properties with between 50% to 100% down, meaning you want to buy some of them free and clear and some of them with conservative mortgages. As you approach this, think in terms of the framework of the level of debt that you are carrying on your properties as a whole, meaning your properties as a portfolio as a whole, frame your decisions that way instead of framing them as how much you're carrying on any one given individual property. And here's what I mean by that. In scenario A, you buy four rental properties, each of which you put 75% down and you borrow

the other 25%. In scenario B, you buy four rental properties, two of which you put 100% down, you buy them free and clear, and the other two of which you put 50% down. Which of those two scenarios is more attractive? Well, it can be tempting to look at scenario A and say, oh, you know, I'm leveraged so little on each individual property that that is what I would prefer. Like it can be very easy to come at it with that framework. And by the way, in all of these scenarios, I'm assuming that every house costs exactly the same amount. We'll just keep that as a constant for the sake of a simplified example. So it would be easy in scenario A to say, oh, because I am putting 75% down on each individual property, that feels good. And it might

feel good, but you're still filling out four loan applications, paying closing costs four times. and if you so choose hampering or at least complicating your ability to borrow against the equity in one home if you did want to access those funds for another. So as you're splitting up your money among rental properties, biased towards having a few rentals that are paid for free and clear, even if that means that on some of the other rentals, you only put down 20%. It's better to have 100% in one and 20% in another than it is to have 60% on two. I know that wasn't your question, though. Your question was, should you split your money between index funds or rental properties? So I'm not going to tell you what to do. I'm going to kind of give you a framework for how to think through that decision.

Okay, framework component number one. Any asset earns value in two ways. Capital appreciation and the dividend or... income stream that that asset creates. So in the case of index funds, the majority of the value comes from capital appreciation. And the dividend that it pays out is some value, but it is not the overwhelming majority of the value of the index fund over the long term if we look at historic averages or historic performance. In other words, the returns on index funds historically biased towards appreciation. Now, with rental properties,

The situation is reversed. The majority of the value that you will derive from a rental property, particularly an unleveraged property, comes from the income stream that it pays out. And the capital appreciation, I mean, historically, real estate nationwide has appreciated it 5%, but I like to be a little bit more conservative and say, you know what, we can just assume that it'll appreciate at the rate of inflation and nothing better. If it happens to do better, that's awesome. It's icing on the cake. but I like to use that as a conservative benchmark when I'm making estimations about what might happen in the future. And so when you compare index funds to rental properties, in part, the question that you're asking is, how do I want to bias these returns? Do I want to bias them towards appreciation or income stream? Now, it gets a little bit more complicated than that because index funds historically have significantly higher volatility. rental properties, in contrast, tend to be a much more stable asset class. So in addition to comparing appreciation versus income stream, you're also comparing more volatile investment with the potential for outsized short-term rewards with a more predictable cash flow, but low opportunity or low chance of some wild valuation spike or drop.

Finally, the third thing that you're thinking about to an extent is liquidity. Index funds are easy to buy and sell. Tap the screen on your phone. Boom, you're done. With rental properties, the transaction cost of buying and selling is quite high. However, you do have liquidity that comes from the cash flow that your properties are creating, as well as from cash out refinancing or home equity lines of credit that you can borrow against the equity that you have in those properties. So when you compare index funds to rental properties, even if you assume the same long-term total returns on both, those are still some of the differentiating factors that you want to consider when it comes to prioritizing which way you would want to direct your money. So with that established, let's look at the two questions that you asked towards the end of your voicemail.

You asked, should we save, save, save until we hit our savings goal in index funds and then buy profit. All right. So we'll take that question because that was one of the final questions that you asked within there. Let's think through that for a moment. So if you were to do that and you saved until you hit that one million savings goal in index funds, at that point, how, and this is not a rhetorical question, how would you be in a better position to buy rental properties? Because presumably you would not want to then sell out of your property. index funds in order to come up with the cash for the properties. So would you then reach your index fund saving goal and then start fresh on a new chapter and begin to save money for those four rentals? Would that be the approach? Or would you draw down from your rental property investments, perhaps at the 4% withdrawal rate, or perhaps a drawdown of the dividends that the index funds are paying you? Would you draw down from them in some way in order to come up with the funds for the rentals. If the option is the former, which is that you would

hit one million, let everything compound, don't draw down, and then start saving for your second goal, which is the rental properties, that might take a much longer time. If, on the other hand, your idea is the latter, if you were willing to invest a million in index funds and then draw down at the 4% withdrawal rate 40,000 a year, you live in fee. You live in fee. You live in Phoenix, let's say that you want to buy properties that are $80,000, you want to buy them in cash. That means once you have that $1 million in index funds every two years, you would be able to buy an $80,000 rental property in cash, not including taxes, of course. So if that were your approach, then that strategy may make sense. That being said, the psychological weight of drawing down on an index fund portfolio, particularly when you're young, is heavy.

It might not be something that you would want to do. Now, the second portion of your question, you asked, or should we buy properties first, save our excess funds, and add those excess funds plus the rental income into index funds. Now, the reason that this approach makes a little bit more sense. It fits together a little bit better is because of what I said earlier about how the returns from rental properties biased towards, the income stream that they produce. Cap rate is an expression of an unleveraged income stream,

and especially since you're talking about buying rental properties free and clear, or with very hefty down payments, you would be buying properties that would produce a very solid income stream. In fact, that's where most of those returns are going to come from that you can reasonably predict. And so a strategy of buying rental properties first, and then using the income stream from those properties to invest in index funds, in addition to additional contributions that come from your day jobs, that approach fits well with the way that rental properties express their performance. But again, that being said, human behavior is often more important than math.

So you know yourself best. Would it be the case that if you bought all four rental properties first and then the markets really went up in value, would you kick yourself for FOMO, for that fear of missing out on buying at this point in time when you could have gotten it at today's valuation? How strong would that FOMO be? That's one question that you'd need to ask yourself. And if you think that the answer is that it would be strong,

you could always take a hybrid approach. Perhaps buy one property per year for the next four years instead of buying all four properties as soon as possible. or if you did that, and again, this goes back to know thyself, if you bought one property per year for the next four years, but four years from now, properties are significantly more expensive than they are today, and property values have risen outpacing what the market has done. Again, what would that FOMO feel like for you? So a lot of this, in addition to the mathematical component of the question,

a lot of this really involves projecting yourself into multiple hypothetical future scenarios, and then forecasting what regrets you may have under those scenarios. And then taking the path that would, as far as you can see right now, minimize regret. Because the thing about human behavior is that loss aversion is more powerful than missed opportunity. We are more impacted by losing money or by the sensation that we've lost money, whether or not we've actually lost dollars from our bank account, the feeling that we have lost money is much more poignant than the feeling that we missed out on what could have been.

If a tenant skips out on the final month of rent payment and also does $1,000 worth of damage to a place, the fact that that would result in a loss of money will feel a lot worse than delaying your purchase of the next rental property by an additional six months and as a result paying a higher price than you otherwise could have paid, right? That scenario B might actually be more expensive for you. It might have a bigger impact on your net worth. But scenario A, which is the actual loss, is going to feel worse. Now in the case that you're asking about, rental properties versus index funds, in both of these cases, the future projecting that you're doing, the minimization of regret exercise, is envisioning missed opportunity. But one of those two, I'm betting, is going to feel more like a loss. When you can identify which one that is, you'll know working backwards how to minimize regret.

So that's the long answer. The short answer is either buy rentals first and then use the cash flow to invest in index funds or take a hybrid approach and do a little column A, little column B. Thank you, Kim, for asking that questions. And congratulations on all of the excellent progress that you've made. Late 20s, self-employed and doing so well. I'm just very, very, very happy for you. So congratulations. We'll come back to this episode after this one.

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So if I'm, like, waiting for the bus or waiting for a shuttle outside of the airport, I can still get power, even when there aren't any outlets around. For $20 off a suitcase, visit awaytravel.com slash Paula and use promo code Paula during checkout. Again, you can get $20 off of a suitcase by visiting awaytravel.com slash Paula and use promo code Paula, P-A-U-L-L-A during checkout. That's awaytravel.com slash Paula. Our next question comes from Nick. Hey, Paula, this is Nick. I wanted to ask a question.

Right now, I just finished my first bird deal. It's cash flowing comfortably about $2.50 a month, very conservatively, and I'm having trouble repeating that process, since I can't find a deal that works under the Burr method, I'm 25 years old, and I've been staying with my parents while I finished my MBA. I was thinking of moving out into a house hack. That's my plan. And right now I have two deals on the table.

But one, that's about 70 grand. One is 150 grand. The one that's 150 grand is going to work better. I'm going to cash flow more. And it'll probably be easier to get tenants in there once I move out. But the one that's 70 grand will be an easier financial hit to take. Something does go wrong. Because things tend to go wrong.

So I wanted to know what your thoughts on that word, knowing that I want to keep the house in my portfolio, and that I eventually want to retire early and move to a country like Medellin, in Columbia. If you can let me know your thoughts on that process, I would appreciate it. And thanks for listening, Paula. I love your show. Nick, first of all, congratulations on being 25 having your first rental property that's cash flowing really, really well. And on doing all of this while you're still a student. That's incredible. Steve, can we get a round of applause? That's very, very impressive. The fact that you already have a rental property,

while you're still in school. You're doing the right thing. You're making smart choices, living with their parents in order to save on rent and thinking about moving into your first house hack. I love the way that you're thinking. So congratulations. You're super on track. Now, first of all, I want to, for the sake of everybody who's listening, define what the Burr method is because I'm sure that there are people who are listening to this podcast right now who are wondering what we're talking about.

So to those of you who are not familiar with this, the Burr method, B RRR, R, stands for buy, renovate, rent, refinance, repeat. The idea behind this is that you buy a property for significantly less than market value. Ideally, you would want to find a property that you could pick up for 70% of its current fair market value, so that that way you have some instant equity in there. And then you renovate the property, which gives you even more equity. Once you're done renovating it, you rent it out. So you have a tenant in there. It's cash flowing well.

And then because you have so much equity, which comes from two sources, one is buying at lower than fair market value and the other is renovating such that the increased equity is greater than the money spent on the renovation. because you have equity from those two steps in the process, you can then refinance it. And even if you can only borrow 70% of the equity that you have in your home, the notion is that that would be enough money that you could then make that the down payment on your next rental property, which is where the final R repeat comes from. So through this method, you cash out refi upon cash out refi leveraging the equity in your properties to buy. buy even more properties. This can be a good method to a limited extent. I tend to be a bit more conservative about leverage than a lot of other rental investors are. I think some is fine.

I've got among my entire portfolio as a whole, I've got about a 50% equity stake in about 50% debt. But yeah, I think leverage when you use judiciously can be good. One thing that I would say broadly about the Burr method for everybody who's listening is, is don't get too carried away with it. But Nick, as you're saying, sometimes it's hard to get too carried away with it because the property that you need to find in order to fit the criteria for this deal can be hard to find. I mean, it is difficult to find a property that you can pick up for undermarket value.

One suggestion that I would make, I don't know how you're looking for properties, if you're looking on the MLS or if you're looking for off-market properties. but typically if you do want to pick up a property that's on clearance, it's helpful to look at properties that are not publicly listed for sale on the MLS. So if you're not doing so yet, you might want to start your own driving for dollars campaign or start your own direct mail campaign like a postcard mailing campaign. Try any of those methods because the beauty of the fact that you're a buy and hold investor, the beauty of your approach is that unlike people who flip houses who need a very strong deal flow, you only need one house next, you know, and you might buy one house a year. So you don't need the type of deal flow that a person who flips homes gets. So for you, launching a postcard campaign or a direct mail campaign, I mean, if it brings you one property, then it's done its job.

paid off. So I'd encourage you to try that route. Alternately, if that is just too much to deal with right now, because you're busy, you're also getting your MBA. So if that would overload your plate too much, then you could also work with wholesalers as well, because they will be able to bring you off-market deals. Now, to your specific question, the two homes that you're looking at, one is 70,000, the other is 150,000. I mean, I think you stated the answer within the question when you said that the $150,000 home will cash flow more. It'll be easier to get tenants in there. It's going to work better.

And you want to keep it in your portfolio for the long term. All of those factors make that $150,000 home the much better option. Now, when you say that with a $70,000 home, it's easier to take a financial hit. The part that I'm curious about is, are you talking about a financial hit, meaning if the markets were to drop and you lost 20% of the value of your home, that would be a smaller, raw dollar amount with a cheaper home? Is that what you mean by that? Or are you concerned about a monthly cash flow situation? If you're concerned about a monthly cash flow situation, there are ways that you can plan for that and deal with that. You could wait for a little while to see if you could save up a larger emergency fund.

That being said, you might need to pick up this $150,000 deal right away. And if that's the case, if you need to close on it immediately, then maybe you could see if you could close with a smaller down payment so that you could preserve some of your liquidity. Or you could, if you're concerned about vacancy, you could immediately, rented out at perhaps a slightly below market rate just so you can get a tenant in there right away while you're simultaneously house hacking. That way, there isn't a vacancy and you can build up those cash reserves and then raise the rent later. Basically, those are just a few of many examples, but the broader point that I'm trying to make by giving those examples is that if your concern is monthly cash flow, then there are ways that you can plan for that. Unless there are

huge, huge cash flow concerns. I wouldn't let a few thousand dollars lead you into buying a subpar property, meaning a property that's just not going to perform as well, that's going to have a harder time finding tenants for that $70,000 property. I would not let a few thousand dollars lead you into buying a property that you'll hold long term and that will be underperforming in your portfolio for years and years in the long term. Buying. Buying, it the wrong property or buying a subpar property is, in the big picture, very expensive. And so when you talk about a financial hit, buying a subpar property is a huge financial hit. So I would choose the one that you know would cash flow more, would get better tenants,

would have higher occupancy rates, I would get that one as long as you can find some way, whether through a lower down payment or just being more aggressive about your savings rate overall, like as long as you can in some way create a strong cash buffer that will give you a safety net in case something goes wrong with this property, particularly at the beginning. Cool. Thanks so much for asking that question. And congratulations again. Our next question comes from Kelly. Hi, Paula. This is Kelly. I'm actually needing help to very. figure out what my next step should be related to getting a rental house portfolio put together. As of right now, I've owned my house since 2013. I bought my first house at 25 and I've lived in it for the last five years. As I've lived in it, I've done some renovations. And I've also rented out one of the rooms, which has helped pay for a majority of the renovations that I've done. Even after five years, there are still things that need to be resolved. But I'm moving on to the next step in my life. I'm getting married this year.

and that means that I either let go of this house or make it my rental house. The reason I'm hesitating on leaving it as my rental houses, I do know all of the things there have been invested in it. I originally bought it for $110,000. It currently is estimated to be about 160 to 170. So my question is, should I pull the money out of the house and sell it and then buy multiple houses? or since I know so much about this house and what's been fixed and since I've lived in it, what should I do?

Is it good to know the history of the house? Therefore, it's a good investment and to stay in it, less risk? Or is it better for me to maybe maximize my portfolio and buy multiple houses with the return that I could get out of this house? Some of the stuff that I know needs to be resolved is there's some plumbing things where I actually need to get new pipes from the city to the house because the water pressure is being impacted and it will deteriorate year after year. Another thing is one of the hot water heater is not up to code. It was a homegrown renovation of converting the garage into an extra room in the house. And so

some of the stuff was not exactly done up to code. So I would need to resolve that before I actually have true renters move into the house. Please let me know your advice. I really appreciate it. Or at least how I can get to answering these questions to find these next steps. Thank you. Kelly, that's awesome. This is the episode of people in their 20s doing awesome stuff, right? Kim, our first caller, is in her late 20s and owns her own business, and she and her husband are debt-free with a six-month emergency fund and a rental property that cash flows $2,000 a month, right? Our second caller, Nick is 25 getting his MBA and has a rental property that cash flows at $250 a month. And now, here's our third caller.

And when you were 25, you bought a house that has appreciated and you cash flowed your renovations by having a roommate. Like, oh, my goodness. All right, the next time that some lazy headline writer on the internet complains about millennials, Those millennials, they're so entitled, they do nothing but sit on the couch and play video games. You know, those really lazy articles that paint the entire, our entire generation with a very negative one-dimensional paint brush. Like, we're all just a bunch of people who take selfies while we're listening to AirPods, and we have, like, nothing, no depth to us other than that. Like, any time that I see the next headline that blast millennials, I swear I'm just going to point to this episode. So, to your question, should you sell the house or not?

Because you've proposed what you would do if you did sell it. But before we get to what should I do with the proceeds of the sale, the initial question is to sell or not to sell. As you mentioned, your home is going to need some repairs, some pretty major ones, right? Pipes are a big repair. I mean, water heater is big-ish, but it's not the end of the world. But new pipes that lead from the city into the home, that's a big deal.

So, sure, you know the repairs that are, no pun intended, down the pipeline. I'm sorry. Okay. So you know the repairs that are down the pipeline. But at the same time, from the intonation in your voice, it sounds as though you're not overly concerned about them. And what I mean by that is that it sounds as though. you've got the cash flow to be able to make those repairs and that in the context of this overall home, its location, its condition, its price, its tenant quality that it attracts, its occupancy

rates, its ability to be rented out. I mean, you sound very, very comfortable with this home. And the upcoming repairs are just the cost of doing business if you were to hold on to this home. So it sounds to me as though you don't have any compelling reason to sell the home other than the idea that maybe there's something better somewhere out there in the future. Maybe you could take the money from this and use it to buy multiple properties and expand and grow big. That what else might be out there concept seems to be the motivation. rather than the there's something wrong with this concept, right? It sounds as though everything with the house is right and fine and good from what I'm interpreting based on the way that you've asked that question.

And if that is the case, if there's no reason to sell the house, then don't sell the house. Leave good enough alone. By the way, this is abnormal. I normally don't like to tell people what to do. I normally like to give people a framework for how to think about what to do. but I guess what I've just done here is I've outlined my thought process around why I would encourage you to hold on to this. I mean, you've got something that's working. Let it continue to work. And if you would like to grow your property portfolio, you can always borrow against the equity that you have in that home in order to come up with a down payment for the next home. You can either do a cash out refinance or take out a HELOC, a home equity line of credit. In the podcast episode that I did with Lucas Hall as a special guest, he and I, we had a little debate. He is also a buy and hold investor, as am I. And I prefer cash out refis. He prefers helix. So if you want to hear pros and cons between those two, you can listen to that one. But six of one, half a dozen of the other. You can pick one or the other of those. And that's a way that you could tap the equity in that home so that you could continue to expand your portfolio.

alternatively, you could also expand your rental portfolio the old-fashioned way, which is living on less than what you make, or from the side hustle perspective, making more than what you need to live, saving that difference. So you could grow that gap and then save that gap for the down payment on your next rental. So if you don't want to borrow against the home, if you are debt averse, if you for some reason can't qualify for a more, against this property, if any factors, whether logistical or personal, keep you from borrowing against the equity on that home, you can still expand your rental property portfolio by aggressively saving for the next purchase. And maybe that'll take six months to 12 months to 18 months longer. But when we talk about a buy and hold strategy, when we think in terms of the next decade or two decades. You know, if it takes another year, it takes another year. In real estate, one of the big advantages is local knowledge. And when I say local knowledge, I mean, ironically, I mean that in the broadest possible way. I mean that in terms of the neighborhood,

the, you know, the specific city or town, I mean it in terms of the neighborhood. But I also mean it in terms of the knowledge that you have of the property itself, your knowledge of the That is an element of local knowledge. And you have so much of that with this home that that is a unique advantage. That is a competitive advantage. And I would be reluctant to give that up unless there was a very compelling reason to do so. But it doesn't sound to me as though there's anything extremely compelling on the other side of that. So that's what I would recommend.

Thank you so much, Kelly. and also, again, congratulations on buying this home at the age of 25. I hope that there are people who are listening to this, who are in their 20s and think to themselves, you know, maybe I could do it too. And that might mean getting super creative. It might mean, as you did, Kelly, bringing in a roommate who would pay for the cost of renovations through their rent. So many people think that buying a home is out of reach. because they imagine this very traditional model of buying a single-family starter home with a yard and a white picket fence and not sharing that with a roommate and being the sole person or being the sole couple responsible for making the entirety of the mortgage payments as well as other home repair and maintenance payments, right?

if you're trying to shoulder all of that by yourself plus the down payment, yeah, that can be a lot. But if you're willing to get creative, if you're willing to buy a fixer-upper and then put roommates in it, that's how you get your foot on the property ladder. So thank you, Kelly, for providing that example. We'll return to the show in just a moment. Afford Anything is brought to you by Skillshare. Skillshare is an online learning community with more than 20,000 classes in things like this. business and design and technology.

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And when they ask, how did you hear about us? Type in afford anything. Our next question comes from Tracy. Hi, my name is Tracy. And I was called him because my sister and I are looking into buying our first property. We are not sure if we want to try to buy land or just

like maybe a duplex or something that we could get started on, small and then go bigger from there. However, I was wondering if you had any recommendations on how we could get started. We're in Portland, Oregon, if that's helpful. Tracy, it's fantastic that you want to get

started. You mentioned buying land. Please, please, don't. I know I'm going to get some angry emails, but I strongly recommend not buying bareland, particularly as a beginner. And here's why. Okay, when you buy property generally, regardless of whether it's bareland or a single family home or an apartment building or storage units or warehouses or mobile home parks, when you buy any type of property, there are two ways that that property can make money. You can either make money by the value of that property going up, or you can make money from some type of income that comes from

that property. Now, if you're getting income from the property, meaning that you've bought a mobile home park or storage units or offices or residential rental properties, then you're getting income from the property, right? And maybe that property might also rise in value, but even if it doesn't, you're still at least getting income from it. If you buy bare land, then you only have one way of making money. And that is that it better go up in value because if it doesn't, you're screwed. It is a speculative investment. Now, I will give the disclaimer that I'm assuming bear bear.

So I'm assuming that this isn't, say, land with a commodity on. As an environmentalist, I hate to talk in these terms. I hate to refer to trees as a commodity. But from a real estate perspective, if you buy bare land that has not bare land, if you buy land that has trees on it, and those trees are the commodity, and you can thin those trees and make some money from some of that logging. That is an example of how some real estate investors make money on land purchases. I'll give a huge asterisk here that if this is the type of investment that anybody is thinking about doing, first of all, please don't come to me for advice about this because this is not what I do. And second of all, I very much encourage you to check with environmental organizations out there to see how you can do this in a sustainable and eco-friendly way.

I do not have the expertise on that, but there are plenty of groups out there that would have better expertise on it. Anyway, that being said, Tracy, I'm assuming that you're not talking about land that has a monetizable commodity on it. I am assuming that you're talking about land that is truly bare in which the way that you would make money is speculation. And so please don't do that. So to your other question and your bigger question, which is how do I get started, really the fact that I've now spent several minutes kind of describing the difference between different. types of investments and what differentiates a land purchase from a home purchase speaks to what I think is really your first step, which is at a conceptual level, understanding where profits and returns in real estate come from and how to analyze those. And I know that that may sound like a dissatisfying

first step because there are so many people who want a checklist and they want me to say like, all right, well, step one is to contact your lender. And after you've contacted your lender, step two is to contact an agent, right? Like there's so many people who want a step-by-step checklist filled exclusively with action items. But I feel that that would be wrong for me to say because as much as, of course, I advocate taking action, before you take any action, I want you to develop an investing philosophy, an investing strategy, an investing approach. I want you to go into this with thoughtfulness and a cultivated, curated, I and mind for what you are about to see.

Because in the world of real estate, once you start talking to people, there are a lot of people who say a lot of things. and I want you to filter the fluff from the wisdom. Here's more of what I mean by that, because I realize I'm being a little bit vague. In the world of real estate, number one, there are, as we just discussed, multiple niches, right? So there's mobile homes, there's offices, there's warehouses, there's rentals, there's land, and each of them have pros and cons, advantages and disadvantages. The one that you decide that you want to go into is going to depend on what your goals are, What types of returns do you want?

In what form do you want those returns to be delivered? How much risk? And not just how much risk, but what type of risk? Because risk exists in multiple dimensions. There's volatility. There's liquidity. So what type of risk are you willing to take on in addition to how much? So that is one thing that you'd want to think about.

In addition to that, there's strategy. There's buy and hold. There's flipping. There's speculation. What strategy does? do you want to undertake because all of them have pros and cons? And then when you start looking at metrics that people use to evaluate different investments, you know, there's cash on cash return, there's gross rent multiplier, there's cap rate.

Now, all of those metrics measure four different things. There's return on equity. Which of those metrics, which of those formulas are important to you? I can't answer that for you because that question is what's important to you and why. and only after you can answer that for yourself will you know what you're looking for? And that's important because when you start talking to people in the real estate industry, when you start talking to agents and property managers and lenders, everybody has a different philosophy and strategy and approach.

And they're all trying to sell you something. And so when you talk to them, you need to listen for what they're telling you because people will give you, you recommendations that reflect the philosophy and the approach that they have, which is not necessarily the philosophy and the approach that's right for you. And that's why you need to be able to filter through what they're telling you so that you can take the parts of it that work for you and leave the rest. So that's what I would recommend. That's how I would recommend that you start. You know what I'm going to do? Okay, this is an impulse giveaway. I literally, I thought of this a minute ago as I was talking. In my course, your first rental property, one of the worksheets

that we have our students fill out is called Your Guiding Statement. It is kind of like an investment policy statement for real estate, for rental property investing. I am going to make that available for free as a download. So if you go to the show notes at Afford Anything.com slash episode 165. That's afford anything.com slash episode 165. You will be able to download that for free. And what this is is it's basically a document where Madlib style, you fill out what your strategy is, what your approach is when you buy your first property.

So you're going to fill out the answers to questions like under what conditions would you sell a property? For example, if you're married and you end up getting a divorce, would you sell a property in that set of circumstances? What if a family member is sick and you need to raise a large amount of cash very quickly in order to help this sick family member? Would you sell a property under those circumstances? And if so, what would be the minimum dollar amount you would require in order to make that worthwhile? Right. So those are the types of questions that you want to think through. before you start investing so that that way you've got it all written down. And you can go back and you can revise it. You can say, you know what, once a year, every year in January, I'm going to sit down and I'm going to revise this document. Because I'm going to change, my ideas are going to change. But when a tough situation happens or when I'm making decisions, I have this guiding statement, something that I've written down so that I know where I'm going. This is the statement that guides me, which is why we're going. call it your guiding statement. So go to afford anything.com slash episode 165 and download that for free

and fill it out and that is what I would do to get started. And as a fun bonus, if you download it for free, you will also join our free email list in which you'll get show notes every week about upcoming episodes. A few other things, Tracy, if you're looking for something a little bit more concrete, you mentioned that you live in Portland. One of the things that I would do if you wanted to buy rental properties is start thinking about whether you want to try to find something locally or whether you want to look to a different area of the country. And if you do look to a different area of the country, think about where you might want that to be. Some of the ways that you can narrow that down, first in terms of rentals, some of the areas with the most attractive, most

landlord-friendly price-to-rent ratios are in the Midwest and the south. Cincinnati, Indiana, Dayton, Ohio, Louisville, Kentucky. I'm just basically just naming cities in the Midwest, but that whole region of the country has some really good deals there. So think about where you might want to look. I would encourage you to pick a city that is at least, it doesn't have to be a major city, but something that is at least large enough that it has a diverse economy, meaning it's not overly reliant on any one industry or any even worse one employer for a majority of its jobs or even a significant chunk of its jobs. You'll also want a city or town that is large enough that you would have a selection of property management companies and contractors, such that if you didn't like the one that you were working with, they wouldn't be the only show in town. You could get rid of them and go with a different property management company, and that wouldn't be a problem. If the area is close to, and this doesn't have to be, you know, this is more of a nice to have rather than a must have, but if it's close-ish to an airport, that's kind of nice. Or at a minimum, if it's close to a major interstate, again, that's not a requirement, but particularly for out-of-town investing, it can be useful.

And then if you happen to have friends or family that live in the area that you would want to visit anyway, that can also be useful in terms of just choosing an area where you would want to invest. Partially because that way, any time you go to visit them, you can combine that with a business trip. But then also partially because they might have some contacts or friends or just general knowledge about the area that can help you at least get started. But if you don't have that, if you don't know anybody who lives in the Midwest or the South or in any other part of the country that you might want to invest in, don't let that stop you because it's easy to go somewhere and Airbnb a room or get a really cheap motel room or hotel room and rent a car. And that's what Emma and I did. Last year, when we went to Birmingham and Montgomery to look at potential rental property locations, we didn't know anybody. So we just, we got an Airbnb and we rented a car and that was it. That's what you do when you're new to a city and you don't know anyone there.

Those are all the things that I would start thinking about right now. Thank you so much, Tracy, for asking that question, and best of luck with everything that you're doing. That is our show for today. If you have a question that you would like answered on an upcoming episode, head to Affordainthing.com slash voicemail and leave a voicemail with your question. Again, that's afford anything.com slash voicemail. And don't forget, you can download that free handout at Afford Anything.com slash episode 165.

If you enjoy today's show, please share it with a friend or family member. That's the single most important way that you can help support this show. Don't forget to subscribe to this show in your favorite podcast player. Just open up your podcast playing app and hit that subscribe button. Coming up on Monday's episode, we have an interview with Michelle Singletary from the Washington Post. Michelle has been reporting on personal finance and money management for the Washington Post for many, many decades. And she is going to talk about what she has learned, what she's observed, having written about money for one of the biggest newspapers in the nation for many decades. What is it that you pick up along the way when that's been your entire career?

and in what ways are the principles of personal finance the same as they were? What classic ideas have not changed? And what things have changed? What's different now? So we're going to talk about all of that. Plus, we're going to talk about the fire movement, the financial independence, retire early movement. All of that is coming up on Monday show. So make sure that you are subscribed to this podcast so that you don't miss that and you don't miss any upcoming shows.

Thank you so much for tuning in. name is Paula Pan. I am the host of the Afford Anything podcast. I'll catch you on Monday. Welcome to the... What month is it? Okay, three, two, one. Welcome to the December 2018. It's 2018, right? Yes. Okay. Woohoo. Three, two, one.