Afford Anything - Ask Paula: Should We Sell a Condo if We’re Barely Breaking Even?

Episode Date: September 3, 2021

#336: Anonymous and his partner have a one-bedroom condo that they rent out in Pasadena, CA. The problem? They’re barely breaking even. Should they keep the condo, or sell it and make better use of the profits? Sam wants to know: how much of an emergency fund does a rental property need? Michael and his wife expect their taxable income to be less than $10,000 this year. Should Michael (age 56) take distributions from his 401k to minimize or eliminate their income tax burden? Shanon wants to switch to an ethical bank with values that align with hers. How can she create a framework for making decisions about financial institutions when authentic information is scarce? Sharon's husband purchased a property with a below-market loan in 2008. They now have an extra $4,000 per month, and Sharon wants to buy a property as a first-time buyer. They're torn between keeping the property or selling it. What should they do? Former financial planner Joe Saul-Sehy joins me to answer more of your questions. Do you have a question on business, money, trade-offs, financial independence strategies, travel, or investing? Leave it here and we’ll answer them in a future episode. For more information and resources, go to https://affordanything.com/episode336 Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything, but not everything. Every choice that you make is a trade-off against something else, and that doesn't just apply to your money. That applies to any limited resource that you need to manage, like your time, your attention, your energy. Saying yes to something implicitly means saying no to all other opportunities. And that opens up two questions. First, what matters most?

And second, how do you align your decision-making around that which matters most. Answering those two questions is a lifetime practice, and that is what this podcast is here to explore. My name is Paula Pant. I am the host of the Afford Anything podcast. Normally, we are a weekly show, but once a month, on the first Friday of the month,

we do a first Friday bonus episode. So welcome to the September 2021 first Friday bonus episode. After today's episode, we will be launching for the rest of September into the September sabbatical. And at the close of the show, I will talk more about what that is. One more quick announcement before we get into today's show. We're launching a four-week-long, weekly mini-series of live-streaming mini-classes on real estate investing. It's totally free. Once a week for four weeks, starting on September 21st, we're going to be live on the internet.

We'll kick off with a live stream in which we talk to real estate investors about how they figured out whether or not real estate was right for them. That'll be the kickoff party. And after that, we will have a live stream on what to do if you live in a high cost of living area. We'll have a live stream on the current housing market in 2021. And we'll have a live stream on how real estate can help you shave years off your fire timeline. You will learn insider tips, myths, mistakes. It's live. So there will be time for live Q&A. you can register for free right now by going to afford anything.com slash real estate. And when you sign up, you'll get all kinds of goodies, even if you can't attend live.

You'll get the recordings, you'll get worksheets, you'll get really cool stuff. So if you want to check out this free four-week live series, head to Afford Anything.com slash real estate. Okay, now on to today's podcast episode. Every other episode, I answer questions that come from you, the community, and I do so with my buddy, former financial planner, Joe Saul C-Hi. What's up, Joe? I am so excited, Paula. Happy to see you and ready to go. All right, let's do it.

Here's what we're going to talk about in today's episode. We're not fooling around. I know, right? See, look at that. We're on task. We definitely did not record some bloopers right before the open. That sure didn't happen. And if you listen to the end of the episode, you definitely won't hear anything.

Nothing. All right, so here's what we're going to cover in today's show. Anonymous and his partner have a one-bedroom condo that they rent out in Pasadena. But the problem is that they're barely breaking even. So, should they keep the condo or should they sell it and make better use of the profits? Sam wants to know how much of an emergency fund does a rental property need? Michael and his wife expect their taxable income to be less than $10,000 this year. Should Michael, age 56, take distributions from his 401k to minimize or eliminate their income tax burden?

Shannon wants to switch to an ethical bank with values that align with hers. How can she create a framework for making decisions about financial institutions, particularly given the scarcity of information? Sharon's husband purchased a property with what Sharon refers to as a below market loan in 2008. She wants to know, should she keep the property or sell it? That's what we're going to cover in today's episode, starting with Anonymous Joe. We give every anonymous caller a name. Typically, the name is based on a show or a movie that you're currently watching.

If you don't have anything, I've got something. Oh, well, then you know what? I will defer to you. Okay, so I'd afford anything a couple weeks ago. We posted our very first live event in New York City, and it was amazing. After the live event was over, and after we did all of the breakdown and put away the supplies and went through the surveys and did all of the post event work, the whole team took Tuesday off. And on that Tuesday, I watched Season 1 of Riverdale, the entire season 1, binge the whole thing in one day. Riverdale is based on the Archie Comics characters, which, fun fact, that is the only comic I have ever gotten into.

I became obsessed with it when I was 10 years old, and I subscribed to Archie Comics through, like, until the age of 25. Anonymous should be called Archie. So, our first question comes from Archie. Hi, Paula. Long-time listener, first-time caller. I have a question for you. So my partner and I have rental property. It's a one-bedroom apartment in Southern California, specifically in Pasadena.

We bought it a long time ago, about 15 years ago. Since it's a one-bedroom condo, it did not go up in value as much as, for example, a single-family home in Southern California. A little background. We bought it for $309,000. Now it's worth about $440,000. With our mortgage pay down, we have total about $275,000 in equity. After tax and commissions, we probably will get $210,000 if we sell the condo right now. My question is, should we keep the condo or should we sell the condo and invest it in another property?

which will grow more rapidly than this one-bedroom condo. Currently, we're renting it out for $1,750 each month. And we close to break even. We have probably about less than $200 cash flow, positive cash flow each month. And on top of that, we have the principal pay down about $300 a month. So each year we make about $6,000 for this property. I'm thinking if I sell this property and invest it in even just the index fund, I can make more money than this or I can get another property,

have probably more bedrooms or a single family home. so the value will go out faster. What are your thoughts? I appreciate your time. Thank you. Archie, thank you so much for that question. I'll tell you a few observations right off the bat. First of all, you are correct.

You bought this for $309,000. 15 years later, it's currently worth $440,000. Once you adjust for inflation, this property has not risen value very much. So I think that to the best of our ability to predict the future, which of course is limited, I think it's reasonable to assume that if the future plays out like the past, you're probably not going to expect much in the way of market gains on this property. You are, however, cash flow positive to the tune

of $200, which is $200 a month, $2,400 a year. Many real estate investors consider that good for one door that currently holds a mortgage. In fact, In the real estate investing community, when people set their criteria for what they want as they're looking for a property, it is not uncommon for investors to set the criteria of wanting $200 per unit, $200 per door for a property that also has financing on it. So in terms of strictly when you look at the cash flow, given the fact that they're still financing on this, or when you look at the total amount that you're making, that cash flow plus principal pay down, it's not bad. It's not terrible. I'm certainly not running for the hills when I hear that. But I also agree with you that you could be doing better. The tradeoff is that if you were to do better, the questions that that open up are, what specifically would that look like? And what I mean by that is, would it be a local property or a long distance property? Would it be a property with the same risk characteristics, such as the age of the property, the condition of the property, the neighborhood profile, class A, class B, class C, what type of risk characteristics would an alternate property hold? And how does that compare to the types of returns that? you're making on this property. So in order to answer your question as to whether you should keep the condo or sell it and invest the money elsewhere, if you wanted to buy a single-family property, which has the potential to cash flow better, have a higher cap rate, and potentially

have better market appreciation, although of those three factors, market appreciation, I believe, is the least, holds the least weight because it is the hardest to predict. If you were to buy an alternate property that has that greater potential, what specific neighborhood would you be looking in, what specific street would you be looking at, I'd like you to do some of that research first, to get a clear idea. You don't have to identify the particular property, but get a clear idea of what type of alternate you're considering so that then you can make a comparison between the two, and you can compare all of the factors, not just the cash flow, not just the principal paydown, but all of the factors, including the risk profile and the age

and the condition of the property. You can compare all of that side by side and then see which one has better risk-adjusted returns. You know, I have nothing to add on the analysis, but I would like to commend Archie on something I thought he did really well that when I was a financial planner, I saw people mess up all the time, Paula, which is that they would spend too much time evaluating the sunk cost, evaluating. Evaluating. where they are and all the time and the energy they put in this and then dreaming about a future that may or may not happen. And you know what? People didn't do this as much with real estate as they did with stocks. I would recommend diversifying a position and someone would say, well,

you know what? This has gone down X amount. When it comes back to Y, I will sell it. Or once it goes up to some other number, I will sell it. It isn't about whether it will come up. It will come it's about how will the portfolio perform if you keep it versus how is the portfolio going to perform if you change it and what I love is that Archie already recognizes that this money could be moving faster and because of that I'm looking at the cost to make a move what is what is my transaction cost to make this happen right and then to your point doing that comparison between the two of the future not just the old place but the old place and the new place when it comes to stocks and especially stocks of companies that were emotional about, I feel like

people have problems with that. You know, I would meet with people and they go, well, you know, I worked at Ford for a long time. I know it's 70% of my portfolio was in this one stock. And man, when it gets back up to X number. And by the way, this was in Detroit during the down years. And the bad news is, is that that stock, of course, over the short run, you know what happened for people that don't know what happened, it got really bad. It got very, very bad when by diversifying

it, the portfolio may not have done better. We don't know that. We can never predict it. But at least we know that we're not in one company and we're not worried about one company. But a lot of people spent a lot of time very focused on predicting the future. On the topic of predicting the future, I want to elaborate on why I am not a huge fan of thinking about market appreciation. And it is for the following reason. A rental property, any property, makes money in a variety of ways. One way in which it makes money is that free cash flow per month, the cash flow that's left over after all operating expenses and debt servicing are paid. One way that it makes money is through the principal paydown, so through the equity growth through principal paydown, that debt servicing. One way that it makes

money is through the tax advantages that are intrinsic to holding a rental property. So for example, you can take depreciation against your property, which offsets some of the cash flow that you earn. So the ability to harness tax depreciation, the ability to offset passive gains, including other passive gains in your portfolio because the IRS considers rental real estate to be passive income. That's not just my opinion. That is the IRS designation of this level of income. And so passive losses can offset passive gains.

So all of those are various ways in which rental real estate makes money. You'll notice the way that it makes money that I haven't mentioned is appreciation. and there are two forms of appreciation. One is market-based and the other is forced. Market-based appreciation refers to broad macroeconomic forces outside of your control that send the value of an asset up. The problem is that this is outside of your locus of control. There is literally nothing you can do about it. The second form of appreciation is referred to as forced appreciation, and that takes place when the decisions that you yourself personally make. make, cause the value of the property to rise. So, for example, if you do a smart renovation of a property, meaning that you are strategic, you know what you're doing, you're not just throwing

money at it, but you have a informed plan of how to execute a strategic renovation in which every dollar that you put into that renovation results in greater than $1 of added value, that is forced appreciation. And that's actually one thing I love about real estate is that hybrid between an investment and an entrepreneurial activity. So if you think of the fire acronym F-I-R-E, and if you think of F-F-F-F-F-F-F psychology, I-investing, R, real estate, e-entrepreneurship, it is perfect that R is that middle letter between the I and the E, because real estate really is that bridge between the I-investing and the E-entrepreneurship.

So all of that is to say there are two forms of appreciation. One is market-based. The other is forced. those two. Forced appreciation is the one that's inside your locus of control. Market-based is not. That's why I encourage people to give very, very low weight to market-based because that's the thing you can't control. Focus on what you can. This reminds me, Paula, of a quote from the man who ran a General Electric for a long time, Jack Welch. And I'm not going to get the quote exactly right, but it was something about confronting reality the way it is and not the way you wish it were or hoped it may be.

We don't live in should. We live in is. Yeah. And I think that's incredibly important. And, you know, hope that your Fordstock is going to go up, hoping that something's going to appreciate, hoping that the market's going to continue, waiting on politicians to make the move that is going to change everything. Washington has had a problem de jure that we're all waiting for my entire career. The problem changes all the time, but there's always something in the way. So somebody else in the way. So I love this, focus on what you can. can control. Right. And Archie, I want to address the suggestion related to putting this $210,000 into an index fund. Depending on the constitution of the rest of your portfolio and depending on your specific goals, that may or may not be a fantastic idea. Rental properties produce returns that have different characteristics than the types of returns that index funds produce. Now, notice that I didn't say a different percentage of returns. I said different characteristics.

So let's assume, we'll just take a step back from your specific situation, Archie, and broaden this out for a conceptual understanding. Let's assume that you have an index fund and a piece of rental real estate. And let's assume, in this example, that both investments over a long-term aggregate average make a total return of 8% or 9%. We're talking cap rate plus appreciation for the rental property. We're talking dividends plus appreciation for the index fund, right? Total long-term aggregate return of 8% or 9%.

But the way that those returns are expressed, even if the returns are identical, the way that they're expressed will be different. returns on a rental property biased towards the income stream. And that income stream is expressed as the cap rate, because the cap rate is the unleveraged dividend. It's the cash flow that you would have if the property were held free and clear. The returns from an index fund bias towards capital appreciation. And the dividend tends to be a smaller portion of the overall.

return. So one of the questions that you need to ask yourself is, do you want to hold rental real estate as an alternative form of dividend investing? And there are many arguments for holding dividend focused or income stream focused assets in your portfolio. Maybe you want to hold it as an alternative debt, a bond allocation. And that's a different rabbit hole that we can go down. but the role that it plays in your portfolio is a major part of the discussion around whether or not you should diversify into rental real estate. And so it isn't as simple as saying, well, I think the returns would be higher on an index fund. Sure, but the returns on equities are still higher than the returns on bonds. And yet, there's space for bonds in a portfolio.

Why? Because the characteristics are different. So it isn't just returns that we want to look at. It's the overall characteristics of all of the assets in your portfolio and the way that they interplay together. That's why I say that depending on your goals, your timeline, and the characteristics of the mix of investments that you want, moving this $210,000 into an index fund may or may not be the right fit. It depends on, if you think about you're making a stew, do you add more salt to the stew? I don't know. It depends on how much salt you've got in there and what other ingredient.

you've got in there. So, Archie, to your question, do you keep the condo or do you sell it and invest the money elsewhere? As usual, we don't give you the answer to the question. We give you frameworks for how to think about the answer. And hopefully you now have better frameworks around how to think through the tradeoffs between scenario A, keep the condo, scenario B, sell the condo, invest the in another rental property, or scenario C, sell the condo, invest the money in index funds, or scenario D, which we actually didn't talk about, which is borrow against the condo and invest that money elsewhere, whether that be in another rental property or in an index fund. What we've talked about in this answer, the discussion that we've had around risk characteristics

and return characteristics can hopefully inform the way that you think. think through this board of scenarios. So thank you, Archie, for asking that question. And best of luck with whatever route you choose. We'll come back to the show in just a second, but first... The holidays are right around the corner, and if you're hosting, you're going to need to get prepared. Maybe you need bedding, sheets, linens. Maybe you need servware and cookware.

And of course, holiday decor, all the stuff to make your home a great place to host during the holidays. you can get up to 70% off during Wayfair's Black Friday sale. Wayfair has Can't Miss Black Friday deals all month long. I use Wayfair to get lots of storage type of items for my home, so I got tons of shelving that's in the entryway, in the bathroom, very space saving. I have a daybed from them that's multi-purpose. You can use it as a couch, but you can sleep on it as a bed. It's got shelving. It's got drawers underneath for storage.

But you can get whatever it is you want, no matter your style, No matter your budget, Wayfair has something for everyone, plus they have a loyalty program, 5% back on every item across Wayfair's family of brands, free shipping, members-only sales, and more terms apply. Don't miss out on early Black Friday deals. Head to Wayfair.com now to shop Wayfair's Black Friday deals for up to 70% off. That's W-A-F-A-I-R.com. Sale ends December 7th.

Fifth Third Bank's commercial payments are fast and efficient, but they're not just fast and efficient. They're also powered by the latest in payments technology built to evolve with your business. Fifth Third Bank has the big bank muscle to handle payments for businesses of any size. But they also have the fintech hustle that got them named one of America's most innovative companies by Fortune magazine. That's what being a fifth third better is all about. It's about not being just one thing, but many things for our customers. Big bank muscle, fintech hustle. That's your commercial payments.

a fifth third better. Our next question comes from Shannon. Hi, Paula. Hi, afford anything team. My name is Shannon and my question is about how to create a framework for making decisions on financial institutions. I've had accounts at a giant bank for more than 20 years. Over the years, there have been countless new stories of large financial institutions who have conducted unethical or illegal activities in pursuit of record-setting profits, from opening accounts without the account holder's knowledge to funding loyal pipelines and deforestation efforts, to discriminating against historically marginalized communities and people of color. The list of nefarious activity goes on and on.

Having a national bank was important because I've had to move quite a lot for work. and there are several times each year when I've needed to go into a branch. So I'm not sure a wholly online bank would work. But I really want to make a change to a bank that is in alignment with my values, especially when it comes to environmental and social impact. But honestly, it's a little overwhelming and it's hard to find authentic information about banks. I've identified a number of institutions who are certified B-court, community development financial institutions, or are members of the Global Alliance for Banking on

values. So I feel like that's a good start. What other factors should I be considering? Are there other resources I should use in my research? And honestly, how do you decide? How do you make this decision that is in alignment with your values when you feel like the industry has a different goal. Thanks. I look forward to hearing your thoughts. Shannon, first of all, thank you for asking that question and thank you for thanking the team at afford anything. I know that they appreciate that, so thank you for saying that. I love that you've done this level of research and that you've thought so carefully about how to align your decision making with your values, which is what the show is all about. Now, you mentioned that you've identified institutions

that are members of the Global Alliance for Banking on Values, you've identified community development financial institutions, and you identified certified B-corps. Those are all fantastic barometers, but I want to call attention in particular to the certified B-corp, because the process of becoming a certified B-corp is extremely rigorous.

It's difficult for a business, for any business to become a certified B-Corp. For people who are listening who haven't heard about this particular certification, certified B-Corps are businesses that must prove that they've met the highest standards of verified social and environmental performance and public transparency and legal accountability. they are built to balance profit and purpose. They want to use their status as a corporation for a force for good, and they want to benefit not just shareholders, but all stakeholders. So, for example, the environment is a stakeholder.

Their employees are a stakeholder. So you can't just slap a B-Corp sticker on yourself. receiving B-Corps certification is the result of a very long process, a very rigorous assessment of a company's impact on its workers, its customers, its community, and its environment. There's a website called B-corporation.net, which we will link to in the show notes, in which a company's B-impact report is published so that all of this information is transparent. and when companies are on the B-Corp list, they must maintain this rigorous combination of third-party validation, public transparency, and legal accountability. So, Patagonia, which is an outdoor recreation apparel company, it's been long known for years for its commitment to the environment.

Patagonia is a certified B-Corp. New Belgium Brewing, the beer company, they're a B-Corp. Cascade engineering, it's a plastics manufacturer based in Grand Rapids, Michigan. They're a B corp. Grove Collaborative, they're a sponsor of the show. They're a B corp. But if you have found financial institutions that are certified B corps, you can be reasonably confident that in order to get that certification, they have had to go through very rigorous

vetting. And so as far as the decision-making framework, I mean, they've been vetted. I guess the question then becomes, do you trust the B-Corp vetting process or not? The process itself is also both transparent and highly regarded, not just by the banking industry, but by some of the most reputable and socially responsible companies across a wide variety of industries. So I don't see any reason to doubt the B-Corp vetting process. When it comes to investment management companies, I know people really like and gravitate toward Vanguard because of the fact that they are owned by shareholders. And I think the same can be said for credit unions and local credit unions or affinity-based credit unions where you have a lot of people that have a similar goal or part of a similar set of people.

Those will often align with your values and your interest. And the neat thing is, is that while you can't tell a credit union exactly what to do, you have, more of a voice because as a member of the credit union, you're a part owner. So local and national credit union organizations, I think, are another thing that a lot of people look at. And I also wanted to say that I really, I think Shannon's distrust of large banks is well placed. I know that most people know about what happened at Wells Fargo. I know because I had seven checking accounts there. No, I'm joking. I'm totally joking. I did not. Too soon. Too soon. For most on Wells Fargo. And even since them. Wells Fargo has had several times in the news where they've done some things that are

very bean-countery and frustrating. So that drives me crazy. And I remember a quarterly earnings call, a Bank of America earnings call, where Bank of America admitted on the call because they were on with their shareholders, who, by the way, different than a credit union, shareholders are different than people that are saving into savings accounts at that bank, that they weren't paying a very high interest rate because, quote, people, weren't demanding it. And so they were keeping the money for their shareholders. A credit union isn't going to, isn't going to do that. And if they do that, it's because the management team and the ownership has decided that there might be some other thing that is more important at the time,

not just sending it to the shareholders versus sending it to the people that trust them with their money and with their bank account. I like that. There's another way to evaluate banks, Paula, that I think people should be aware of. And this was something that we all wanted to do back in 2007 and 2008 when we had a big rumbling in the financial community. And there's two statistics to look at. One is called a CET-1 ratio. And this is, does the bank have enough capital to sustain themselves if things get bad? Now, the CET-1 ratio, which is common equity to.

or one compares the amount of equity in the bank minus the revaluation reserves. In other words, do they have a lot of money that's at risked that's outstanding that's loaned out to other people? Do they have enough capital? A lot of people call it the capital requirement. Do they fulfill their capital requirement? That number, the higher the value, the better the bank's capital strength. So that's the way you can compare one bank to another.

A bank has to have at least an 8%. value. So that's the bottom. They have to keep 8%. But that number, the higher it goes, the better. And you might be asking yourself, where do I find that? Any bank that is open for business should have it on their website. So you should be able to find their CET one ratio and you can compare two banks against the other. The other one, and this one I don't like as much, which is why I'm going to mention it second is there's rating services. S&P, Moody's, Fitch, different rating services that rate banks against each other. I mentioned the second polo because bank ratings kind of failed us all back in 2007. There were a lot of highly rated institutions that did very, very poorly.

And man, now, I hope and I think, and we've heard from these rating institutions that they've changed their methodology so that that doesn't happen again. but we haven't had an event like that again. So we haven't had the acid test yet to see if that's the case. But certainly I would definitely think because it takes five minutes to do, look at two banks' ratings against each other. Shannon, the last thing I'll say is, you know, the last piece of your question, you said, how do you make this decision when it feels like the banking industry has a different goal that ultimately doesn't align with your values? How I would respond to that is that the good news is there is not just one monolithic banking industry. There are many, many players inside of that industry. And some of those players are terrible.

And I'm going to call out Wells Fargo by name because we all know what happened there. Can I take Big of America then? Yeah, yeah. Hi five. Yes. Yeah, some of them are absolutely awful. and other ones are fantastic. So I would caution against all or nothing thinking

because in virtually any industry or any field, you will find good players and bad players, good agents and bad agents. They're everywhere. You find bad agents in the nonprofit world and you find good agents in the banking industry and vice versa. The good news is that despite the health, headlines, headlines that fuel our negativity bias, there are a lot of great players in the banking

industry. And there are vetting processes that allow consumers to find them. So thank you, Shannon, for asking that question. Speaking of banks, Sam wants to talk about cash reserves. So let's hear from Sam. Hey, Paula, and the Afford Anything team, this is Sam. And I'm calling. I'm calling. because I am curious how much you guys think one should save monthly for like an emergency fund for your property. You know, if at a certain point you hit X amount, like what is that X amount when you stop contributing to that? You know, having some type of prudent reserve seems great. I just don't really know what that amount should be. I'd love to hear y'all's thoughts on it. Thanks so much. Hey, Sam. Thanks for the question. So short answer and long answer. The short answer that I give to people

when they ask that is minimum, minimum three months of gross rent. And I say that just so I can like have a five word answer. And I've known Paula for a long time. I've never heard that five words. Oh. I've heard the 50 word answer. But you could do this and I think you should do this. But I think really if you thought about this and this and this, it might be this. But you know, when you factor in these things, well, then maybe it's probably this, which is what we appreciate about Paula. Well, I'm about to give that answer next. Here it comes. So, Sam, the short answer is minimum three months' growth. The long and better and more accurate answer is the following. There are a few different ways you can look at this. So, Joe, I can see you laughing at me already.

Why? I'm not laughing. I'm admiring. I am not worthy. It's fantastic. The thing is, when you make an emergency fund a reflection of gross income or a reflection of historic expenses, you're inherently making the assumption that income and expenses in the future will be reflective of what they have been in the recent past. But that doesn't necessarily correlate with the needs that a property has. So one way that you could look at this is by, if you've owned the property for a while, pull up your profit and law statements, your P&L statements from the last few years, and look at historic data around how much you, you have actually spent on that property in a given year.

We're talking repairs, maintenance, major capital expenses, debt servicing, cash out of pocket if there was a vacancy. Look at what you've actually spent over the last two years and then divide that by 24 so that you have a monthly average. That'll give you an idea of how much you spend, how much you actually spend, per month. It'll give you a more clear idea than using a crude barometer like, oh, it'll probably be around 50% of gross. And so once you see what you've actually spent per month, then you can save a six to nine month emergency fund similar as what you would do in your personal life.

So that's one possible way that you could do that. But of course, that only applies once you've owned the property for a while. However, here's the problem with what I just said. If you had a of deferred maintenance during the past few years, and you've got some big CAPEX coming up, then what I just said is going to not work, because the historic data that you're looking at is a function of a period of time where there was deferred maintenance, and CAPEX didn't get handled, which means that the future will not be like the past. And so scenario B, like the alternate route that you could do when you're trying to figure out how big of an emergency fund you should have would be to game out the CAP-X needs of the property for the next few years.

And there are really two different ways you could do this. The simpler way would be to take a look at the components of the property and just eyeball what's likely to fail in the next five years. If you've got a 12-year water heater and it was installed 10 years ago, all right, that thing's probably on its last legs. maybe you'll get lucky and your 12-year water heater will last for 18 years. One can only hope. But you might also get unlucky and that thing's going to puts on you tomorrow.

So one way that you can take a look at what KAPX is coming up is by looking at the property, noticing the age of its individual components, the siding, the roof, the windows, the plumbing, the garbage disposal. and based on the longevity of each individual component, map out what's likely to fail in the next five years, and then how much is that going to cost to replace, and then set aside an emergency fund that reflects all of the CAP-X that you reasonably expect for the next five years

plus a handful of months of vacancy. That would be the simpler way to make a CAP-X estimate. The other more complicated way of making a CAP-X estimate is to do what the HOA of a major condo would do, which is to have a big detailed spreadsheet that lays out every individual component and when it was installed, or at least your best guess as to when it was installed, and then how many years of life it has left, and then divide that out so that you know how much each individual component is costing per year or per month, and then come up with an average from there.

That would be the other way to do it. But that's more time consuming. It's more spreadsheet building. But it could be a fun, if you're into that, it could be a fun exercise. It could also be a fun exercise to do both of those to look at what you expect for the next five years, but then to also do this more theoretical spreadsheet building thing and then compare those numbers to see how what you estimate as your yearly average compares to what you actually estimate in the next five years. Like if you really want to go into the weeds, that would be the

way to do it. You know all the fun weekend activities. I know, right? I am so much fun at parties. That's great. There's another piece of this, Paula, which is if you are bringing in income from another source and you talk about vacancy for X amount of time, I think you also need to talk about if it gets really bad for me, if that Black Swan event happens, as they call it, where would my other sources of money be? And I think I would want to have a bigger reserve if I'm not able to somehow fill in an extended vacancy with some money that I bring him from somewhere else. I never want to do that. But I think if I have a very secure job with great cash flow outside of this, then I could probably go a little smaller with that reserve. And if I don't, and if this is really my primary source of income,

then I need to make sure that I shelter that and I have a big enough moat that I can withstand a storm. Yeah. You know, and that reminds me of if a person asks, hey, how big should my emergency fund be for myself personally? And that was a discussion that definitely came up a lot at the start of the pandemic. I mean, part of the answer is what are the other risk factors in your life? And part of that, like I hate to say it, but part of that is, look, are you single or a single income couple? Or are you dual income? because at least for your personal life, if your dual income, one person loses their job,

you still have the income of the other, right? So that's one of the factors to keep in mind. Well, and I think a factor the other way is, are you supporting a rental property, you know, that normally is cash flow positive, but what if it's cash flow negative? When I was a financial planner, I would ask people that. Are there any people or things or institutions or whatever that might need money at some point where you're going to have to take your own personal money and invest it in this thing, A rental property could be that.

Right, right, exactly. Like, if you own a business and you don't want that business to fail, and if push comes to shove, you're willing to put your own money into the business to staunch the bleeding in the event of negative cash flow. If you're willing to put some of your own money into making sure that you can meet payroll, which many entrepreneurs are willing to do, then, yeah, that does inform the size of the emergency fund that you keep. And I love that analogy because even if you only own one,

one rental house, you should always treat it like it's a business. Separate it, treat it like it's a business, give it its own balance sheet, make it run on its own. Don't treat it like a pastime, treat it like a business. Exactly. Exactly. We have a free ebook. It's called seven expensive mistakes that rental investors make. You can download it for free at afford anything.com slash mistakes. It's a good introduction and expansion to some of the things that we're talking about here. You can find it affordathing.com forward slash F*** anything.com forward slash seven oopses. What else you got, Joe?

I love that you say forward slash. Like anyone would ever backslash that? Oh, man. Well, it's almost like, it's funny. So you're giving me the old guy comment with a forward slash, right? Which is funny because even me, I laugh and people go, you'll find us at www. Oh, as if I was going to go, WHRZ dot. You'll find us at H-T-T-P-S colon, forward-slash, forward-slash.

W-W-W-W-W-Afford-anything.com. It's actually H-T-T-PS because we want to be safe. Exactly. Afford-anything.com slash mistakes. You're never going to forget that URL now. Thanks, Joe. So the fact that I say forward slash means I'm I'm old, but the fact that I said W, didn't say WWW means I'm not that old.

Exactly. I'm like in that middle ground. Yeah. Is that how we define middle age now? Oh, is that it? You know what? It might be. It might be.

They still say pound sign, not hashtag. Do you call people on the phone without texting them first? No, I'm serious. Do you? It actually depends on who they are in their age. I think that puts me a middle age too. Yeah. Because I work in tech, right?

So I'm like, okay, it's Paula. I got a texter. But if it's Len Penzo, people listen to the Stacky Benjamin show, no. I will call Len. I will text you. Len will never answer a text. You will never answer a phone call. Yep.

And I would definitely never answer an email. Especially from me. So anyway, download our free ebook. It's at H-TPS colon slash slash. www. afford anything.com slash forward slash forward slash mistakes. And with that said, thank you, Sam, for that question.

We're going to take one final break for a word from our sponsors. And when we come back, we'll hear a question from Michael, age 56, who wants to know if he should take money out of his 401K. So stick around. It's week two of Canadian Tires early Black Friday sale. These prices won't go lower this year. So you're lying on the floor? Save up the 50% November 13th to 20th.

Conditions apply, details online. Make their holiday unforgettable with a gift that says it all from Pandora Jewelry, a gift that tells a story and shows you know theirs that doesn't just sparkle, but speaks. From new festive charms to forever rings and personal engravings, this season give a gift that's perfectly theirs. Whether you're shopping for a shiny surprise for your significant other, matching bracelets to celebrate your friendship, or a heartfelt gift for a family member.

Say more this holiday season with Pandora. Shop now at CA.pandora.net or visit your closest Pandora store. Our next question comes from Michael. Hi, Paula. My name is Michael. I live in New York, and my wife and I are both 56 years old. We have two adult children. Our daughter's 26 years old, working and living on her own, and our son, is 21 years old, and he's just graduated from college and back living while it's at home. After 30 years of working and saving, I decided to pull the retirement lever as of 12, 3rd. 31, 2020, and I have no plans to return to work. I'll be taking a well-deserved break. My wife and I have over $3 million in tax-advantaged retirement accounts and have a very small

mortgage on our home at a decent rate, and we don't think it's worth paying off right now. We're paying our bills with comfortable post-tax savings and expect our taxable income to be less than $10,000 this year. As a person over 55 years of age, I believe there'd be no penalty to take distributions from my 401k now. We're interested in minimize or even eliminating our income tax burden this year. Is this a good opportunity and cost strategy given our earned and investment income will be solo this year? And maybe next year too. Thanks, Paula. Michael, this is one of my favorite types of questions. I think many people focus on putting money into investments when they also should be thinking about how do I take money out. Now, initially,

if you're listening to us and you're 25 years old, I don't think you need to be thinking too much about how am I going to withdraw for my 401K? But I love this question because, as Stephen Covey said in Seven Habits of Highly Effective People, when you pick up one end of the stick, the other end comes with it. And this is definitely the other end, right?

How do we take the money out? And I think you are 100% correct that there'll be very little consequence. You're going to be in the lowest tax bracket or at least a very low tax bracket. And paying attention to those tax bracket lines, Michael, I think is going to serve you nicely. Here is a strategy that I really like.

If you have money in pre-tax and in post-tax deferred spot. So that would be like a 401K where you put money in pre-tax and either a Roth 401K or a Roth IRA where that money is going to come out tax-free, I love taking out money all the way up to the tax bracket line, whatever that is in any given year, from the pre-tax position, and then money above that take from the after-tax tax-free position. So you could successfully be living maybe midway into the next tax bracket and only be taxed at the lower tax bracket. And this is why, going back to the 25-year-olds listening, this is why I love tax diversification, straight optimization because I don't know what it's going to look like in the future, but I sure like having some at different pots that I can go to, right?

And because the rules are going to change and we don't know how, staying diversified with your tax approach gives you wonderful opportunities like Michael has right now. So, Michael, I'm on board. I think it's a great time. If you know that you have very little taxable income, pull money from that 401K. And the only thing that I would stress that you should do first is if that money's in a 401K, you've separated from service, you are still not yet 59.5. Just make sure in the plan document that that's okay. I am 99.99.95% sure that you are okay. But because you're not 59 and a half yet, I would just check it with them.

It's a quick phone call to make sure that you're not going to regret this later. And Joe, I'm sure that's part of why you talk about the tax triangle so much. So for people who are listening who haven't heard this discussion, the tax triangle is, you imagine a triangle, one corner are tax deferred accounts. Triangles have corners, right? It's like a circle, but with three points. Would you call it a corner? Is that what a triangle has? Does anybody not know a triangle?

This is like the most intelligent show ever, and you're trying to explain what a triangle is? I mean, is the word for the pointy end of a triangle? Is that word corner? I think it is. Is that what you call it? I think we can run with it, even if there's a more succinct title for those pointy spots. Oh, I'm literally laughing so hard. I'm crying right now.

Okay. One of the pointy ends of the triangle. Edge? Triangle edge? Corner? Corners. Corner. one of the triangle corners has tax deferred money.

You see, look, now no one's ever going to forget this either, right? Tax triangle burned into their brains. We are burning Joe's tax triangle into your brain. So, yeah, one of the corners of the triangle has tax deferred to money. One of the corners is tax exempt money and one of the corners is taxable money. And if you have that triangle built out where you've got money in all three of those accounts, So Roth accounts, pre-tax accounts, and your standard brokerage taxable accounts, if you've got those three corners of the triangle built out, then not only will you be able to have an assortment of buckets to pull from so that you can make the kind of choices that Michael is making, but also you will always remember that the pointy corners of a triangle are referred to as corners. Is that really what they're called?

Are they called corners? I'm Googling this. It just doesn't sound right. Corners are what squares and rectangles have. Don't you hate that when you're podcasting when you're tired and the word just seems wrong? Like, that just seems strange today. I'm literally Googling pointy side of triangle. What is the pointy part of a triangle called?

Ooh, a vertex is a point where two or more curves, lines, or edges meet. I feel like I used to know that. The three vertices are joined by three lines segments. It's a vertex. That's the word. You feel better, don't you? Yeah. It's not a corner at all.

It's a vertex. No wonder corner didn't sound right. No wonder. Well, while Paula gloats, Michael. And you wonder where this went off the rails. Yes, fantastic idea. Love it. Congratulations on a great job of saving.

And it sounds like raising two great kids. So thank you, Michael, for asking that question. Our final question today comes from Sharon. Hey, Paula, this is Sharon. I do have a question for a below market rate type of loan. My husband bought his property back in 2008, and it was a below market type of loan. The benefit of that is demortgage payment is comfortable every month.

But we're in this point where we paid off all of our cars and daycare is done. And so for my income, I would have an extra $4,000. I would say a month that could just be in the savings. So we're at this point where we're wondering, do we keep this below market rate property? And then I would just save that $4,000 a month and buy myself my own property as a first time home buyer. Or do we just get rid of the below market rate? property and whatever we make out, make after the loan is paid off, whatever is left, we can use as a down payment for a mortgage that we're not tied to any of this type of loan. So just wondering, I want to get your feedback about that. Thank you so much and I love your show. Thanks. Sharon, thank you so much for asking that question. So I have a couple of questions back to you.

So you mentioned multiple times that this is. a below-market-rate loan. You said your husband bought this property in 2008. It's a below-market-rate loan, and the advantage is that that means the mortgage payment is a comfortable amount. I'm struggling to understand what a below-market-rate loan is, because if you took out this loan from an institutional lender, such as a bank or a credit union, then you would have received market rate at the time that you took it out. Now, you may have received the best possible rate at that time that a person could receive based on their credit score and qualifications and based on prevailing mortgage rates at the time that you took it out. It may be a very attractive

rate. It may be a very low rate. But if you took out this loan from an institution, then by definition, whatever rate you received would have been market rate at the time. So the only other alternative that I can come up with is that you took out a private loan, possibly from a friend or a family member, and that that person gave you an interest rate that was lower than what you could have received from an institution. But from the way that you asked the question, I'm not getting that impression. I think there's a third option, Paula, which is has a loan on a property that's below the average cost in the market. And so because of that, because she talked about the mortgage payment being very comfortable, and that's an upside, that it's a small amount.

Maybe what she's really referring to is not the rate of the loan, but the fact that the property value is less than average in the area. So if that was the case, then it would be a market rate loan, but it would be a property rate loan, but it would be a property value. purchased at a below market property. Yeah. Sharon, if you purchased a below market property, then that's fantastic. That means you got instant equity at the closing table. But if what you mean is that the property was one that you acquired for below market rate, great, but that doesn't really affect anything going forward.

You got the instant equity at the closing table, end of story. Now the property is worth more than what you paid for it. She also may be talking about the same thing that Archie was talking about, which is it's not appreciating as quickly. Maybe she's saying that. I don't know either. Yeah, because, you know, because Sharon, when you said, when you asked, do we get rid of the below market rate property and use the profit as a down payment for a mortgage? And then you said that if you were to do that, that means that you're no longer tied to a below market type of loan. I mean, you could still take out a loan at today's interest rates, which are also at.

at a generational low, and you would get an interest rate that would be pretty comparable to whatever you received or your husband received in 2008. Because the rates that banks and credit unions are giving today are, relatively speaking, rock bottom. I mean, we are living in the era of cheap credit, and we have been for a long time now. And granted, that was also true in 2008 as well. So if it's a low interest rate loan, I think our answer then, Paula, would be, and it's going to be similar to what we told Archie, I think either way, which I think it's going to be, if it's a low interest rate loan, it's not about the loan, it is about the cap rate. So that's number one.

Number two is, and going back to my answer with Archie is if it's, it isn't about what it's appreciated in the past, it's what your money's going to do in the future. So if you think you can redeploy the money and make more money at a similar risk level, then by all means, it's a great move, assuming that the goal stays the same, right? Like if you move the money and the goal changes, well, then that changes everything. But if the goal is the same with property one as it would be with property two, then do the homework we talk to Archie about and make your best move there. Sharon, what you might be saying is that the interest, rate on the current loan that you have is lower than the rate that you could get on any new

mortgage that you take out today. And this means that if you were to sell the property, you'd be trading a lower interest loan for a higher interest loan. And you're wondering if that trade-off is worthwhile. So if that's what you're asking, then I'll reiterate the idea that it's not about the loan. It's about the property. If the property is giving you great risk-adjusted returns, great returns relative to its risk profile, keep it. And if it's not, then as Joe said, redeploy that money. But it's not about the loan. It's about the property. The only other thing that I would add is that as a principle, as a philosophy, I would recommend evaluating an asset not based on the type of loan that you have, but rather based on the asset

itself, don't use a cheap loan to justify holding an underperforming asset. And now I'm not saying that this property is underperforming. I'm stating, as a principle, never in any situation, use a cheap loan to justify holding onto an asset that you would not hold onto in cash. In fact, one of the things that I teach my students in my course, I have a real estate investing course and I have principles that I outlined within the course. And one of those principles is, if you wouldn't buy it in cash, don't buy it with a loan. And what that means is not that you literally have the cash to buy it. I'm not stating that. I'm stating if in theory, something is not worthy of being held in cash, then don't take out a loan to hold it.

which is another way of saying don't use debt to justify holding a mediocre deal. So that's the only other comment that I would make. It sounds as though this loan, whatever its characteristics are, is a loan that you think is a very good deal and a loan that you would like to keep. And that's great. But don't keep the loan just for the loan's sake alone. Only keep the loan if the asset that it's holding justifies having a loan, no matter how good the loan is. So thank you, Sharon, for asking that question.

Joe, we did it. We did do it. That was fun. I know what a vertex is now. I'm so happy. I'm going to throw that word around everywhere. I'm just going to work it into conversation. Find a way to include it in all my text messages.

Not your phone calls or your emails. It'll be just your text messages. Can my smartphone make a call? It would be crazy talk. Your microphone seems so unloved. Speaking of microphones, Joe, you get on the microphone three times a week to record a particular podcast that I'm sure you'd like to talk about. Yes, and that you're on and that people can hear us live every, almost every Monday at 5 p.m. Eastern. If you download the fireside app or if you follow us on Falk Stacking Benjamins on social media, listen to it wherever you.

you're at on Instagram, Facebook, Twitter. You'll get a notification that we're going live now, and you'll hear Paula quite often. Or you can go just to our website, which is at stacking benjamins.com. Well, that is our show for today. Thank you so much for tuning in. You are listening to the first Friday episode of September 2021. Now, the first Friday episode is a monthly bonus episode that we do. typically we do episodes once a week, but on the first Friday of every month, we do a first Friday bonus episode. And since September is starting with a first Friday, you know, since the first Friday comes so early in the month of September, we decided that this would be a fresh show. But for the rest of September, I am going into the third annual September sabbatical. Now,

what does that mean? For the past three Septembers, well, I guess this is the third one. So for the past two Septembers in a row, our entire team, and there's a whole, and there's a whole, and there's a whole team that goes behind creating these episodes and running afford anything, the organization, our entire team is able to shift their focus for one month, away from producing podcast episodes, and onto the many other projects that we're running. So what else are we cooking up behind the scenes that you might be interested in? Here is a quick rundown in no particular order. Number one, we've launched a new newsletter. It's called First Principles. It's all about how to think from first principles, how to be a better thinker, better decision maker, around

the four core verticals of F, financial psychology, I investing, our real estate, and e-entrepreneurship. So that newsletter is called First Principles. We just launched it a couple weeks ago. You can subscribe for free at afford anything.com slash newsletter. Number two, we are hosting in-person face-to-face live events. We just finished hosting our very first event in New York City, and it went spectacularly well. had a great time and really got us excited about the next series of live face-to-face in-person, in real-life events that we'll be doing.

So we're eyeing Washington, D.C. and L.A. as the next two locations. And we have a short list of cities after that. Stay tuned. We will eventually be announcing our quote-unquote tour dates for 2022. So that's project number two. Number three. Of course, there are other conferences and speeches that I'm doing. I just returned from Nashville, where I spoke at podcast movement.

I will be the MC along with Andy Hill. Andy and I are going to be co-MCs at the FinCon conference in September in Austin. And I'll be speaking at the Economy Conference in Cincinnati in November. If you subscribe to the newsletter, first principles, we'll keep you posted on where I'm speaking and when. Plus, if we do any meetups in those cities, we'll announce it all there. So again, you can subscribe to that newsletter for free at affordanything.com slash newsletter. Number four, we are shooting new material for the course. Our course is called Your First Rental property. In between every cohort, we always shoot new video, we make updates, we iterate based on the survey responses that we receive from our students. We've had more than 1,500 students come

through the course. We're currently in the middle of scripting and shooting and editing new material for the course so that every cohort is as strong as we can make it and so that we can offer as much to our students and to our alumni as we can possibly give them. So we will be reopening our doors for enrollment sometime in the fall, we will announce those dates first to the people who are on the VIP list. And if you sign up to come to our live stream four-week miniseries, you will be on that VIP list. So if you're thinking at all about investing in real estate, don't miss the opportunity to get free education, a free four-week miniseries plus loads of other goodies, plus you will be the first to hear about the dates that we're reopening our doors. Affordanithing.com slash real estate. And then

Finally, we're also building software. We are, and we have been for a while now, building out software for out-of-state real estate investors to help out-of-state investors or long-distance investors figure out-of-state investors and how to build a team and get the support that they need. The students inside of our course are the first users of this. Right now, everything is in beta privately with the students inside of our course, and we will be working on that as well. well during this September sabbatical. So zooming out, big picture, our team uses the September sabbatical to take a one month break from podcast production so that we can focus on developing out all of these other projects. Now, what does this mean for you as someone who enjoys listening to this podcast? What can you expect to hear during the month of September? We've picked four of our

favorite episodes out of the last 336 episodes that we've created. We've picked four, and we've themed them around F-I-R-E, financial psychology, investing, real estate entrepreneurship. For the next four weeks, you will hear one episode around each of these four letters from our archives. So it will be a great chance to catch up on the best of the best. Perhaps listen to something that you missed when it first came out, or something that you haven't heard for years, representing each of the four pillar fire verticals. So enjoy those episodes. And also, please, enjoy the newsletter.

enjoy our live stream mini-series, enjoy all of the other things that we are producing and working on for the benefit of you, the Afford Anything community, and for the advancement of the financial independence movement. Thank you again for tuning in. My name is Paula Pant. This is the Afford Anything podcast. If you enjoyed this episode, please share it with a friend or a family member. That's a single most important thing that you can do to spread the message of financial independence.

Make sure that you're following us on whatever app you're using to listen to this show. And while you're there, please leave us a review. Thanks again for tuning in. You can find me on Instagram at Paula Pant. That's P-A-U-L-A, P-A-N-T. And I will catch you in the next episode. Here is an important disclaimer. There's a distinction between financial media and financial advice.

Financial media includes everything that you read on the internet, hear on a podcast, see on social media that relates to finance. All of this is financial media. That includes the Afford Anything podcast. This podcast, as well as everything afford anything produces. And financial media is not a regulated industry. There are no licensure requirements. There are no mandatory credentials. There's no oversight board or review board.

The financial media, including this show, is fundamentally part of the media. And the media is never a substitute for professional advice. That means any time you make a financial decision or a tax decision, or a business decision, anytime you make any type of decision, you should be consulting with licensed credential experts, including but not limited to attorneys, tax professionals, certified financial planners or certified financial advisors, always, always, always consult with them before you make any decision. Never use anything in the financial media, and that includes this show, and that includes

everything that I say and do, never use the financial media as a substitute. for actual professional advice. All right, there's your disclaimer. Have a great day. Hey, everybody. It's Steve, that guy who does stuff for Paula. I just want to give you a quick little behind the scenes look at what I have to deal with when editing this show.

Uh, uh, it's because I just started the new recording. So the first word Steve is going to hear is that. He's good. Hi, Steve. Wait, I'm pretty sure those aren't the words that show intros with. Welcome to, oh, f***.

So good. That'd be so awesome. If you forgot to edit it. Oh, fuck. Sorry, Steve. That polo pants such a nice. Oh, my goodness. What a potty mouth.

Steve, I think we might have our blooper. Ha ha ha ha.