Afford Anything - Ask Paula - Should I Sell Stocks to Buy a Rental Property

Episode Date: May 21, 2018

#130: Anna and Dave want to get married … eventually. But they want to buy a rental property together first. How should they approach this from a paperwork/legal structure standpoint? Note: They’re thinking about having one partner purchase the home, with the other partner acting as a lender (with proper paperwork in place). Would this be a wise approach? Fred lives in Saskatchewan, Canada and owns two duplexes. He’s thinking of buying rental properties in the U.S., and he has 4 questions: What requirements or criteria do you establish ahead of time? For example, do you look for a minimum cap rate? Or a specific type of property? When you’re looking out-of-state, what steps do you take to identify a community? How about the type of property? What market research do you undertake? How would you caution an international investor who wants to start investing in U.S. properties? Jordana wants to build financial independence. She’s thinking about selling off stocks and index funds in order to buy her first rental property. Is this a good idea? Cheryl lives in Texas, where property taxes are astronomical. How should she factor this into her rental property decisions? Rachel is worried about bed begs. (Yuck!) Have I dealt with these in any of my rental properties? How do I protect against pests, termites and roaches? I tackle these five questions in today’s episode, which is dedicated to rental property investing. Enjoy! P.S. Need software to manage your rental properties? Collect applications, screen tenants, and collect rent online with Cozy.co/Paula. (And P.P.S. — If you’re not interested in rental investing, don’t worry! Check out last week’s episode about debt payoff with Laura Adams, or the previous week’s episode, in which Joe Saul-Sehy and I answer a smattering of general personal finance questions. Have fun!) For more information, visit the show notes at http://affordanything.com/episode130 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything but not everything. Every decision that you make is a trade-off against something else. And that's true not just for your money, but your time, your focus, your energy, your attention, your emotions, anything in your life that is a focused and directed and limited resource. And so the question becomes, what are you going to focus on? Part of that is understanding what is most important to you. And how to align your day-to-day behaviors to reflect those priorities. Answering these questions is a lifetime practice. and that is what this podcast is here to explore. My name is Paula Pant. I'm the founder of afford

anything.com and the host of the Afford Anything podcast. Every other week we interview a guest and on the weeks in between, I take questions that come from you, the community. Now, of these weeks in which I take community questions, half of those are general personal finance questions and half of those are real estate questions. This happens to be that one in four episode where I answer real estate related questions that have come from you. So if you're interested in rental property investing, keep listening. And if that's not your cup of tea, don't worry. There are plenty of other topics to explore. For now, though, let's start with this question from Anna and Dave. Hi, Paula. It's Anna. And Dave. And we have a question about investing

as a couple. We've been dating for about four years and are hoping to begin investing in buy and hold residential real estate, purchasing our first property in the next year or so. We're committed to each other and plan to get married, but not anytime soon. So our question is really about investing as an unmarried couple. We would likely plan to have one person buy the property and have the other person give the buyer a loan with a proper agreement in place. Do you have any suggestions for how we should think about or structure this deal in a way that's responsible but not overly complicated? Or is there anything else we should consider? Thanks so much, Paula.

Bye. This is an excellent question. First of all, congratulations on buying your first rental property or being on the cusp of buying your first rental property. Now, as far as how to purchase a home together, there are a couple of options that you have. Number one, you don't have to be married to buy a home together. Both of you can hold title on the property. So there are two ways that can happen. One is called tenancy in common and the other is called joint tenancy.

If the two of you take title as tenancy in common, that means that each of you has a distinct and separately transferable interest in the property. If you hold title under joint tenancy, then that means that the two of you jointly, as one cohesive unit, own this property together and that if one person dies, the other person gets the total share. This is sometimes also called joint tenancy with right of survivorship. The broader point, though, stepping back a little bit, is that you're not required to be married in order to own a property together. Like, the marriage part is optional. You can co-own property with friends, with siblings, with cousins, with cousins, with. anybody that you want. So I do want to make sure that you understand that. Now, to your suggestion that one person by the property and the other provide a loan with all of the proper paperwork in

place, that sounds like a perfectly fine arrangement. However, what I would ask you is, are you doing that because only one of you wants to be the investor and the other person is fine with being a lender but not an owner? Like, is that the reason that you're doing that? Or is there a different reason? Because it sounds to me as though, if you are entering into an arrangement in which one person is the investor and the other is the lender, then that should be each of your distinct goals. And if it's not, if you both each individually intend to be an investor and owner in the property, then it makes more sense to set up a business arrangement that reflects the type of arrangement that you actually want. Now, I'm going to throw out a few more

options here. You could purchase the property. You would probably have to purchase it within your own name in order to qualify for financing. But once you purchase the property, you could quit claim deed that property into an LLC that both of you are the member managers of. What that would do is it would mean that the two of you would co-own a business together, and that could be 50-50, it could be 6040, 70-30, but in some form, you would co-own an LLC together, and that LLC would hold the property. That's another way that you could go about this. One of many possible ways. And that type of structuring would be really analogous to any business partnership. Another option is that rather than have a business partnership, you could have a

joint venture. And a joint venture is something in which two parties retain their distinct individual separate identities, but they come together for a specific business project, which in this case would be your rental property. So structuring this as a joint venture would also be another way to do it. So you've got a lot of options. And the route that you suggested with one person being the owner and another being the lender, that's perfectly fine as long as one person intends to be the lender and only the lender. But it sounds to me based on the way that you've asked that question that that isn't actually your intent. So I would urge you to set up the business structure in a way that reflects what your true intentions are. And in this case, it sounds like both

you being the owners, whether that's as co-owners of an LLC or as partners in a joint venture, or quite simply as two individuals who both are on the title. It seems to me like any of those would more accurately reflect the way that you want to hold this. Now, final disclaimer, I am not an attorney. I am not a professional. I'm just some random person with access to the internet. So take that as you will. This is not intended to be legal advice in any way whatsoever. This is, as they say, purely for entertainment. So thank you so much, Anna and Dave, for asking that question, and best of luck with your first rental property.

That's exciting. Our next question comes from Fred. Hey, Paula, and greetings from Canada. My name is Fred, and I've been binging on your podcast for the past year. I really enjoy your real estate investing segments, and I've actually been inspired to take the leap and invest in properties outside of my home community, and maybe even the United States.

I'm already a real estate investor in my province, Saskatchewan, and own two properties in my home city with two units each. I'm at the stage of thinking of expanding my portfolio, but prices are prohibitive in my neck of the woods here in Canada, and thinking of investing in places outside of my local area. This will be my first time investing outside of my community, and I'm looking for some guidance and possible tips on how to best approach this. My timeline is to purchase two multi-unit properties over the next five years. I have a lot of questions, but I'll limit it to just four. What type of requirements or criteria do you establish ahead of time before investing in real estate? For example, do you have a minimum cap rate, a specific type of property you favor, or a demographic you like to target?

My second question is, when looking to purchase a property outside of your own city or state, what steps do you identify the neighborhood or community you want to invest in, and how do you decide the type of property you want to invest in? My third question is what type of market research do ahead of time to guide you in your decision process? And finally, are there any cautions you might suggest for someone who's investing in U.S. real estate that is from a foreign country? Thanks to your time, Paula, and thanks for all the great work that you're doing. All the best. Fred, first of all, congratulations on already owning two duplexes.

That's a huge accomplishment. And I often tell people the first rental property is the hardest. So the fact that you bought the first and the second tells me that you've paved the road. You're going far. So let's take your questions one at a time. So your first question was, what requirements or criteria do you establish ahead of time? For example, do you have a minimum cap rate or a particular type of property that you look for? All right. So the answer to that question, first let me step back and give this a little bit of a broader context. And this is for the sake of everybody who's listening to this. So you know how in the stock market, or in like general market investments, risk and reward are commensurate with each other.

They exist on a spectrum. So for example, stocks are generally higher risk than bonds, but because they're higher risk, they also have the potential to give a higher reward, right? The same is true when you are looking at rental properties. Generally speaking, rental properties that are located in higher risk areas, which are often known as Class C or Class D neighborhoods. Those are properties where your tenants will generally be a little bit less qualified. They may not have as good of a credit score. They may have a history of evictions. The house itself or the other houses in the area may be older or in need of repair

or have a lot of deferred maintenance. There may be higher crime in those neighborhoods. So those are higher risk neighborhoods. They might have more frequent turnovers. All of those factors play into it being a higher risk neighborhood. There is, of course, the potential for a higher reward, i.e. a higher cap rate as a result. Now, in contrast, there are lower risk neighborhoods, which are often referred to as Class B or Class A neighborhoods. These neighborhoods typically have a lower risk profile. For example, they may have lower crime rates. They may have tenants who stay longer, meaning that you'll have fewer turnovers and fewer vacancies. The tenants that you attract may tend to have significantly higher credit scores. And so these are generally considered

more stable neighborhoods. They're the bond market of rental property neighborhoods. Your risk isn't going to be as high, but your rewards may not be as high in these areas. So now, Fred, let's bring it back to your question. You asked what minimum criteria do I look at? for. For example, do I have a minimum cap rate? Cap rate is contingent upon what type of neighborhood we're talking about. In the same way that you wouldn't compare the returns that you get on shares of Tesla stock to the returns that you get on a treasury bond, because it would just be silly to compare those two because the risk profile is so different. In that same way, it doesn't make sense to compare the cap rate that you would get on a Class A new construction property in a stable,

highly desirable, trendy, low-crime neighborhood, you couldn't compare that cap rate to the cap rate that you would get in a neighborhood that might have a much higher risk profile. And so for me personally, now, before I tell you what I personally look for, I also want to give the disclaimer that what I look for is kind of irrelevant because I'm just one person. And in the same way that Joe from the hardware stores preferred stock bond asset allocation really has nothing to do with yours. Like my preferred risk profile and what I look for in an investment really has nothing to do with yours because mine is a reflection of my own preferences, my goals, my risk tolerance. You know, mine is contextualized to what I am looking for in an investment, just as it would be if you are asking me about my preferred asset. allocation in terms of making a portfolio investment. So with that disclaimer out of the way,

what I personally look for is at least a 6% cap rate in a class A neighborhood and at least an 8 to 10% cap rate in a class C neighborhood, depending on are we talking C plus, C minus, depending on the other context around that property. In terms of what type of properties I look for, I myself am open to anything that is considered a residential investment. So, residential is anything with four or fewer units, meaning a single family home, duplex, triplex, or fourplex. I don't look outside of those personally. That's not to say that you shouldn't. That's just my take on it. But again, a lot of people, Fred, I just want you to know a lot of people ask me what I do. And asking me what I do is not necessarily going to be illustrative for you. Because my reasons for looking only at residential may not apply to you. So I think the better question to start with is, what are your goals? How much time are you willing to invest in this? Do you want your rental property income to replace your current day job income,

or do you just want it as a stream along the side? How comfortable are you with vacancies and turnovers and other risk? How much effort do you want to put into finding a property? The answers to all of those questions will play a role in you deciding what's right for you. Okay, so to your next question, which is, when you're looking out of state, what steps do you take to identify a community and a type of property? I talked about this in episode 126, which was our most recent Ask Paula Real Estate episode. Of course, that was recorded after you asked that question. So I won't elaborate on it too much in this episode.

You can go back to episode 126 to hear my answer for that. But very quickly, I look first and foremost for areas where gross monthly rents are at least, 1% of the purchase price of the property. That's number one. Number two, and this is a little bit redundant, but I look for areas where the price to rent ratio is at least 8.3. And you can calculate price to rent ratio as the price of the property divided by the annual rent. So if a property costs $100,000, and it rents for $1,000 a month, which is $12,000 a year at full occupancy, then $100,000 divided by $12,000 equals $8.3. So I look at $1,000 a month. for communities where not all properties, but where at least a sizable number of properties

have a price to rent ratio of 8.3. In terms of the type of property, meaning single family home versus a duplex, triplex, or fourplex, I myself don't have a strong preference. Generally speaking, you're more likely to find properties that meet the 1% rule and properties that meet whatever minimum cap rate you're looking for as multi-units. And the reason for that is because the non-income-producing overhead, such as the underlying land, is consolidated. You have multiple income-producing dwellings consolidated onto that same parcel, which means that your returns are more likely to be better. That said, there are fewer of those options out there. And there are plenty of single-family homes. So if you keep digging, needle in a haystack,

Sometimes you can find a single-family home that does as well or even better than a multifamily. And so for that reason, I don't have a strong preference between the two. My preference is based purely on cap rate rather than type of property. But again, that's just me. Preferences are, by definition, personal. Fred, your next question was what market research do I undertake? First of all, market research is a generous term. So thank you.

That implies that I am more. professional than I actually am. But broadly what I look for are economically well-diversified areas, meaning I don't want to invest in a city that is overly reliant on just one industry or worse, one company. Ideally, I would want the place that I am looking at to be near some type of a transportation hub. Like maybe it has an airport. It doesn't have to be a big airport, but maybe it has some airport that is at least an hour, hour and a half away. I do look at population statistics, and the city doesn't necessarily have to be expanding. It can be stable, but I just don't want it to be rapidly contracting.

I don't want it to be losing jobs and losing people. Growth is not necessary. In fact, oftentimes cities that are growing invite speculation into them, and speculation drives up prices unnecessarily. It drives up prices to the point where the income stream can no longer justify the price that's being asked. So sometimes growth can actually be a deterrent for an income-focused rental property investor. That's not to say that you should avoid places that are growing. It's just to say that sometimes that growth can work against you by inviting in a different breed of investor, a different breed of speculator that can drive up the prices.

And so I look for places that are stable and places where the economy is well diversified. So that's the short answer to that question. Now, to your final question, how would I caution an international investor who, who wants to start investing in properties in the U.S. First and foremost, my only experience is as a U.S. investor who earns money in U.S. dollars and has a U.S. citizenship and purchased homes in the U.S. So I don't have the knowledge and experience of a Canadian who may earn money in a completely different currency and whose familiarity and assumptions with the laws and with tax code are Canadian-based.

That's the boat that you're in. And so I guess my chief caution is that everything that you know, everything that you've worked with, with regard to laws, with regard to taxes, with regard to, I mean, and this applies to everything ranging from the actual negotiating and purchasing process of the mechanics of actually how to buy a house, the mechanics of how to apply for a loan or how to report income. I mean, everything that you have worked with, I'm assuming, has been entirely in the Canadian system. And that means that you carry with you a set of assumptions that work in Canada but that don't work in the U.S. So the number one thing that I would say is to learn the American system of how this whole thing all works. And I'm not just talking about rental properties. I'm talking about generally how to buy a house in the United States, how to sign a lease in the United States, how to create a business. how to create a business structure such as an LLC or a trust in the United States.

What the tax implications are going to be. Those are all the basic building blocks that you'll need to learn. And they're not just building blocks related to how to invest in rental properties in the U.S. They're generally building blocks around how to live in the U.S. Not that you're going to live here, but how to operate, how to function inside of the U.S. system. So that is the number one thing that I would encourage you to learn. And also work with both an accountant and an attorney who have experience specifically in working with Canadians who invest in the U.S. Thank you so much, Fred, for asking those questions.

And good luck with your expansion. We'll come back to this episode after this word from our sponsors. So a few months ago, I became a Grove collaborative VIP member and started getting all of my household staples delivered right to my door, things I absolutely need, like my dish soap and towels or my window cleaner. In the beginning, I was all about using Grove to replace the big items on my monthly shopping list, since they're all about the best prices right to your door. But then, Grove started introducing me to their own in-house line of flagship products. And let me tell you, their things are amazing.

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And when they ask how you heard about them, type in, afford anything. Our next question comes from Jordana. Hi, Paula. Just wondering what you think about this. I've been saving up for financial independence for the past two years, and I've most of my money in the index funds. This year, I discovered real estate investing and I'm really keen to buy my first property. What are your thoughts on taking money out of the stock market to buy a property, especially when it seems to be down? Would it be better for me to save up again in a separate account, but that might take another year or two?

What do you think? Thank you for your thoughts. Love your show. Sure, Dana, I think that's a great idea. In fact, I have several regular taxable brokerage accounts, non-retirement accounts, in which I've invested in stocks over the years, well, index funds and stock funds, that I have often looked at and thought, you know what? I could liquidate this and use it to buy a house. So I think that there's absolutely nothing wrong with that idea, assuming that the investments that you're talking about are outside of retirement accounts. Now, there is a way that you can buy rental properties through retirement accounts, through something that is known as a self-directed IRA. But for your first property, I might not get into that level of complexity because your first property is going to be the learning curve property. I mean, that's true of your first time doing anything. Your first time giving a speech on stage, your first time writing a book, your first time

playing a game of tennis, first time you try anything, it's the learning curve attempt. And specifically when it comes to rental property investing, there's so much to learn and there's so much to process and think through and get used to that it's better to keep that first property as simple as possible. And so when it comes to buying a property with the money that you would have in an IRA, I might, I would save that for your second or third or fourth property, but don't attempt something like that with the first one. And so for that reason, that's the reason that I am recommending only doing this if you're referring to money that is coming from outside of retirement accounts. That's my answer, but you know, just telling you an answer is not actually

serving you very well. Because what I want you to understand is how and why I arrived at that answer so that once you understand the thought process behind it, you can critically assess it and decide whether you agree, disagree, or need more information. So here's my thinking process behind why I said that. An investment, any investment, whether it's a stock or a rental property or a bond or shares of a privately held toy store, any asset makes money in two ways. One is the appreciation or the gain of the asset itself and the other is the income that it provides.

Now in the world of stocks, this is referred to as capital gains and dividends. The capital gains are the way in which the stock rises in value and the dividends are that little payment that you get a handful of times a year. And in the world of stocks, historically, the majority of the gain has come from capital gains. The majority of the returns have come from capital gains. So if you look at the history of stocks over the 20th century, they have, depending on what years you're looking at, produced total returns of somewhere between 7 to 9 percent, of which around 2 to 3% have come from dividends and the other 5% to 6% have come from

appreciation of the asset itself or growth in the value of the asset itself. Now, when it comes to rental properties, this situation is reversed. With a rental property, the primary way that you're making money is through that income stream that it provides. And that income stream,

the unleveraged income stream is what's known as the cap rate, which I mentioned in the answer that I gave to Fred. That cap rate might be 6% or 8% if you can find the right property in the right neighborhood. And so that cap rate is analogous to the dividend on a stock. In addition to that, if you assume that the property goes up at about the rate of inflation, no more, no less, which is historically around 3% annually, then that rate of inflation price growth is the other piece of the puzzle. And so that produces on a property that has a cap rate of, say, 7% plus 3% price growth, meaning it keeps pace with inflation, yields a total return of 10%.

So when you're comparing index funds to rental properties, in terms of total return, I think that, I mean, conservatively, I think that you can expect them to be about neck and neck. So then the question becomes, how do you want to collect these gains? would you rather collect the bulk of the gains in the form of appreciation, or would you rather collect it in the form of an income stream? Now, this thought framework assumes that you're paying all cash on both ends, where a lot of real estate investors like to start hyping rental properties is when they say, yeah, but you can't quite compare the two because then you can finance a property, which means that your cash on cash return is higher

because you're only putting X amount of your own money into the deal, and yet you're still getting all of the returns, blah, blah, blah. A lot of people say that, and that is true. But I don't like to emphasize that point. In fact, I intentionally try to steer away from that point when I'm talking about how to think about rental properties because I don't want to, I don't want people to get caught up in this game of relying on debt in order to make a mediocre deal good. And so when I'm trying to show people how to think about rental properties, I like to start. with the assumption that everything is purely cash-based, so that that way you can evaluate the asset itself.

You can evaluate the deal itself to see whether or not it matches up. And if you think that the deal itself is good, then you can start talking about ways to further improve that performance via financing or not. But before we even have the financing conversation, let's first make sure that the deal is worth doing. So anyway, the reason that I think that it's totally okay to take money out of index funds or to take money out of stocks and use that money to buy a rental property is because essentially you're just diversifying your portfolio. You're moving from one type of

asset to another. And since your goal is financial independence, receiving those returns in the form of cash flow makes a lot of sense. And so that's the primary reason that I say that even before we get into conversations around financing and cash on cash returns, and even even before we get into conversations around tax breaks or other tax advantages that rental properties have. There are a lot of real estate investors who would lead the thought process with a discussion around those two elements, leverage and taxes. But I like to kind of keep those off to the side because don't let the tail wag the dog. So that is my long answer to your short question. And I hope that was helpful because what I really am trying to do with this answer is to give you a framework around how to think about that question.

So hopefully that was helpful. And one other thing is if you do start selling off your stock funds, think about how you want to do that. Do you want to sell off everything in one lump sum on one day? Or do you want to gradually ease out of the market over time? And do you want to do so after you have identified and maybe even gone under contract on a property? Or do you want to do so earlier when you're still searching? And if so, how long will your money be in cash? And are you okay with that? I keep lots of money in cash. And the benefit is that we can pay cash for improvements and that we've made cash purchases of houses. But of course the drawback is that during the time that I'm accumulating that cash, the money sits on the sidelines outside of the market. So there are pros and cons to all of these questions, and that's something that you would also need to think about if you are deciding to sell off some of your stock allocation in order to diversify that into rental properties. So I hope that helps and best of luck with whatever you decide. Our next question comes from Cheryl and it's a really good one. Hi, Paula. This is Cheryl from Texas. Thanks so much for all of the free resources and great information. I am a big fan. My question is this. It's about property taxes. So I'm really interested in the 1% rule and using it as a guide to buy rental properties. Specifically, I'm wondering about rental properties in Texas because I want to buy Texan rents. But all of my research and resources that I've looked at show that Texas has some of the highest property taxes in the nation, which, I mean, Paula, can we just appreciate for a minute that

taxes and taxes have the same letters? Okay, sorry. Anyway, to that end, would my properties actually need to bring in more than 1% in order to be profitable, hit the target payoff window and all those sorts of good things? Or am I overthinking it, and I should just take the 1% rule? But in any case, thanks again for everything you do, Paula, and I really look forward to hearing from you. Bye. Cheryl, that's a great question. Now, first of all, for the sake of everyone listening, I'm going to briefly describe the 1% rule because I know that there are some people who are listening to this. We're scratching their heads right now wondering what that is. So the 1% rule of thumb states that as a bare minimum criteria when you're looking for a property, that property should collect gross monthly rent of at least 1% of the total acquisition price. So in other words, for every $100,000 worth of house, it should. should rent for at least a thousand a month. A $200,000 house should rent for $2,000 a month. A $300,000 house should rent for $3,000 a month. And so forth. If you're looking at a multi-unit property, then that rent would be the total rent that that whole thing collects. So if you're buying a duplex

for $300,000 and it's got two units and each unit rents for $1,500 per month each, then cool, that duplex meets the 1% rule because the two units inside of it collectively collect $3,000 per month. And by the way, if you buy that duplex and you move into one of the units and rent out the other one, remember, math must always be identity agnostic in order to truly be math. So if you end up moving into one of the units, you still run the equation based on the fair market value of that rent, because you are, in essence, taking the place of a renter who would have otherwise paid X. So if you buy a duplex for $300,000, you rent out one of the units for $1,500 and you move into the other unit, but the unit that you've moved into also has fair market value of $1,500 a month, well, you still have met the 1% rule because you are essentially paying $1,500 per month in the form of opportunity cost.

That is fair market rent that you could be collecting. And the only reason that you're not is because you're living there yourself. So with that background established, for the sake of everyone who's listening, that is the 1% rule of thumb. Now, one of the frequent questions that I get about this is how do operating expenses factor into the 1% rule? And operating expenses include everything from shareless you asked, property taxes, homeowners insurance, utilities, management, maintenance, all of that. All of that falls under the umbrella of operating overhead. The answer is they don't. The 1% rule of thumb does not take any operating overhead into account.

It purely looks at the total acquisition cost of a property, meaning purchase price plus repairs necessary to get it rent ready for that first tenant. It takes that number and it compares it to the gross income that you could get per month. And that's all it does. It does no more than that. And that's because the 1% rule of thumb is not a deciding criteria. It's a sorting criteria. And I'm going to repeat that because this is very, it's a very important distinction. It is not a decision-making criteria.

It is a sorting or filtering criteria. If you find a property that meets the 1% rule of thumb, that property merits further consideration. But that property is not necessarily something that you should or should not buy. It's not to say that you should buy everything that does meet the 1% rule. It's just to say that you shouldn't waste your time looking at properties that don't meet it. So, with all of that background laid down, Charlotte, to answer your question directly, it is true, property taxes in Texas are, whew! Yep, that is the sound of property taxes in Texas.

But that being said, taxes are only one variable. And the other elements of your operating expenses might be the same or lower than the national average. There are rental property investors in all of those cold wintery states, Montana and Wisconsin and Michigan and New Jersey and Pennsylvania, who have to pay for snow and ice-related things. If you own a multi-unit property there, you might actually have to pay for regular snow and ice removal. That's a serious line item.

And even if you don't, even if you have a single family home where the tenant is responsible for shoveling their own driveway, you're still going to have the additional wear and tear on the property that comes from exposure to that freeze-thaw cycle. If you have properties in the Pacific Northwest or in some particularly rainy part of the country, you're going to have the additional operating overhead that comes with the fact that it's wet all the time. And the two things that ruin houses are time and water. If you have a property that needs supplemental flood insurance or that just generally is located in an area that is more expensive to insure,

that's also going to be part of the operating overhead. Heck, my properties are in Atlanta. don't even get me started on the cost of water in Atlanta. And as the owner of a triplex, I pay the water bill for that triplex. And it is painful. So my point is that, yes, property taxes are higher in Texas. They're very high there. But that may be offset by the fact that you don't have to pay as high of costs in other areas, which really is another way of saying that every location has its pain points. You know, every location has its benefits and every location has its pain points. And at the end of the day, what's going to matter is the cap rate on the property

rather than one isolated variable, one isolated line item within that big spreadsheet. Rental property investors in Las Vegas don't have to pay for gutter cleaning or leaf blowing because we're in the desert. Meanwhile, rental property investors in Georgia are paying loads of money for cleaning gutters, restaining decks, blowing leaves, constantly treating for pests and termites, all the stuff that comes with living in the middle of a forest, which is what the state of Georgia is. Atlanta is a city of trees. And that means higher maintenance costs. So don't overthink it. Just stick with the 1% rule of thumb as your sorting criteria. And then once you found a couple of properties that you like, dig deeper into the numbers on that specific

property so that you can come up with what you think the cap rate for that property will be. And then once you know the projected cap rate for the property, then you can make an informed decision about it. By the way, final thought that I will leave you with is income taxes on rental property income are assessed based on the location of the property, not the location of you. So for example, I live in Nevada and my properties are located in Georgia. The income that I get from the rental properties in Georgia, I have to pay Georgia state income tax on. And so one advantage that you have as somebody who would be owning properties in Texas is that you're not going to have to pay state income taxes to the state of Texas on properties that are located in Texas.

So, hey, that lack of state income tax, that's an advantage right there. Thank you so much, Cheryl, for asking that question. We'll come back to the show in just a second. But first, Guess what? The average national interest rate on a savings account is 0.07%. That's not a lot. Would you like to earn more on your savings while investing in local communities? Check out C-Note, a socially conscious savings alternative that pays you up to 35 times more than the national average. With C-note, you can earn up to 2.5% on your savings. There are no fees, no minimums, and no earning caps.

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Our final question today comes from Rachel. Hi, I was calling to find out if you have ever dealt with a bed bug issue with any of your rentals. And if so, do you normally have like Terminax or pest control service every month? Do you pay for that for each of your rentals to prevent something like that from happening? Do you have any kind of prevention that you do? or have you run across this problem in any of your rentals and what the expenses, if so, what the expenses were in relation to that? I just was interested to know because that is becoming a bigger and bigger problem in some of the larger cities, especially in the city that we live in. Thanks.

Woo, bedbugs, lovely. No, I have never had a bed bug issue in any of my rental properties. thank God, knock on wood. But that being said, I've definitely had pest control issues. In several of my properties, we've definitely had lots of insects running around, spiders, and I realize this is going to sound bad, but we've had cockroaches. And that's not, and I'm talking about in the property that I myself lived in, in Atlanta, we had cockroaches in my own property. So it's not like I was being a slumlord. It was just that when you have a house that's built in the year 1911, and it has all of these gaps and cracks and all these little, like,

ways that insects and bugs can infiltrate the property. And it's surrounded by trees. So especially in the fall, you've got lots of leaf litter, which is where insects like to congregate. Those are the conditions necessary for having lots of pest control issues. So the way that we deal with that is a couple of things. So first of all, sealing all, sealing all, And you can never really seal all of the ways that a pest can get into the house because there are so many, especially if it's an older house. Our oldest house is 107 years old. There's no way we're going to seal all the drafts. But sealing as many drafts and cracks as you possibly can is one of the most effective ways of keeping the outside outside. The way that we've done that, number one, that means that if we have a property with old windows, we eventually replace the windows. Now, this isn't. necessarily something that we'll do right at the time that we buy a house because it's an optional upgrade rather than something that's necessary for the first tenant. But we do prioritize replacing the windows so that we can get better weatherproofing, more of a tighter seal in those

areas. And that actually does two things. It prevents pests from running in, but it also just makes it more environmentally friendly. It makes it more energy efficient. And so in that regard, it's better for the tenants and it aligns with my own values more. You know, I don't want to be wasting a whole bunch of energy by having these single-paned windows with lots of cracks around them. Even if I'm not the one who's paying the energy bill, that's still just a not nice thing to do. So that's one of the ways that we do it. For our Triplex, we had a pest control company come out to seal a lot of the entry points. So, for example, the dryer duct event, the one that leads from the dryer to the outside of the house,

we had them put a piece of netting over that so that mice or other insects couldn't crawl into the house through the dryer duct vent. We saw a bunch of cracks in the mortar in the foundation, and so we had a lot of those patched, had our contractor come by and just remorder a lot of the joints. So that's one thing that we've done. Keeping the yard free of debris or litter, so like leaf litter, for example, is one of the big things that attracts. insects. And again, I've never had any specific experience with bedbugs, so I just don't have the experience to comment on bedbugs specifically. But when it comes to insects and pests generally, keeping the yard mode, the hedges trimmed, leaf blowing, gutter cleaning, all of those are ways that you kind of keep the exterior of the property cleaner. And when the exterior is cleaner,

there are fewer pests that can get in. And then finally, you can hire pest control companies to come in and spray the unit. They'll typically, they'll come once a month and you just set up a recurring thing with them so that you don't have to bother managing it. They know to come once a month. They'll have a key in which they can access the property. The tenants are informed that they're showing up once a month. And then they just come in and they spray around the baseboards and around the cracks. And that'll usually be somewhere between about, in my experience, between about $40 to $60 for a monthly service depending on the size of the home. Now the thing that that does not include, but that is super important, and I'm kind of shocked that more rental property investors

don't talk about this, is termite treatment. Now, the way that we did this is that we planted ad vion cockroach baiting stations around the property. I'll link in the show notes, which are available at afford anything.com slash episode 130. I will link to the exact product that we use. It's on Amazon. I just check the price. It's $36. That'll get you a bag of 60 of these pieces of bait. So we just bought a couple of bags on Amazon and then gave it to our contractor and had him plant them around the perimeter of the property. That has helped a lot in terms of being that preventative force. So I think it's wise of you to be proactive about this and to be thinking about this because when it comes to pest control and pest management, prevention is so much

cheaper than a cure. So good for you for thinking about this in advance. In terms of the price that it's going to cost. Of course, that's going to vary depending on exactly what type of pests you're looking at, what type of prevention you're going to need. Are we talking about a single family home where you're going to have to possibly remorder the foundation? Or are you talking about a rental condo in a major city or a rental apartment in a major city? I mean, so the price is going to vary. And I'm not trying to dodge the question. It's just that I cannot give you an honest answer without knowing the type of property, the size of property, the type of pests that you're dealing with. the condition of the property.

All of those are going to play a role in this. But what I can tell you is that as a general rule of thumb, you can expect to spend approximately 1% of the value of the property per year on maintenance. Maintenance and minor repairs. I'm not talking about major repairs like you're putting a new roof on a house. Those are things that fall under the purview of CAPEX. But when it comes to ongoing regular routine maintenance,

plus minor little repairs, those will, as a broad rule of thumb, cost about 1% of the price of the property. So for $100,000 home, you can expect to spend about $83 a month on this. Ballpark. Now, here's a disclaimer. That rule of thumb, I think, becomes more true or at least more likely to be truer as you climb in price point. So if we're talking about, let's say, a $300,000 duplex, it's reasonable to assume that for a $300,000 duplex, you'll spend 1% annually, which is $3,000, which divides into $250 per month. All right, yeah, that totally makes sense. $250 per month for all of the maintenance and repairs, that sounds reasonable because we're talking about a property with a $300,000 price point.

When we go further down the price graph and we start looking at properties with a $60,000 price point or even an $80,000 or even $100,000 price point, you're more likely to spend a larger percentage of money when you look at it as a percentage on maintenance for this property because the property didn't cost that much to begin with. The most recent house that I bought, three years ago, I bought a house that cost $60,000. No, I'd take that back. It costs $45,000. and then we put another $15,000 in it.

So our total purchase plus repairs, we bought the house for $60,000. One percent of that is $600 and divided by $12. That's $50 a month. So if we were using that rule of thumb to try to guesstimate our maintenance and repair costs on this property, then we would be estimating $50 a month. But as I've already established, that's the cost of just the pest control alone. if you choose and if you think it's necessary to have monthly servicing, which it may or may not be. So that is something to bear in mind when you are considering these rules of thumb is remember that if you buy a lower price property,

you will spend proportionately a greater amount of that on maintenance. But the benefit is that you've bought a lower price property, which means that you're more likely to have a higher cap rate. And again, that's why I don't want, this kind of goes back to my answer to Cheryl's question. And that's why I really encourage people not to isolate certain line items. I mean, how much is pest control going to cost? Sure, that's an important question. But in the scope of I want to learn about how to invest in a rental property, what you actually want to know is what are the overall repair, maintenance,

and other operating expenses going to be? And what is that overall cost? Particularly as a proportion to the value of the property. because those two questions are what's going to lead you to figuring out the net operating income, which is the net income that you have after all of the operating expenses are paid. And once you've figured that out, that's when you'll know whether or not a property is worth pursuing. Because that net operating income is what leads you to your cap rate. So hopefully that was helpful.

I'm sure that was a much longer answer than what you were looking for. But the key takeaways of what I just said are, number one, when it comes to pests, prevention is key. Number two, that prevention does not necessarily have to come in the form of hiring a company to do monthly servicing. It can, but more effective prevention might be sealing the house through all of the cracks and gaps and drafts, as well as staying on top of other ordinary routine maintenance, such as leaf blowing and gutter cleaning. And key takeaway number three, remember that the the X that you are trying to solve for is not the cost of pest control per se, but the cost of overall of maintaining the property and more broadly the cost of operating the property.

So thank you so much for asking that question. Coming up on future episodes, in early June, we have an interview with Shane Snow. He is the founder of Contently, which if you're a freelancer, you might be familiar with it. It's a technology communication company. And he has also done a significant amount of research in how people make rapid breakthroughs. in any industry, how people hack the latter, and how people form excellent teams, ones that work together well. So you won't want to miss this episode. We recorded it live in person in New York. It's one of my favorites. I've been a big fan of Shane's for a long time. He's an incredible writer and a

really sharp thinker. So that is coming up in early June. If you have a success story that you want to share, head to afford anything.com slash voicemail. And please share your success story. If you've just bought your first rental property or if you've paid off your debt, if you have reached financial independence or generated enough passive income that you've just moved from full time down to part-time, whatever success that you have experienced in the past however long, a couple of years, I would love to hear about it. And I think this community would love to hear those success stories as well. And to kick this off, here is an awesome success story from our listener, Alma. Hi, Paula. My name is Alma. And I just wanted to share.

a little bit about my story with you. So I graduated school in 2009. I tried to join the workforce. It was during the recession. So trying to find a job and education was really tough. I saw an ad that advertised work in the United Arab Emirates. I responded, got the job, moved, saved up money to pay off my student loans about $35,000 in about a year and a half. I met my husband there, saved some more money, moved back to the U.S. We tried to start a business. even though we had no idea what we were doing and save money in the U.S., which was really hard. So we decided to go back to the UAE a second time around and really focus on not just saving this time, but investing our money in things that we were informed about.

So using sites like yours and other similar blogs and websites, we were able to have a plan and make our money work for us. So we invested in index funds. We have basically learned about real estate. and are ready to look into that when we move back to the U.S. We're currently traveling in Southeast Asia with our two-year-old son. We've been traveling for the last four months, and we are hoping to move back soon to the U.S. and really have a focused vision of what we're going to do with our money to help make it

grow. Again, a thank you for all the great information you put out there. Part of the reason that we had such a high savings rate is, you know, we took your philosophy of getting side hustles and being able to. to really maximize what you're able to save initially. We used that to the point where when we worked in the UAE, we were saving up to 90% of our salaries during most months because we had these side hustles.

We worked it to be around the time that we were with our son, if that makes sense. So we still made time to be with him and to have moments together. Anyway, again, thank you for the wonderful things you put out and for continuing to inspire people to reach their financial goals. Thank you so much.

And congratulations. I love stories like these. So if anyone else has a success story that they want to share, please afford anything.com slash voicemail. Let us know. Share it with the community. If you enjoyed today's episode, please do three things. Number one, most importantly, tell your friends.

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Rate us, leave us a review. And while you're there, please upvote any other reviews that you find helpful. I am so excited to hit the 500 mark. Oh, also, last thing, I promise. If you head to Afford Anything.com slash store, you can check out the shirts that we're selling. So we've got three shirts. One of them says take radical responsibility. One says you can do anything when you stop trying to do everything.

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My name is Paula Pant. I am the host of the Afford Anything podcast. I appreciate you so much for sticking with me. And I hope that you got something out of this episode. Thanks to all of you, and I will catch you next week.