Afford Anything - Ask Paula - Should I Sell My Rental Property and Invest the Proceeds in the Market?

Episode Date: November 6, 2017

#102: This week, I'm back to answering questions posed by listeners of the podcast. An anonymous listener asks: Should we continue to rent out our home, or should we sell it? We bought a home in California but have since moved to New York and have been renting there. After all expenses on the rental are accounted for, we receive $150/mo in profit. We estimate that even with repairs factored in, we'll still be in the positive. However, my husband thinks it's better to sell the property and invest the profits. I think we're better off keeping the house and having someone else pay the mortgage. Who has the better idea? What would you do?   Jessica asks: My husband and I are about to relocate from the mid-west to Colorado Springs, and we anticipate making $80,000 from the sale of our house. Should we take the proceeds from the sale and put it toward our next home? Or should we put that money in index funds instead? For context, we plan on buying either a duplex or triplex, or doing a fix-and-flip like we did with our current home. Terri asks: How can I find a good real estate agent - especially one who is good with short sales and foreclosures? What are the signs of a good real estate agent? Laura asks: My husband and I currently own a three-family home (in which we live on the bottom floor), but in light of getting a new job that requires me to commute an hour each way, we are thinking about either converting the three-family home into three condo units and selling them, or buying another house and keeping the three-family home as a rental. There's another factor to consider, though: the property is located on a peninsula, and with sea levels rising, we don't think it has long-term potential (in terms of equity). What should we do?   For more, visit the show notes at http://affordanything.com/episode102  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else. And that's true, not just of your money, but also your time, energy, focus, attention, anything in your life that is a scarce or limited resource. And so the questions become twofold. What are you going to do with those limited resources? What is most important to you? What do you value? What do you prioritize?

And question number two, how do you align your day-to-day behaviors to reflect those decisions, those priorities? Figuring out these answers is a lifetime practice. That's what this podcast is here to explore. My name is Paula Pat. I am the host of the Afford Anything podcast. Every other week, I answer questions submitted by you, the listeners. And actually, for the past three weeks, I've been doing interviews because we had a, normally on every even-numbered episode, we do an Ask Paula episode where I take your questions. But two episodes ago, the last even-numbered one was episode 100, which if you did not catch, please go catch that because that was awesome.

episode 100 was a special celebration. We did a video interview with Brandon the Mad Scientist. That video is up on YouTube. Go check it out. YouTube.com slash Fort Anything. But for the rest of you who are tuning in for the Ask Paula episode today, I will be answering questions that you have submitted specifically this episode is specifically about the topic of real estate. So what I do is because I get a bunch of questions about real estate and also I get a bunch of questions about general personal finance, I do. divide those out into different episodes. That way, those of you who are interested in hearing about real estate can tune in. And those of you who don't care about real estate can skip this episode and go on to a different one. So today, I'm going to answer questions from you about real estate. But first, regardless of whether or not you have debt, managing healthy credit is important if you want to buy houses, whether it's a personal residence or an investment property, or if you want to open up new credit cards, if you want to lease a home in a different city for lots of other things,

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Our first question comes from Jessica. Hi, Paula. My name is Jessica, and I have a real estate investing question. My husband and I are about to relocate from the Midwest of Colorado Springs, and we anticipate that we'll make about $80,000 from the seal of our house above what we owe on our mortgage. So I'd love you thoughts on whether to take the proceeds from the sale and put that towards our next home versus put that money in index funds.

We plan to either purchase a duplex or triplex and live in one of the units or do another live-in flip like we've done with this house and do all the work ourselves. We are 30 years old. We have about $75,000 saved for retirement. We have no debt and we really, really value our freedom and hope to eventually reduce. reduce or eliminate our reliance on W2 employment. Thank you so much for your thoughts and for all you do. Jessica, congratulations on moving to Colorado Springs. That is a beautiful city. So there are actually two questions inside of this. Question number one is should you pursue a real estate investment in

Colorado Springs? And question number two is, if you do so, should that $80,000 go towards it? After all, you could house hack without putting that much money to, you know, towards it. For example, you could look for a cheaper house that requires a smaller down payment, or you could apply for an FHA loan, which requires a much lower down payment, or you could look for private lending or creative financing. So there are two questions here. Should you become a real estate investor? And if so, should that ADK go towards it? The short answer, in your specific situation, what would I do? I would invest in real estate in Colorado Springs assuming, I haven't studied that market, but assuming that the numbers work, given that your

owner occupants, I would be opting for putting as little money into the deal as possible so that you can then do both. Because your owner occupants, you're going to be able to qualify for the lowest interest rate mortgages on the market. Therefore, I would try to take out an FHA loan, in which case you only have to put as little as 3.5% down, or even if you wanted to take out a loan with a 20% down payment, I wouldn't put in any more than 20. Now, I looked up the median home price in Colorado Springs, and it is $258,000, which means that even if you made a 20% down payment, you'd still have about $30,000 left over, assuming that you walk away with $80,000.

That means that you would be able to do both. You could have your cake and eat it too, or in this case have your rental property and invest in index funds as well. Now let me give a little bit of context here for the sake of everybody listening. So your goal, it sounds like, is to reach financial independence. In order to do that, your investments need to generate enough income that you could live off of those. Now, assets generally, any asset, whether it's stocks or index funds or even ownership in a business, assets tend to gain value in two major ways. One is capital appreciation, which means that the value of the asset itself increases.

over time. And the other is the dividend or income stream that that asset generates. So if it's a business that you own, it's the income stream that kicks off from that business. If it is a stock, that would be the dividend. And if it's a rental property, that dividend is the unleveraged net operating income that comes from your rents. So generally speaking, index funds are an appreciation play, whereas rental properties are more of a dividend play. And what I mean by that is that historically, index funds have gained most of their value through long-term capital appreciation. They may generate one or two percent in dividends, but the rest is long-term appreciation. And of course, reinvesting those dividends helps with your overall growth, but that's true no matter what asset you own.

But broadly speaking, index funds gain most of their value from the asset at stake. self gaining value over time. Rental properties, on the other hand, are a dividend play in that the primary value that you derive from them, or at least that you can reliably anticipate deriving from them, is the income stream relative to the value of the asset. Now, that income stream is referred to as the cap rate. The cap rate on a property is analogous to the dividend on a stock. The total return that a rental property generates is the cap rate plus the appreciation. So I'm throwing all of that out there as general background on how to think about a comparison between a rental property and an index fund. The fundamental underlying question is,

are you chasing long-term growth or are you chasing an income stream? And if you want financial independence, then chasing an income stream could get you there faster as long as you have the discipline to reinvest those dividends. So you could take the income that comes from your rental property, invest that into index funds. And as long as you are diligently reinvesting the money that is coming off of your investments, you're gaining that compounding interest and that's how it gets you there faster. Let me give an example because I'm not sure. Again, I'm sitting alone in my closet and I can't see any feedback, any from facial expressions from anybody, so I have no idea if what I'm saying is making sense right now. So let me walk through an example. Let's say that in order

to reach financial independence, you need to generate $40,000 per year as living expenses. Now, let's say, just hypothetically, you have a million dollars in cash laying around. Congratulations. Drinks are on you. If you put that million dollars into index funds, let's say that the index funds as an aggregate generate a dividend payout of about 2 to 3%. That's between $20,000 to $30,000 per year on a million dollars in cash worth of investments. That's not a huge amount of money. Now, that being said, those index funds historically are likely to appreciate at about an overall 8-ish percent over the long term. There's some debate.

Some people say 9 percent. Some people say Warren Buffett says that you can expect 7%. percent moving forward. So people like to debate about what that number is, anywhere between the 7 to 9 percent range. I like to use 8 percent just as a reasonable ballpark looking at historic averages. So TLDR, index funds are appreciating, but the dividend, the actual income that they're kicking off is only about 2 to 3 percent, so 20 to $30,000 per year, which means that you have to pull from some of that principle in order to get the, you. the $40,000 that you need to be financially independent. Now, that's probably not going to be a

problem because as a general rule of thumb, most of the research indicates that a person can safely withdraw about 4% of their overall portfolio, which is $40,000 in this example, per year, and have a reasonable likelihood of not outliving their money. But the point that I'm trying to illustrate is that the income that's specifically kicked off by those investments is not in and of itself, enough to cover your cost of living because the income generated from an index fund is not the primary way in which that index fund gains value. In comparison, let's say that you have a million bucks in cash and you put that all into rental properties that have a cap rate of 6% and that they appreciate historically at the rate of inflation, which is about

3%, so their overall return is 9%. In fact, you know what, screw that. Let's make the rental property, the overall return, let's give it a total return that's equivalent to an index fund just for the sake of being super fair. All right? So you're in rental properties. They all have cap rates of 5% and they appreciate a rate of about 3% making their total return 8%. So with a bunch of five cap properties, you are generating a net operating income of $50,000 per year, which means that your principal, which is the equity in those homes, remains totally intact, and you collect and live on that 50,000 per year as that income stream. So in this hypothetical example, the returns on both of those assets, the total returns are the same

at 8%, but they come in different forms. And the form that the returns come in with regards to a rental property are more friendly to or more aligned with the goal of financial independence at an early age. Now, all of that being said, and in fairness to index funds, because I love them too, one of the big risks of pursuing FI via rental properties is the risk of not reinvesting the money that you make from the property. It's the risk of not generating compounding returns that will build over time because that money comes to you in the form of cash, which means that you can then go spend it on like champagne and caviar. Essentially, any time that you unautomate the system, there's the potential for human error. So that's a thing. It's a real thing. It's a real thing. thing. All right, so I hope that that answer made sense. There are a couple other things that I want to mention. So number one, you mentioned the reason that I got so excited when you mentioned house hacking is because general, I'm speaking in very, very broad generalities. Generally speaking, multi-units often create stronger dividends, stronger cap rates, all else being equal as compared

to single-family homes. And the reason for that, and again, this is a huge generality, right? So the reason for that is because with a rental property, the underlying land is a non-performing asset. You don't make money from the land itself. That's just overhead. You make money from the structure that is on the land, specifically from the value of renting out that structure. So what's fantastic about duplexes, triplexes, fourplexes is that you are consolidating your overhead. You only have one roof. You've got one set of gutters. You've got one home exterior with all of its siding and windows. You've got one yard to maintain. You really, you consolidate that overhead quite a bit. And that often translates into a higher income stream

as compared to the value of the property. By the way, when we talk about rental properties, it's really important not to think about the cash that you're getting from a property in a vacuum. I've noticed I've been getting a lot of questions for this podcast, questions from listeners, that often focus on here's how much money this property is making and as a dollar amount. Don't think of it as a dollar amount. Think of it as the return that you're getting relative to the price that you paid for the property. Because that's how you figure out what the return on the asset is. And when you do that, leave your mortgage, the principal and interest portion of your mortgage out of it.

because you don't want to ever conflate the financing arrangement that you have with your evaluation of the asset, the inherent asset. At 0% financing, a lot of really terrible assets might look good. And at 99% financing, a lot of amazing assets might look bad. So strip the P&I, the principal and interest portion of your mortgage payment, strip that out of it and look purely at how much income. a house produces after you pay the operating costs, such as property taxes, insurance, repairs, maintenance, vacancy management, after you pay those operating costs, leave the principal and interest out of it, look at that number, and then compare that number to the value of the asset itself. And that's how you can determine how solid of an investment you're holding.

And oftentimes, multi-units will, because that overhead is consolidated and you have sometimes lower operating costs and or a lower entry price, you can oftentimes just get stronger cap rates there. So I've gone all over the board with this answer, but I hope that that helps provide a framework about how to think about rental properties. Oh, a couple of other things I want to mention and then we'll move on. You mentioned the live and flip. I'm not familiar with flipping, but there is an amazing guy by the name of Jay Scott. He writes a blog called 123flip.com. If I were to ever flip, I would first binge on everything he's ever written. He's incredible.

You mentioned that you'd be doing the work yourselves. That's awesome. Bear in mind, though, that do it yourself will increase the money in your pocket, but it won't increase the profits because you, as an investor, you want to make a problem. after paying yourself. So when you're doing the math and you're evaluating any asset, whether it's a rental or a flip, embrace a little bit of split personality. There's investor you and then there's worker you. So run the numbers as though you're outsourcing everything so that you can see how much profit investor you will have. And then if you choose to work

within your business, if you choose to do it yourself, sweet, you'll have more money in your bank account, that's awesome. But just make sure that when you are running the, you're doing the math, make sure that you're doing an apples to apples comparison. And the final thing that I wanted to mention, you said that you expect to walk away with about $80,000 after paying off the existing mortgage. Don't forget that there are closing costs, selling fees, the cost of staging, the cost of any repairs that the buyer is going to request during the negotiation. So all of those could take a pretty decent bite out of the money that you're expecting. So just be prepared for that possibility that the money that you walk away with may not be 80K. All right. So that is my answer. And I feel like I went

all over the map on that one. So I really hope that it made sense. It is currently midnight. And I have not been home for about a month. And I'm finally home for a grand total of 72 hours. have to catch a flight in about seven hours from now. And so, yeah, it's midnight. I've been home for less than 72 hours and I'm about to leave again. So, man, not trying to make excuses, but, whew, I am tired. I was talking to somebody the other day and she was like, well, you know, you don't spend any time on your rental properties. What do you do all day? Like, I kind of had this air of like, aren't you bored all the time? And I'm like, oh, man, I'm the, I'm the opposite of that. In the last 90 days, I went to Portland, then to Burning Man, then to Portland again, then to Colorado, then to – actually, then I had to go back to Portland again.

And then I went to Ecuador, then San Diego, then Dallas. Tomorrow I fly to Seattle. And when I come back from Seattle, I'm home for, I think, 48 hours, and then I fly to Denver. This wouldn't all be so bad, but I know everyone's like, whey, cry me a river, Paula. Geez. But trying to balance that with a weekly podcast and working on the course and trying to keep up on social media, trying to keep up with emails. So sort of pseudo kind of maintaining a blog and a YouTube channel that I'm constantly feeling guilty about how behind I am on posting stuff there. It's been a little rough lately. I got to admit, I have this classic problem of saying yes to far too much. This is like the first-est of first-st-to-first. world problems, but I have so many great opportunities that I really have a hard time being selective. I know, right? Like, this is the stupidest thing in the world to complain about, but there's just too much good in my life and it's exhausting.

So I'm setting a goal here. And you know what? I'm going to announce it right now and make it public. My goal is to stay at home for 30 consecutive days. At home, I mean, within my city. I mean, I'm not leaving the city for 30 consecutive days, November 15 through December 15. That is the goal. My best friend has already invited me on a trip that starts December 8th, but I'm going to say no.

I'm going to be strong because I really have to learn how to say no. It's not a random rant. I'm sure you didn't actually care that much to hear it, but hey, here we are. Thank you for listening. Wow, I get loopy at midnight. All right. Our next question comes from Wally. Hi, Paula. I have been a long-time listener and I love your show. My question essentially is,

should we continue to rent out our home or should we sell it? My husband and I, we own a home in Northern California, but almost a year ago we moved to New York City and now we became renters. We decided to rent the house and after mortgage, property taxes, property management fees are all paid for. We get about $150 in profit. We think that even with the small repairs and things like that, at the end of the year, we'll still be in the positive. My husband thinks that it's time to sell the house. He would like to sell it, invest the proceeds, probably putting it in index funds.

I, on the other hand, think that we should keep the house, have somebody else pay for a mortgage, and once we reach FI, we could just either pay the house down or we'll be so much more, will be so much closer to having a mortgage paid for. Right now, we owe about $246,000 on the house at 3.5% interest. Because we purchase at the bottom of the market, we think a conservative selling figure would be about $425,000. What should we do? What would you do in this situation? Do you think that we should sell and invest the proceeds? We could always rent or purchase another home later on, or would you have somebody continue to pay the mortgage, even though it doesn't make that much profit? Thank you so much. Bye-bye. Oh, this is an interesting one. First of all,

congratulations on owning a house that has gone up in value so much. Okay, so here's how I would look at it. So based on the numbers that you gave, it sounds like if you sold the house, you could walk away with approximately $179,000 in your pocket. So, $179,000 in an index fund at the 4% withdrawal rate, in other words, 4% of that amount, equals $7,160. In other words, if you were to sell the house, take all that money, put it in an index fund, and then use the 4% withdrawal rate as your guiding benchmark during FI, that money would produce an income stream for you of about $7,000 per year. So now the question is, take a look at this property. Forget about what it's making right now. What would it be making if the mortgage was completely paid off if you held it free and clear?

By looking at what that house will pay you, if you held it free and clear, you can make an apples to apples comparison because you know, you're looking at the income stream that you would earn from an unleveraged asset, right? So you want to look at the income stream that an unleveraged house would give you so that you can compare the two options. That way you're comparing the assets themselves rather than looking at one through the lens of financing and the other not through it because that's going to distort your comparison. Another way to look at it, and again, this is basically saying the same thing but from a different angle, is what is the cap rate on that property? And in order to calculate that, here's the official formula. First, you take the potential gross rent, which is the total amount of rent that the property could collect over the course of one year at full occupancy. So that's what's known as your potential gross rent. If it rents for $1,000 a month, for example, the potential gross rent is $12,000 a year.

Then you subtract out some reasonable vacancy estimate, maybe 5%, depending on the neighborhood. From that, you add in any additional fees that you might collect. So, for example, if you charge pet fees, if you charge parking fees, if you charge additional fees for storage, you add that in. And then the total is what's known as your effective gross rent. So then that is the number that you're working with. Now, from the effective gross rent, you then subtract out all of your operating overhead, property management, repairs, maintenance, property taxes, insurance, long-term capital expenditures. you subtract all of that out. The two items that you do not include are the principal and interest portions of the mortgage payment.

Because, again, that's financing and you want to evaluate financing separate from the deal itself. At the end of all of that, once you subtract the operating overhead from the effective gross rent, you are left with a number that's called the net operating income. And that net operating income divided by the price of the property is your cap rate. Now, there are two schools of thought, right? There are people who argue that you should, in terms of when you're comparing the net operating income to the price of the property, there are people who argue that you should compare it to the purchase price, by which I mean the price plus initial repairs required to get it rent ready for the first tenant. That's camp one. And then camp two, you have the other people who argue that you should compare it to the current value of the property.

So in your case, you know, Camp 1 would say that you would compare the net operating income to the $200 and, what did you say, $246,000-ish or no, sorry, that's what you currently owe on the mortgage. All right, so I don't know what you paid for the property. Let's say it was $300,000. I don't know, I'm pulling that number out of thin air. Camp 1 would say that you compare the net operating income to the $300,000 that you paid for the property. And Camp 2 would say that you would compare the net operating income to the first. $425,000 that the property is currently worth. I tend to be a little bit more in Camp 1 because what you want to evaluate is the cap rate that you're getting on the deal that you have.

You know, you spent X amount on this property. Let's say it was 300,000. That's what you spent. So in my viewpoint, you want to see what kind of return you are currently getting relative to what you actually spent. But in your case, I mean, since you are evaluating opportunity cost, sure, you know what, run the math twice, get both numbers. And also look at the total payout that you're getting. If you held it free and clear, the unleveraged payout in terms of actual unleveraged free and clear cash flow. And then based on those numbers, I think you'll have your answer. There's one other thing that you said that I want to touch on. Within your question, you said, when we reach FI, what is your plan for reaching FI generally? Like, is your plan to reach FI through

primarily through index fund investing? Is your plan to reach FI through owning rental properties? Is it through owning businesses? Like, what else are you doing? And how else will you get there? Because essentially the question is should we direct our assets into an index fund versus into a property? That is one pixel of a bigger picture. It's, you know, one piece of the mosaic. That's the other thing that I would want to know is how does this decision play into your broader plan to reach FI? And I mean, that context can take it in either direction. If you plan on reaching FI primarily through index funds, then there might be something to be said for holding on to a rental property in order to diversify a little bit.

Or there might be something to be said for selling the rental property and just going 100% in index funds. I mean, it's important to understand how this fits into the bigger picture, but at the same time, the way that it fits could sway the decision either way. I guess what I'm trying to say is that there's no formula, but it's still important to contextualize. I hope that helps. And congratulations again on doing so well with your property. That's fantastic. We'll come back to the show in just a second. But first, this episode is brought to you by LinkedIn Learning, now featuring

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And before you do anything else, click on the microphone at the top of the homepage and type in Paula, P-A-U-L-A. That's ShipStation, S-H-I-P-S-H-I-P-Sation.com, enter Paula. ShipStation. Make ship happen. Our next question comes from Terry. Hey, Paula. My name is Terry, and I am newer to your website. I have a real interest in real estate and am doing my due diligence to find out what becoming a real estate investor actually means. One of my main questions that I've come across so far is, how can I find a good real estate agent? in particular, how can I find somebody that's good with short stales and foreclosures? And what are some

signs of a good real estate agent? Because it seems like there's certainly going to be an important partner in the beginning of all this. Even though I love the person that sold me my home, I don't know that she's versed in real estate investment. So I'm trying to figure out some good ways to get to the bottom of finding an agent that's really going to be a resource for me in buying my first rental property. Thanks so much. That's a fantastic question. So first of all, there's a particular certification that real estate agents can get. It's an optional certification, and it is called the short sales and foreclosure resource certification, or SFR, for short. It's issued by the National Association of Realtors.

If you go to their website, which we will include the link to that in our show notes, which is at afford anything.com slash episode 102, there is an online directory of realtors who are SFR certified. And so what you can do is you can type in the name of your city or your zip code and search for realtors who have specifically completed that particular certification. that's one way that you can do it. Now, another possible way, and that's just like one of many options, right? So do that. But in addition to that, here's the other thing that I would recommend. And honestly, this is yielded much better results for me. If you've identified a particular neighborhood that you want to invest in, you know, if you narrowed your criteria geographically, take a look at the current short sales and foreclosures that are for sale within that particular area. And if, if, if, if, if you're in, if, if, you know, if, If you start looking at them, you'll notice that a lot of them are listed by the same one or two agents, or sometimes by the same agent team or small brokerage, a mom and pop brokerage that operates within that particular locality. The thing is real estate is very, very local. And once you niche down, you start seeing who the players are within that market. if as you're looking around, you don't see a huge number of properties that are currently for sale as a foreclosure or a short sale, just look at the recently sold listings. Now again, here you're looking for the names of the agents that are representing these properties because these are agents who, by definition, are working with short sales and foreclosures.

Sometimes these agents will be representatives of a bank or, you know, there'll be people who don't represent buyers, but just call them. them up and have a conversation with them because even if they can't represent you, they know the people who will. They can refer you to the people who they recommend that you call. Again, all real estate is local, so you only have to meet one or two players in the game before those players can start introducing you to the people that you need to know. You know who else is really good to get referrals from? And nobody ever thinks of this, and I don't know why. Contractors and inspectors, ask them. what agents they regularly work with.

Particularly if you're interested in short sales and foreclosures, because those are the ones that oftentimes need a lot of fixing up. So again, all of this hinges on narrowing your search to a specific locality. And when I say specific, I don't just mean Boise or Birmingham. Like, that's too broad. I'm talking about the 1, 2, 3, 4, 5 zip code. Or even more specific than that, the section of blocks. in between X Street and Y Street, as framed on the East and West borders and A Street and B Street on the North and South borders.

Like narrow your search to that tight-knit geographic area and then just start paying attention to all of the goings-on that are happening in that area. And in real estate, it's fairly obvious, right? Like if you're driving around or even if you're not physically there, if you're just Google-earthing around and zillowing around, you'll see. who the agents are. You'll see if there's contractors, you'll see their signs in the yard. You'll see the names of the major contracting firms that have pulled permits. You'll see if you're using Google Maps. You'll see the name of the plumbing company that is located in that district. And unless they totally suck, the plumber that's located right there is most likely going to be the plumber that services that area. And they'll know who. you know, that plumber is going to know which general contractor he or she typically likes to work with. Or they may directly be able to tell you about, oh, these are the agents that I like to work with. These are the property managers that I like to work with. Again, once you narrow it to a very specific geographic area, then you get into the zone where like

everybody knows everybody. So that's the other way that you can do it. But again, if you don't know yet where you want to invest, the SFR directory, which we will link to in the show notes, is a really good way of getting that process jump started. Again, those show notes are at afford anything.com slash episode 102. You also asked about the hallmarks of a good agent versus a not a bad agent, but an agent that isn't suited for investments. Woo! Oh, I could go on for hours about this.

But the TLDR of it is, first of all, if the agent talks to you in the way that an agent would talk to an owner-occupant, walk away. Any agent worth their salt who represents investors knows that an investor does not care about, oh, it's so cute. Oh, look, the yard is so big. Oh, all that stuff that agents say to primary residents. You know, the emotional appeal of selling a house. Agents who work with owner occupants, many of them, are well-versed in making statements that harken to the emotional appeal of visualizing yourself in a home. Oh, look at the fireplace. The kids love it.

You're an investor. You don't care about that. And when you talk to an agent for the first time, you're going to let them know that you are an investor. And if in spite of that knowledge, they try to sell you on some emotional appeal, then that means that they're not speaking your language. And you've got to move on. The other red flag are agents who assume that they know what you want. So oftentimes as an investor, when I approach a new agent and I tell them that I'm an investor, a lot of times I've noticed that they assume that that means that I am chasing appreciation. And so then they start talking about, oh, I think this house is totally going to go up in value or I think this neighborhood is totally going to go up in value.

And of course, they're not allowed, technically quote unquote, they're not allowed to make any investment projections. but they'll certainly strongly hint at their hope or anticipation that like, this neighborhood's going to rise. Real estate always goes up. I have two problems with that. Number one, I'm not chasing appreciation. As it's clear from everything I've said earlier, I assume that a property will merely keep pace with inflation and nothing better. If it happens to do better, sweet, that's icing on the cake, but if it doesn't, I'm still satisfied with the cap rate that I am getting on that property. I'm still satisfied with the income stream that I'm getting from that.

And I'm satisfied with the total return that that cap rate plus the inflation only appreciation provides. In other words, I'm not chasing appreciation. And if an agent just assumes that I am, I see that as a red flag. And particularly, if an agent makes that assumption and then I correct them, and then they continue to make statements that bear that assumption. That's not even a red flag. That's whatever color is redder than red. That's like so red that it's a heat signature. Dorky science joke. Sorry, I couldn't resist. Here's the other thing.

Agents don't have any skin in the game after the transaction is complete. So if they say, oh, yeah, I really think this neighborhood's going to go up in value. And then it doesn't? Well, guess what? They're not accountable for that statement. Now, to be clear, I'm not saying that they're bad people. I'm not saying that they're deceptive. I myself am a licensed real estate agent. I don't represent anybody. I just only buy and sell my own properties. But hey, actually, I don't even sell my own properties. I just buy my own properties. But I guess my point is, I'm not trying to insult them as a group of people. I myself am one of them. I am merely pointing out the fact that the incentive structure is set up in such a way that even if they honestly think that a neighborhood will go up in value, they're still not going to suffer if it doesn't.

That's why it's so critical, in my opinion, not to make any investments based on appreciation. I believe appreciation is speculation. and the best definition that I heard to differentiate speculation from investing is that speculation is based on hope, whereas investing is based on earnings. But yeah, back to your question, how do you assess who's a good agent and who's not? Avoid the ones who make assumptions about what they think that you want. Or worse yet, avoid the ones who tell you what you should want. That's all up to you. Oh, and final tip, ask the agent if they own any rental properties.

and if so, how many? And for how long? And how well are they doing? And where are they located? Could you drive by and see them from the outside? That last question might be pushing it for, you know, privacy sake. But still, before I got my license, I worked with an agent once who had two rental properties, two single family homes, in the same area where I was buying a home.

She gave me the address for both of them, and I drove by and I saw them from the outside. And they were both just a couple of blocks away. So, yeah, that's the other way to do. know if an agent is good, just essentially figure out, hey, are you one of us? Cool. Thank you for asking that. That was a great question. Our final question for this episode comes from Laura. Hi, Paula, this is Laura. I've been following you since we bought our three family and we're currently living on the bottom floor. I just got a tenure-track job that would have my toddler and I commuting an hour each way. So we're deciding between converting the building to three

condos or buying a house closer to my job and keeping the multifamily as rental property. The building is just outside a major metropolitan area. It's a very family-friendly community on a peninsula. But with the sea levels rising, we can't really think about this property as a long-term investment in terms of equity. I really think the building is going to go the way of Katrina and Sandy in our town isn't doing anything to stop the sea levels. So after many of school spreadsheets, We're estimating that we would make about $2,800 a year if we kept the three family after taxes and expenses renting out the three floors. And if we sold it as condos, we think we could make $226,000. But we still have to figure out some details like condo reserves.

We're also not sure how the mortgage company would deal with changing multifamily into condos. So we have to do a little bit more research on that. But we also have a timing issue. Our second floor tenants are moving out in September. So it would be ideal to clean the place up. and sell it then somehow with one other unit so we could pay off the mortgage and they wouldn't have to worry about the conversion. But it's also when I'm starting my new job and I'll be making about $70,000 a year, but I don't have a track record of making a lot of money recently because I was a grad student.

So we're wondering, should we keep the property for a few months in order to have another source of income that could help us qualify for a mortgage on a new home? We're thinking how difficult will it be to sell three condos and somehow buy a new home and then start a new job. But mostly we're just wondering if we're thinking about this correctly or if we have some kind of major blind spot that we're not thinking about. So we appreciate your thoughts and any insight that you have. Thank you. Hey, Laura, first, congratulations on your tenure track position. That's awesome. That's huge. So I'm really happy for you. And sorry to hear about your town. That sounds terrible. The thing that you said about how you think there's another major disaster impending and nobody's doing anything about it.

That's, um, yikes. I don't know what to say other than, ugh. And finally, I just wanted to apologize for not being able to get to your question before September. The questions that we have in the queue have been building up for a while. So right now we have at this point, it's running between a three to four month lead time. Again, it depends on the topic and it depends, you know, it depends on a number of factors. We don't take them entirely in chronological order. Aaron, my assistant sort of. through all of the questions for me and then makes recommendations about what show to slot it into based on alternating the Askpala real estate episodes with the Askpala General Personal Finance episodes and then also based on applicability to the greater audience and so on on on so on forth. So at any rate, I try as best I can to get to all of the questions. And but as you've heard, I spend a long time answering each question. So I only get to about four questions per episode. And yeah, so that has all resulted in some fairly long lead times. So my apologies for not getting to this prior to September. And so I'm sure you've made a decision based on

about in terms of timing-wise, in terms of that aspect of your question. But I, of course, would like to address the rest of your question. So here are a couple of things to think about. First of all, you mentioned, and I think you probably can guess what I'm the first thing I'm going to say, which is you mentioned that you'd make $2,800 per year if you keep it. That is the money that you would make right now with a mortgage. So my first question is, if you owned this free and clear, how much would you make from it? And conversely, if you were to sell it off as condos and make $226,000, what would you do with that money? So what is the other alternative? Would you put that $226,000 into index funds? Would you use that $226 to buy a different property that you would own

free and clear. Would you use that 226 to buy a different property that you would take out a mortgage on and use as a rental property? Would you use the 226 to pay off loans? Would you use it to buy some other type of business? So the first thing that I want to know is the comparison. What alternatives are we comparing here? And what type of money are we looking at within each of those alternatives when you remove financing from the question so that you can compare asset to asset. So that's the first thing that I would want to know. Second of all, well, okay, actually the first first thing that I would want to know would be a zoning question. Because depending on your municipality, you may or may not be able to actually make the condo

conversion. So that's actually the first, first thing that I would want to know is, is this feasible based on zoning and permitting? If not, it's all a moot question anyway, but it is an interesting thought exercise. So, okay, the third thing I would want to know is realistically, do you have the bandwidth for this right now? Because making a condo conversion, which is just a paperwork and bureaucratic nightmare, while also starting a new job and also moving, like all of those are very big projects. So you can certainly do all of them, but do you want to do all of them at the same time? It just goes to the you can do anything but not everything and not all at the same time. So perhaps you might decide to do a condo conversion later down the road, but it might not be a bad idea to defer it for a year while you're settling into your new job and dealing with all of the hassles of moving yourself and your family to a new personal residence. Now, one thing about your situation that I think is very good news is your cash flow positive by $2,800 a year.

So what that tells me is that you have a pretty decent buffer. Like, you're unlikely to be in a major cash flow bind. And it sounds as though that $2,800 figure, when you calculated it, you've already factored out, repairs, maintenance, CAPEX, vacancies. It sounds like you've already factored all of that out, and that's the amount that's still left over. since you do have that nice cushion, that nice buffer, it means that you seem to be, based on what you've told me, in a relatively low risk situation for having to make some type of less than ideal decision because of a cash flow issue. I am going to assume that you also have some type of an emergency fund that's specifically for the house itself. So with all that being said, you seem to be in a good position. there doesn't seem to be any urgency around selling the house or making the condo conversion.

So, you know, if the zoning and permitting allows it, the condo conversion may not be a bad idea, given that you don't want to hold on to this in the long run. But that being said, the condo conversion isn't imminently necessary. You can delay that by a year. Now, I know that you mentioned that if you sell it as condos, you would use that money to buy a property, a personal residence that's closer to where you live. But again, you also mentioned that you'd be getting 226,000 from it. You don't need that much money in order to buy a personal residence.

You don't need 226 unless you're either making a very substantial down payment or just buying a house and cash outright, depending on property values in the area that you're looking at. So I guess the other question that I would ask is depending, and I don't know what your numbers are in terms of your personal budget, but you've been a grad student until recently, so you're certainly accustomed to living cheaply. If you were to continue living at a grad student standard for the next couple of years and save a significant chunk of what you're making, could you or could you not, and I don't know this because I don't know the prices in your area or the type of personal residence that you're looking for, but could you save up enough money to be able to buy a home for?

yourself without doing the condo conversion. That's, I guess, the final question that I would ask. And if you could, how long would it take? Would it take two years? Would it take four years? Yeah, how soon do you want to buy a personal residence? So there are a lot of moving pieces to this. And it's not entirely a financial question, or at least it's not entirely an investing question, because the tricky part about this question is that it necessarily blends your personal residents and your personal lifestyle and desires with investing decisions. And that always gets tricky because when we're asking a pure numbers question, you know, should I invest in X or Y, then it's fairly easy to run spreadsheets and start assessing the pros and cons between asset A and asset B. But when we're asking questions about an investment property in the context of how it relates to a owner-occupied personal residence or any other type of personal lifestyle factor, well, then we're no longer comparing an investment to an investment. Now we're comparing an investment to a lifestyle decision.

And that means that this is not just a money question. This is a how soon do you want to buy a personal house and how necessary is this condo conversion in terms of allowing you to do that. That's the other baseline question. And if the answer is that you want to buy a personal house and this conversion is absolutely necessary in order to do so, well, then you have your answer. Thanks so much for asking that question and good luck with everything and congratulations on the physician.

That is our show for today. You can find the show notes at Afford Anything.com slash episode 102. You can follow me on Instagram at Paula Pant. That's P-A-U-L-A, P-A-N-T. And if you like today's episode, share it with a friend. Coming up on future episodes, so I recently delivered a little mini-keynote in Dallas. I'm going to be playing that on an upcoming episode. I also delivered a longer, much longer speech in Ecuador that I've been doing a lot of traveling, and a lot of it, not all of it, but much of it has been meetings, conferences in which I've had these speaking gigs.

So coming up on the next episode, I will be playing the speech that I gave. both in Ecuador and in Dallas. So tune in for that. You'll get all the benefit of hearing it without any of the hassle of having to board a plane. Speaking of boarding a plane, I've got to do that in a few hours. So again, you can follow pictures of all of my wacky travels on Instagram at Paula Pant. My name is Paul Pant. I'm the host of the Afford Anything podcast. Thank you so much for tuning in. I'll catch you next week.