Afford Anything - Ask Paula - The Real Estate Edition

Episode Date: March 20, 2017

#69: So many Afford Anything listeners have great questions about real estate investing. That's why this episode of Ask Paula is dedicated to answering them. Our first question comes from Ade, who has $25,000 to invest in real estate and lives in the Bay Area. Understandably, he's thinking of investing out-of-state, and wants to know if Atlanta is still a good city to invest in. Where can the best deals be found? Krystina lives and has four rentals in Vermont, but she's sick of the cold. She's thinking of selling the properties and moving elsewhere. She asks: if you had to start over, where would you buy and what type of property would you buy? The next question comes from Kayla, who wants to know how to report rental income on your taxes when you also live in the property. Are there any tax implications to be aware of? Claire is relocating to California, and is curious to know if she's better off renting, or if she should max out her mortgage loan potential and buy a house that has a detached garage she can rent out to cover the increased mortgage. Our next question comes from a listener with a paid-off rental who also has an Airbnb on her property. Nice! But, she has a $160,000 mortgage on her own house. She has $30,000 in the bank and wants to know: should she put it toward her mortgage, or use it to buy another property? Our last question comes from Katie, who's eyeing a vacation rental in one of her favorite destinations. Does it sound like a good idea? And how can she estimate the cap rate (and her expenses) without a ton of information on the property? We dive into these topics - and more - in today's episode. Enjoy! To be included in Paula's Real Estate Course, click on the link in the show notes at http://affordanything.com/episode69   Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford absolutely anything you want without any restriction. Not you can afford anything, but you can't afford everything. That's just the fundamental truth. There are limits to what you can afford, and that's true not just for your money, but also your time, your focus, your energy, your attention, literally anything in your life that is a scarce or limited resource is something that you have to make crucial decisions about. because given that you do have certain limitations,

how are you going to use those limited resources at your disposal in the wisest way possible? How will you make smart decisions about the most optimal use of your time, your money, your focus, your energy, given that we have more opportunities, more choices at our fingertips, that we have this abundance of what we could possibly do and only so many things that we could do it with? how will you make those choices and equally as important, how will you make sure that your day-to-day actions align with the choices that you're making? That's what this podcast is here to explore. My name's Paula Pan, I'm the host of the Afford- Anything podcast

where we try to answer all of those questions that I have just described. Today, I'm answering questions that you, the Afford- Anything community, have sent in. By the way, if any of you listening do want to send in a question for a future show, head to Afford Anything.com slash voicemail where you can leave your question. Now, today's episode is a little different than normal because I got a lot of questions related to real estate investing. And I know that some of you are into that and some of you aren't. So what I decided to do was take all of the real estate investing questions.

Okay, well, not all of them, but a lot of them. I took a bunch of the real estate investing questions and I consolidated them all into one show. So today's show is a special edition of Ask Paula where I answer only questions that are related to real estate investing. If you're interested in this topic, listen on. And if you're not, then thanks for joining us and check out some of the other shows in the archives. You know, I wanted to respect the fact that a lot of you just aren't into real estate investing. And if you're not, then that's okay. I'll meet you in the next episode.

This one is just the episode where we're going to focus on that. Thanks so much. Our first question comes from Aday. Hi, Paula. My name is Aday. And first of, I want to say that you've been a complete inspiration to me and many others. So please keep up the good word. I have about $25,000 that I can invest into real estate.

And that's not going to get me very far here in the Bay Area. So I've turned my attention to the South, specifically Atlanta. and I know that you've had a lot of success in Atlanta. I was wondering if you still consider Atlanta a good market to invest in, and if you do, what regions should I look into and what regions should I avoid? I was specifically inspired by your second rental property story, and if I could emulate anything half as good as that, that would be wonderful. Thank you in advance, and take care.

Awesome. So the reason that I led with your question is because I just really like it at a personal level. So for those of you who are listening who do not know the background, I'm just going to take a moment to explain it to everybody out there. So what Aday is referencing is I own a bunch of rental properties in Atlanta, Georgia. I myself live in Las Vegas, Nevada. I lived in Atlanta for a while. I live there from 2010 to 2015. But I'm not from there and I never plan to live there again.

And honestly, I never plan to live in the same city where I have. own properties again because I've I've done that I've lived local to my properties and now I've also had the experience of living 2,000 miles away from my properties and personally I like living 2,000 miles away from my properties so much better for a couple of reasons. Number one, when I lived in the same city as my properties, even though I would, I always had the ethic of run this like a business, you know, create systems, hire people, build a team, outsource. You know, like I was always, not always, but, you know, for much of the time, I was thinking about it as though it was a business.

I was committed to that cognitively. But, you know, the sloppy fact of the matter is that if I can hop in my car and drive 10 minutes to a rental property, if I can do that, I'm more likely to. It's like if there's ice cream in the freezer, I'm more likely to eat it. And so moving 2,000 miles away from my properties, it took the ice cream out of the freezer. And as a result, it forced me to really truly treat it like a business and to build the systems, get the team in place, and design it in a way that professionals do it. Basically, it forced me to be a grown-up, which is probably the first time in recorded history that anybody has ever said that moving in Las Vegas forced them to be a grown-up. So a day I totally support the idea of you living in the Bay Area and investing in a totally different region.

I think that's awesome to directly answer your question. Yes, I think Atlanta is still, and the South in general, as well as the Midwest, is a great place to invest. Specifically in Atlanta, there's a lot of great stuff south of I-20. Personally, and I'm not going to tell where you to invest, but personally, my first, favorite zip code there is 3034. I'm also a fan of the 30314 zip code. But generally, let me add a caveat to that. Anytime you're looking at a rental property, and this is true no matter where you are, whether it's Atlanta or St. Louis or Dayton, Ohio's got some great stuff. I've got some friends who invest there. Wow. No matter where you are, there's going to be a gradient of

risk and return. So you know how like in traditional stock. investing, there's this gradient where you've got like higher risk but higher potential reward and then you've got the gradient of like lower risk but lower potential reward. I mean, just to use a very broad analogy, like stocks versus bonds or even within stocks if you look at different asset classes, you know, emerging markets is higher risk but potentially higher reward as compared to large cap. in the same way that you have that risk-reward continuum in stock investing, you've got the same thing happening with rental properties. Properties that have higher cap rates and generate higher

returns generally end up also being in places where you take on a little bit more risk. And likewise, properties that have lower cap rates, lower returns, generally end up being in places that are a bit more secure. There's less risk. So, you know, when you're looking at at neighborhoods. And that's the reason, I mean, I'm happy to share the, I just did share the zip codes that I like best. But when I share those zip codes, bear in mind that that is comparable in some ways to me saying, oh, I really love small caps as an asset class, you know. Functionally, I'm talking about my personal favorite type of investment based on my own comfort with risk and reward. And that doesn't necessarily mean that that's going to translate for you. Just because I like small cap index funds doesn't mean that you're going to be comfortable with small caps.

Just because I like emerging markets doesn't mean you're going to be comfortable with emerging markets. And similarly, just because I like particular neighborhoods doesn't mean that you'll be comfortable there. So what I would encourage you to do is first and foremost, decide what minimum criteria you are going to set when you're searching for properties. For example, for me, that minimum criteria is something that I call the 1% rule of thumb, which means that any property that I look at, the gross monthly rent must be at least 1% of the purchase price. In other words, for every $100,000 of house, it's got a rent for at least $1,000 a month, gross. If it meets that minimum criteria, I'm willing to look further into it. That doesn't mean I'm going to buy it. I'm not going to like,

date every guy that, like, meets my minimum criteria, it just means that I'm not going to completely write off the possibility. Emma, who was just on the podcast a couple of weeks ago, Emma has a very similar minimum criteria. She looks for a cap rate of at least 7%, which, if you follow the 1% rule of thumb and you make, you know, certain assumptions about what you're operating overhead is going to be, et cetera, et cetera. Basically, we're just expressing the same thing using two different languages. Because, you know, for the most part, with some exceptions, if a property meets the 1% rule of thumb, it's got a pretty reasonable likelihood of meeting a 7% cap rate. So Emma and I effectively have similar

criteria just expressed through different words and through different formulas and in different ways. But anyway, my point for that is decide what your minimum selection criteria is going to be. Once you do that, apply that filter to any property that you're looking at within the city, And you will quickly start to see patterns in terms of certain neighborhoods that fit that profile and certain neighborhoods that don't. So, for example, Midtown Atlanta, it's going to be pretty hard to find something in that area. Inman Park Atlanta? Yeah, dude. I mean, what I tell people is to not look at neighborhoods where there's a Panera bread.

Because if you're in a neighborhood where people can afford to spend $10 on like a kale and spinach sandwich, which probably not going to get great rental returns there. Like hashtag broad generalization, but hashtag probably true. And a lot of times when I talk to people, these people are looking at the Panera bread areas, which I call the paneras. And, you know, they're like, oh, I can't find any good deals here. And I'm just thinking, okay, are you only looking at the type of neighborhood that you yourself grew up in? Because if that's the case, then you are, not you a day, but I'm just talking about the general hypothetical person. If that's the case, then you are limiting your search only to what is comfortable and familiar.

By definition, if you limit your investment search only to things that are comfortable and familiar, you're going to exclude a lot of really good options. Imagine if I only bought stocks of companies if I was comfortable and familiar with their product. Like if I only bought Coca-Cola stock because I'm familiar with Coke as a beverage, but I refuse to buy stock in any fund that held to the 3M company or Abbott Laboratories or Accenture because I'm not familiar with them. I mean, if that was my approach to stock buying, I would be excluding entire industries, like the healthcare industry. I'd be excluding a lot of stuff. So it doesn't make sense to limit yourself only to the places that you know. And I know the analogy isn't perfect because at the end of the day, you can't truly compare buying a stock to buying a house. There are many, many, many differences, like to make an obvious statement.

but the underlying thread, that underlying framework of explore the world of investments and then make a decision based on rational criteria rather than a feeling of not wanting to leave your comfort zone, that framework, I think, applies in both cases. So I don't know if I totally answered your question. I guess to give you the short answer, yeah, I think Atlanta's awesome. Check out West End, check out Mosley Park, check out anywhere. of I-20 that's around where the belt line is going to be built. So thanks for asking that question. I hope that helps. Our next question comes from Christina. Hi, Paula. My husband and I

live up in Vermont with our two children. We currently have four rental units, one multifamily and one single-family rental. It's going well, but we're tired of winters. We're thinking about selling everything and starting over someplace new. We were wondering what you would do if you could start your investment anywhere in the country, would you choose to do a multi-unit? Would you choose a few single-family rentals? And where would you go? What a great question. We were just on this topic, so I'm just going to go deeper into it. First of all, congratulations, Christina, on those awesome property. I mean, what you've already built. You've got four properties. You've done some great stuff. So actually, before I go into my answer, like, kudos to you for doing all of that because

you know what I love about that is like people who listen to this show. I'm just going to make more blanket statements now. People who care enough to take their finances into their own hands, whether that is through real estate investing or putting money into your retirement account or paying off debt or just paying attention to your money, like regardless of what form that takes, people who care enough to do that are generally the type of people who take matters into their own hands. They make stuff happen. They don't just let life happen to them. They take responsibility and take action and actively create a better life. And I love that. And that's why I love this community because it's, you know, it's a community of people who build and create and imagine and then bring that imagination to life. and there's something really beautiful about that.

I am totally straying away from your question. So let me get back to that. So there's kind of two parts to your question. Part of it was where within the nation would I invest? And the other part was what I focused on single family homes or multi-units. Since I've already been talking about where within the nation I would invest, I guess I'll go a little bit deeper into that. I've talked about the Midwest and the South. I've talked about the Peneborhoods or the Pinerias.

You know, be cognizant that you are looking. outside of the areas that have a bed, bath, and beyond. Because there are a lot of neighborhoods that don't. And, you know, the neighborhood that I grew up in in Cincinnati, Ohio, there's a house, there are houses there today that are for sale for $50,000. I could buy, and that's crazy to me. I went back to Cincinnati last year. I went for my high school reunion, and I drove around that neighborhood,

and I looked at some of the houses that were on my same street, or one block over. And I was like, oh my goodness, I could buy this in cash right now. And that like blew my mind. That was just, wow. Okay. Well, I keep getting distracted. I'm not answering your question. But yeah. Wow. So anyway, there was no bed bath and beyond in my neighborhood. But it was a great place to live. You know, I grew up there. I sold Girl Scout cookies there. I enjoyed it. Like, please. And I say this in my course material, and I tell this to the beta testers, I'm trying to repeat this as much as I can. Please don't be afraid of things that might be different from what you've previously experienced. That's not to say that you shouldn't do your due diligence. You know, that's not to say that you shouldn't get the facts and the information. And sure, there are neighborhoods that are genuine war zones.

as many investors call them. And by the way, that term war zone used to offend me because I used to think like, people who say that don't know what an actual war zone is like. And then I saw some of those neighborhoods. Like there's a particular neighborhood in Atlanta that I would not feel comfortable there even in broad daylight. So, yeah, there are some neighborhoods like that for sure. I'm not denying the existence of those places.

I'm just saying that you should put, not you, but generally people should put some conscious thought into where they've calibrated the bar and make sure that you're setting your bar based on actual data and information rather than just a general discomfort with the fact that there is a mini market nearby that sells single serve. items mostly and there are a lot of check cashing businesses nearby. You know, like there are a lot of perfectly safe neighborhoods that have those types of businesses around. So, you know, and I grew up there. I think that's part of, I think that's part of what makes me a good investor is just understanding those areas. And like anything, the more that you experience certain things, the more you sort of develop a cultivated eye around certain areas, you know, the more you know what to look for, the more you can suss out what's on the surface from what's truly underneath. I hope I'm not being too, like, esoteric. Like, please stop me if this is getting a little bit too, like,

like, fluffy in the clouds. I feel like I should tell a joke right now just to lighten the mood. I've been listening to a lot of jokes through like, hey, Alexa, tell me a joke. And I don't know if anybody else finds them funny, but I totally crack myself up. So here we go. Hey, what did Earth say to the other planets? You guys have no life. Okay, back to your question. So to answer your question, where would I invest? I typically look for Class B neighborhoods in the Midwest and the South. That's the shortest and most direct answer to that question. As far as multi-unit versus single-family home, I theoretically prefer multi-units because of the consolidated overhead. When you're buying a property, the physical

structure, the building itself is your primary asset because that building is the thing that you're renting out. That's what generates cash flow. The underlying land is overhead. That's why it's hard to find good returns in areas where the underlying land value itself is high. So that's Now that we're like 20 minutes deep into the podcast, I feel like I've actually finally said something useful. That's one key thing to remember. Generally, when you're looking at different areas, look at places in which the underlying land value is low. Because you're not going to be making any money off of that. Okay.

That being said, the reason that I like multi-units is because you consolidate multiple units, multiple properties, effectively, on one single piece of land. you consolidate your overhead. In addition, you also consolidate your literal overhead, the roof, as well as, you know, just a lot of other expenses. You kind of get some economies of scale going. So in theory, for those reasons, in theory, I like multi-units more. But that being said, the reason that I own so many single-family homes is just because, frankly, there are more of them. And when you've got a bigger supply and you're looking through that supply, it's like shopping for clothes. you look at the clearance rack, you're going to find some good deals if you keep looking. And so that's what happened with me. Like every time I went to buy a property, I would always start my search intending to buy a multi-unit. And at some point within the course of that search, I would stumble across a single family home that I thought was fantastic. And it was such a good deal that I just, I couldn't not buy it. So that's the reason that I ended up with a portfolio that is predominantly single-family. It's not because I prefer them. It's just because there are more of them and therefore I just

ended up finding some great deals there. So I guess that's a really long way of saying I like them both and I, you know, unless you have a compelling reason to go for one or the other, I would just be open to both and go where the deals are. So I hope that helps. Best of luck with this transition. I'm excited for you. Our next question comes from Kayla. Hi, Paula. My name is Kayla. I purchased a time. home and have been renting out several rooms to friends. And I'm wondering how I should report the rental income from the rooms and the homes that I also live in. I'm not sure what the tax implications are and if I should be deducting any expenses. If you have any ideas on what the best way to do this is, I would really appreciate it. Thanks for the wonderful podcast. I appreciate your work.

Thanks. Kayla, great question. Actually, it's super easy. Here's exactly what you do. or here's exactly what I did and worked really well for me. Number one, you run all of the income and expenses from your rental through some separate business entity. You know, you can form an LLC, separate personal from business so that you've got separate accounting. And what that means is that you go to a bank, you open up a business bank account, all of the rental income gets deposited into that business bank account, and all of the expenses associated with the property get paid, associated with the rental aspect of the property get paid from that business bank account. So you run it as though it's completely separate.

You can use just a debit card that's tied to that business banking account or you can get a business credit card, something with rewards or miles. That's totally your, I'm not going to chime in on the debit versus credit card debate, whichever one you're comfortable with. get one of those and just run all of your expenses through that. Then link all of that to bookkeeping software so that your bookkeeping software automatically reads everything that happens on your business credit or debit card and in your business bank account. So all of that is going to automatically flow through to your bookkeeping software. There's going to be a record of it.

It's going to generate profit and loss statements. The whole shebang. So all of this is super automated, right? All you have to do is set up the business, set up the bank account, and open a debit or credit card. That's it. And then at the end of the year, or whenever tax season comes around, you hand all of this over to your accountant. All of that is going to get sussed out based on what proportion of the house you used versus what proportion of the house your tenants used because that's what your roommates are. They're your tenants. So, for example, hypothetical. aesthetically, if your portion of the house is, let's say, if the property in general is 1,500 square feet and you've got two tenants, a total of three people living there, your accountant might decide that it would be fair to consider, say, a thousand square feet of the house to be the income generating portion and another 500 to be your portion. That's just an example. It's just a hypothetical. The point that I'm trying to illustrate is that all of that's going to get divided up proportionately. And what that means is that, that, That goes for the expenses too. You know, if you are paying to get your ordinary operating expenses in the course of running your rental business, because you also live in the property, proportionately, some of that will be a business expense and some of that will be a personal expense. But again, the most important thing that you need to do over the course of the year is record keeping and all of that record keeping can be automated. You just set it all up in advance.

The whole system runs itself and then you give it to an accountant and the accountant figures out. exactly how to break it down proportionately so that it can get reported to the IRS in the right way and that the parts of it that are deductible will be reported in the correct way. So anyway, TL, DR, your job is just keeping really good records and what that means is setting up the automations that will keep the good records for you so that you don't have to think about it. Thanks for asking that question, Kayla. I'm really excited for you. Our next question comes from Claire. Hi, Paula. I have a quick question for you about real estate and high cost of

living area. We're looking to relocate from northern New England to central California. Our current mortgage is about $175,000. And I am looking at if we were to move to Central California, what our housing options would be. The first thing that comes to mind is just renting and spending more than we currently spend, but not having the stress of such a potentially volatile market. And my other option that I've been thinking about is, is, you know, kind of maxing out our mortgage loan potential in buying a unit that has a detached finished garage or something like that and renting out that unit to help cover our mortgage. We would be looking at this as a long-term move.

So I'm not sure what the property values are if that's worthwhile to do something like that in such a hot market or if the better option is to just look at renting or buy a single-family home and looking at rental properties elsewhere that would get you more return for your money. Any thoughts you have would be appreciated to keep of the great work. Claire, thanks for asking that question, and congratulations on your upcoming move. I've been fielding a lot of questions lately from people who seem to be moving from the East Coast to the West. I wonder if is this a trend or is it just a coincidence? I don't know.

At any rate, to recap your question, it sounds like option A, once you move to California, option A is to rent and option B is to buy and rent out a portion of what you've bought to use as an income property. Those are like the two, for the first two options that you had mentioned. Okay, first of all, option A renting is always a solid plan, particularly like when you're moving somewhere new and you don't know the area yet, you don't know the neighborhood. you're making a personal lifestyle decision based on, you know, where's going to make you happy to live. Yeah, there's totally nothing wrong with renting for six months or a year while you're settling in and getting the lay of the land and figuring out what neighborhoods you like and what you don't and where you want to live and, you know, just while you're learning your new environment. So I totally would encourage, not just, I mean, anybody kind of in any situation, if you're going to move somewhere for a while, sublet, at the very, least, get a three-month sublet just so you can really learn the area before you put down roots

and commit to somewhere. I typically think that's a good plan. Now, as to option B, which is max out your mortgage potential, buy as much as you can and rent out a portion of the property. The thing that concerned me about the question, the way that you phrased that option, is that you mentioned property appreciation. I am an average. advocate of not making any decisions based on what the market may or may not do in the future. And here's why. You have, this is a concept that came from the book Seven Habits of Highly Effective People by Stephen Covey. You have this circle of concern.

And your circle of concern is anything and everything that you could ever possibly be worried about. from nuclear war to how Game of Thrones is going to end, to whether or not your socks match, to what the real estate appreciation market is going to do for the next 10 years. All of that is within your circle of concern. And then inside of that circle of concern, you've got this thing called the circle of influence. And those are the things that you can directly influence to the greatest degree that any human can control anything. You have control over the outcome. So whether or not your socks match, for example, is something that's totally within your circle of influence.

What time you wake up in the morning. How well you're eating. How often you shower. How nice you are to other people. All of those things are inside of your circle of influence. Now, the problem with reliance on market-based appreciation, which is appreciation that happens as a result of broad economic forces outside of your control, is that it's outside of. your control. You can't do anything about it. And so I believe that it is extremely risky and, in my opinion, inadvisable to make decisions based on speculation about what may or may not happen in the

future. I like to say appreciation of speculation. Now, when I say that, I'm referring specifically to market appreciation. There's a different type of appreciation that's called forced appreciation. I should maybe give it a new name just so the two don't get conflated. But forced appreciation happens when you buy a fixer up and you improve it, thereby forcing its value to go up by virtue of making improvements to it. That's a different type of appreciation because that appreciation is within your locus of control. That part's cool. I like that. But I would hesitate to buy something based on the hope that it may go up because if it doesn't, then what are you going to do? Nothing. There's nothing you can do. So if you're interested, and that, by the way, is the reason that I got

into rental properties and I stuck with rental properties is because rentals are based on cash flow. They're not based on, or at least in the approach that I take, they're not based on some crystal ball speculation about what may or may not happen in the future. It's what kind of cash flow am I getting? Can these investments generate enough money to cover part or all of my basic cost of living. Can it supplement or replace my income? Not with one house, I mean, but if I bought one property per year for the next five to ten years, then in ten years time, would I have enough money that I could retire early?

That's my approach to rental property investing. And that approach has absolutely nothing to do with market value. Market value in my book is completely irrelevant other than insofar as you can borrow against a property if you want access to capital in order to buy more. As I see it, there are only two times in which property value actually matters when you buy and when you sell. And if I wanted to throw in a third, I would say when you refinance if you do a cash out refi. those points of transaction are the only times that property value matters. Anything else is noise. Anything else is volatility.

All right, that's my little rental property valuation soapbox. If you are interested in generating cash flow from properties, I'd encourage you to go where the money is. I mean, this kind of goes back to the theme from earlier in this episode. There's no reason necessarily to invest somewhere just because you happen to live there. And I know this is not a perfect analogy, but, you know, I wouldn't buy stock from a company just because that company was based where I happened to live. Like in Atlanta, you know, Home Depot and Delta Airlines and Coca-Cola, I mean, I'm not loading my portfolio with those

stocks just because those companies happen to be Atlanta-based, you know. In Cincinnati, I didn't only think about buying Procter and Gamble stock because P&G is Cincinnati-based. Similarly, maybe I should use a different analogy because I myself can see all the flaws and all the holes in this analogy. But I guess the reason that I keep going back to this is because I'm really trying to impress upon people that just because a house is tangible and familiar, just because you live in it and many people have emotional attachments to it, that doesn't mean that it's any less of an investment than a stock. And therefore, that doesn't mean that it's, that doesn't mean that it should be subject to a different set of emotional criteria.

I don't know if I'm expressing that very well. But the reason that I keep going back to these imperfect analogies is basically to impress the point that an investment is an investment is an investment. So if you're going to make an investment, then don't seek suboptimal returns. Get the investment that's going to produce good returns relative to your risk-reward profile comfort zone. just as you would if you were investing the balance of your 401K. So yeah, so that is what I would encourage.

So I hope that answered your question. I'm trying to refrain from telling you what to do. I'm more trying to give you a framework around how to think about this. But, yeah, long story short, don't think about appreciation. And if you want income and cash flow, think first about where you're going to get awesome income and cash flow as opposed to what happens to be in your own backyard. Thanks, Claire, and good luck with the move.

Hey, hey, we'll be back to the show in a second, but first, I want to give a shout out to Fresh Books. They have signed on as one of our main sponsors in 2017, and they have an awesome product. It's meant for freelancers, solopreneurs, small business owners. If you have a side hustle or if you're self-employed and you need to send out invoices to your clients, yeah, it's necessary. You've got to send invoices to get paid, but it's also annoying and it's time-consuming and nobody really likes doing it.

It's just one of those costs of doing the job. Enter FreshBooks. They automate the invoicing system. You type in some basic information and their system handles the rest. It automatically sends follow-ups to invoices that haven't gotten paid. It lets you know whether or not

your client has even opened your invoice or not. Basically, they take the suckiness out of invoicing. Give them a try for free for 30 days at FreshBooks.com slash Paula. That's freshbooks.com slash p-a-u-l-a. All right, our next question comes from Anonymous. Hi, Paula. I'm a 32-year-old working person in a government job, and I currently own a rental property that is 100% paid off that provides me $1,30 monthly.

I also have an Airbnb on my property that is, bringing an income. However, I do carry a mortgage on my house and about $160,000 in debt with that. No other debts, though. I have about $30,000 in the bank, and I'm wondering, I'd like to invest it. I'm wondering if I should pay down my mortgage, put, you know, say $25,000 into my current mortgage, or invest it into another new rental property, getting something in the local area of Orlando. It would be great if you could help me with this advice. I'm just kind of not really certain. I don't really want to do investing in the market or stocks.

I really like real estate and taking care of the locals. So thanks for your help. Awesome question. First of all, you're in a great position. No debt other than $160,000 mortgage. and I assume it's a relatively low interest mortgage, that's a good spot to be in. So your question is functionally, wow, I have all these savings. What do I do with them?

And that is an awesome position to be in. Like, that's a, what do I do with all these savings? That's a good question to ask. First of all, I am going to go out on a limb here and I'm going to assume that this $30,000 in savings that you're referencing is in addition to an emergency. fund. If it's not, if this 30K is the alpha and the omega, the A to Z, then some of that should be an emergency fund. And for those of you, I'm everybody listening, I'm sure is familiar with what an emergency fund is. But long story short, it's money that you put aside in the event that like some massive catastrophe happens. Like let's say you lose your job and your roof starts leaking and your car breaks down and your car breaks down and you. You break your leg and go to the hospital and have to have an expensive copay all in the same week. Okay, I'm exaggerating, but only slightly. And then an asteroid hits in your backyard.

And then, okay, so an emergency fund is for that. It's for unexpected emergencies. There's, of course, lots of finance experts like to sit around on Friday nights having debates over whether it should represent like three months of living expenses. No, six months. No, nine months. No, I think eight months. But the point is it should represent some X number of months of your living expenses. Three is like kind of the minimum that most people agree on.

So I don't know what your ordinary monthly living expenses are. But if this 30K and savings that you have is in addition to an emergency fund, then everything that I am about to say following applies. But if it's not, then that's your number one priority. By the way, okay, quick tangent. I was on this call with this guy this one time. This was, I loved this. This was a very, very fond memory that I have from a coaching call that I once did.

And this guy, he was really worried. He was like in this, I don't want to say a state of panic, but I could hear the anxiety in his voice. And he was like, I have all this money saved up for a down payment. But I have no emergency fund. What if something goes wrong? And I was like, did it ever occur to you that maybe you have a really big emergency fund, but, you know, not very much saved up for a down payment? And it blew his mind. It was so cool. It was, I don't know if you're as amused by that as I am, but I found that really gratifying. Because, I mean, to me, what that illustrates is that sometimes the labels that we put on things and the frameworks and just the way that it's very common to compartmentalize money and put it in box.

and then get stuck in that way of thinking. I mean, that's just a natural human thing. Like, I do that. We all do that. And so it was just, it was very gratifying to be able to, like, with a quick, like, have you ever tried, like, zooming the lens this way? To be able to just alleviate all of his anxiety in one sentence. That was super cool.

Anyway, back to your question. If this 30K in savings is something that you could, you know, functionally your question is, should I repay the more, should I pay down my debt or should I invest? That's basically the question that you're asking. And both of them are really good options. So then the answer really is going to depend on what your goals are, what you want to do. I will say from a purely mathematical perspective, if your goal is to maximize potential returns over the long term, investing money, will probably give you a better return over time. According to historic norms, of course, nothing is guaranteed. Disclaimer, disclaimer, but investing money will probably give you a better returns over time than what you would get if you paid off a very low interest rate loan such as a mortgage. Again, you've got what sounds to be a very reasonable mortgage. You've got one rental property that's already paid in full, which is awesome. And you've got another

property with a $160,000 mortgage on it, if that mortgage is at like a three, four, five percent interest rate, that's already going to be not very much of a monthly bill. And you're offsetting part of that with Airbnb income. I mean, it sounds like that mortgage isn't really a major cloud hanging over your head. So unless you have like emotional or, you know, peace of mind related reasons for wanting to pay off that debt. And if you do, that's totally legitimate. But unless that is a strong motivator for you, I would probably lean more towards investing that money. And it sounds like you're interested in buying another rental. You like your local market, which is awesome.

If you like it and you're getting good returns there, if you're finding properties that meet your minimum criteria, then sweet. Cool. More power to you. That is awesome. That's a great position to be in. So I guess I answered your question. I think you're in a really good spot. So congratulations for putting yourself there. All right, we've got one last question, and this one comes from Katie.

And by the way, when I say that we've got one last question, there are other questions that we have not yet gotten to. I will be getting to them on future episodes. So for anybody who's listening, if you have a question that you want to submit, head to Afford Anything.com slash voicemail. That's Affordanithing.com slash voicemail, where you can leave. your question, which I'll tackle on a future episode. I'm loving these Ask Paula episodes. They're so much fun. I love answering these questions. I love hearing from you all. So you keep asking questions and I'll keep answering them. Deal? Deal. All right, cool. Let's hear from Katie. Hi, Paula. I love the podcast. I have two separate questions for you, totally unrelated to one another.

My first question is regarding vacation rental properties. Recently, a condo went up for sale in one of my favorite vacation locations. And while I might not want to rent that out for long-term tenant occupancy, I know that during peak tourist season, that I could generate quite a bit of income. So I just wanted to get your thoughts and opinions on that. I'm going to pause here so I can answer each question one at a time. So first of all, vacation rentals. There's a couple of things that I'm going to say about this. Number one, vacation rentals and long-term traditional nine to 12-month lease situation type rentals are, in my opinion, totally apples and oranges. The best way that I could, the best analogy that I can give is that one is being a landlord

and the other is running a hotel. So one is the real estate industry and the other is the hospitality industry. And what I mean by that is that if you're running a vacation rental, then you or the management team that's underneath you are responsible for. making sure there's enough toilet paper, cleaning the bed sheets, folding the towels, making sure that there's enough tea and coffee and maybe creamer and salt and pepper, ensuring that there are clean dish sponges and dish soap, and that the shampoo and conditioner provided is sufficient and lovely. Those are not things that a landlord does.

Those are things that hotel owners do, or that, you know, bed and breakfast owners do. Airbnb. be. And so that is, you know, on the surface, because we're dealing, again, it's that, that concept of familiarity. Like, because you're dealing with a dwelling, it's, I think, easy to imagine that, you know, you have a dwelling and you are renting out said dwelling. So it's easy to imagine that the only difference between the two is the duration of time under which you are renting said dwelling. But the reality is no tenant ever calls their landlord because they've run out a toilet paper. No tenant ever calls their landlord because they can't figure out how the cable TV works. That's something that vacation property owners have to deal with.

And so the first question that I would invite you to ask yourself is, how much time are you willing to put into this? Because running a vacation rental and running a rental property are completely different things. Like forget apples and oranges. We're talking like bananas and kiwis. Oh, pineapple and durian, pomegranate seed. And, ooh, and tomato. Tomato is technically a fruit.

Chiching. Avocado also. Hashtag technically a fruit. That's the official hashtag of today's podcast is hashtag technically a fruit. Oh, man. I could use that to describe myself. Okay, so that is the first thing that I would say, I don't know if you're amused by this.

I am sitting here alone in my closet cracking myself up. So I hope that at least like a few of you are amused. You can tweet me at Afford Anything, just to let me know if I'm a complete dork or just a total dork or technically a fruit. Anyway, so that's the first thing I would say about vacation rentals. And yeah, you can definitely get property management companies who will, be those boots on the ground for you. You can find property management companies, particularly in vacation areas. Like if this property is in an area that a lot of people vacation in,

then there are certainly management companies there that specialize in vacation rentals, in short-term rentals. So if you did want to pursue this, go to those companies and ask them, ask them the following questions. Number one, what type of occupancy do you? do they see in the units that they represent? What are the occupancy rates? What are the vacancy rates? Because, yeah, it may seem on the surface that you're collecting like a whole bunch of really awesome gross income at high peak tourist season. But for a property owner, for a landlord, there is nothing more expensive than vacancy. Like, the only thing that could possibly be more expensive than vacancy is, like, a really Jack the Ripper type tenant, like the kind who pours a bag of cement in your toilet.

super worst case scenario sort of stuff. But vacancy is the most expensive thing you're going to have to deal with. And so that's the first question I would ask. What's the occupancy? What's the vacancy? What do those numbers look like year round? A second question I'd ask is what are their fees? What do they charge? Many management companies, vacation management companies, will charge as much as 50% of gross. And frankly, that's fair. They're responsible for making sure the place gets vacuumed between every turnover. They're responsible for making sure that the pillowcases get washed and then put back on the pillows. So no, they're not going to charge the 10% that a traditional 12-month landlord's property manager would charge because

that person is not putting pillowcases back on the pillow. Again, totally different lines of work. One's running a hotel. One is not. So, you know, they're going to charge, I think, a rate that is quite fair given the responsibility that they have and the work that they do. And that could be as much as in many places as much as 40 to 50% of your gross income. So, yeah, ask them those questions. Find out what the numbers are because ultimately, I hope the reason that you'd be buying this property is because the numbers work out. Right, right, right.

You can't see me, but I'm like elbowing your elbow right now. Like, right. You're buying this because of the numbers, not because you want to own a property in your favorite vacation spot. And you want the emotional reassurance of telling yourself that the income will help it pay for itself. Right? Okay. So let me repeat that because that was a really long run on sentence. Reason A, you're buying it because the numbers are awesome and because an investment is an investment is an investment.

reason B, you're buying it because this is your favorite vacation spot. You have an emotional attachment to wanting to own a home in this location, and you want the emotional gratification of believing that it will pay for itself. I'm hoping, here's the gnar-kn-n-nodd elbow, I'm hoping that your reasoning is A, because that is the only good reason to enter into an investment. Otherwise, it's far more rational if what you really want money so that you can enjoy vacationing in the spot that you love, it's far more rational to not suboptimize your investments, to go make an more optimal investment, an investment with a great return that's somewhere else and then use the income generated from that to rent in wherever you want to rent, whether it's in the spot that you're referencing or Italy or Antarctica or. Mars, wherever it is that you want to rent, you can go rent there using the money that you've

earned from your investments. If I want to buy a pair of Nike running shoes, I don't go out and buy a share of Nike stock. I go out and buy the investments that I think are going to give me the best returns relative to my risk profile and timeline. And then I use the returns from those investments to buy my Nike running shoes. Does that make sense? Am I making sense here? This answer is getting really long and hopefully not too far off the rails. But I guess that is my answer in terms of what I think about vacation rentals. Number one, make sure that you're doing it for the right reason. And number two, if you are doing it for the right reason, then it's a simple math problem.

I mean, then that's what it boils down to. What type of – and let me – actually, this, I guess, can tie into the second half of your question. Oh, this can totally tie into the second half of your question. All right, let's play the second half of your question. Then I'm going to walk you through what this math problem is. Ooh, I didn't even realize I was going to have such a good time. This is exciting. My second question is regarding the cap rate.

How do you go about calculating that on a property when you don't know what the rent values are? You don't know what your maintenance fees will be, things like that. I'm just having a hard time, I guess, trying to figure out how to calculate the cap rate for a property when I don't really have all of the facts and info. I don't know if you have a good suggestion on how to either estimate that or to go about finding out that information. Thanks so much, and I look forward to hearing your response. Awesome. Okay, so here is the tie-in to the second half of your question, because your question, on the surface, your question was how do you calculate cap rate?

But what I heard your question to be really under that surface is how do you estimate your expenses? And also, really, how do you estimate your income? Like, how do you estimate those numbers? because if you knew how to estimate those numbers, then you just plug them into a formula and then you can calculate the cap rate, right? So the question really is, how do you make those estimations? So let's talk about that.

And let's, again, I'll walk through this in both a vacation rental and a 12-month traditional rental, all right? So let's take a vacation rental, for example. I use already the example of talking to the management companies that represent that area to find out what the occupancy and vacancy rates are. The other way that you could do that is go to Airbnb, look at other properties that are listed there, and then look at the calendar on Airbnb.

You don't want to look too, too far out, but look like a month out and see how booked they are and keep checking back. Like just schedule yourself a Google calendar reminder every Sunday night. Just keep checking back and see how scheduled they are. and you'll get a sense of the occupancy slash vacancy. And so what you're going to have at that point is you're going to see the occupancy in these properties. And you're also going to see the price point, the gross price that the property rents for per night. And you'll also see the condition of the property that merits that type of price point.

So you'll have all of that data. And the thing I like to say is there is no such thing as like price in a vacuum or occupancy in a vacuum, those two are super closely related. And to illustrate this by using an exaggerated example, if your rent was a dollar, you'd have 100% occupancy. And conversely, if your rent was a million dollars, you'd have zero percent occupancy. So the ideal rent is somewhere between a dollar to a million dollars. You know, point that I'm trying to make is that if you imagine a seesaw, the rent price that you set and the occupancy rate that you have, like those balance each other on that seesaw.

And I guess if we could add a third leg to that seesaw somehow, the condition of the property. And I guess if you could add a fourth leg to that seesaw would be just how well you create the ad, the quality of the listing, the photos that you use, how well those photos are taking. the way that the listing is written. Do you have lots of features clearly bullet pointed out in a way that's easy to read and easy to skim? So now we have a four-pointed seesaw. There's probably a term for that. I think that's a thing on a playground. But those four, like they all exist in balance with one another. And there is no one without the other. And so that is all of the information that you're going to be looking at. I'm sorry this isn't a more straightforward. forward answer. But if you're trying to figure out, and again, this is specifically, I mean, this applies to both long-term 12-month leases as well as vacation rentals, but the recommendation for looking at Airbnb specifically is around vacation rentals, you know, you want to see the properties that are at the 300 per night price point, what kind of occupancy rates are they

getting? When you look at their Airbnb calendar and you look at the next week ahead, how booked are they in the next week ahead? How booked are they in the next two weeks ahead? And if you just keep doing that, just keep checking in once a week, you'll be able to start spotting patterns. And you look at that for the $300 per night price point. And then you look at that for the $100 per night price point. And you see what the discrepancy is, where the disparity is. You see if one has a much higher or lower occupancy rate than the other. You see how big that gulf is. And that's how you get that information. Now, if you are looking at a rental property in like a traditional 12-month rental that's not meant to be a vacation rental.

Then finding that information out is a bit more straightforward. Just approach the search as though you were a tenant and start looking online. Look at Zillow, Trulia, Redfin, cozy, Craigslist, look at any online listing. From the point of view, like literally put yourself in the tenant's shoes, imagine that you wanted to rent a property that was similar to the subject property that you have in mind. So let's say, for example, that you were thinking about investing in a three-bedroom, two-bath, single-family home in the 90210, zip code, right? From the perspective of a tenant, start looking for three-two SFRs in that zip code and see what's available, see what condition they're in, see if they're currently vacant or if they are going to

become available for rent at some indeterminate point in the future, or I guess determined point in the future. You know, like, just put yourself in the shoes of a tenant and see, you know, go shopping as a tenant. By virtue of doing that, you will be able to see a few things. Number one, you'll be able to get a pretty good handle on the price point. Number two, you'll be able to get a pretty good handle on how quickly things disappear from the market. Because again, set your Google Calendar. If you do this search once a week and you notice lots of turnover, lots of listings going up and then almost right away coming right back down, then you know that stuff's going quickly

and properties that are getting listed are not staying on the market for very long. Conversely, if you repeat the same search every week and you keep seeing the same properties over and over and over every week, and then you start to notice that the landlords after 30 or 60 days begin to reduce the rent, well, that's also a clue of where the market's at. So that's how you get that information about rent.

And it's worth stating, wow, this is really turning into a monologue. Thank you for bearing with me through this. So it's worth stating that, yes, there are these websites that will estimate what the rent is. You know, like Zillow doesn't estimate and there's a rentometer that doesn't estimate. Yet sure, there are these algorithms. But you really have to take them with a grain of salt because an algorithm is, it's a machine, it's AI. It gathers a whole bunch of data without necessarily knowing the nuance of a particular market. or a particular neighborhood. And yes, AI is, by definition, intelligent, and it's going to

only become more and more intelligent over time. And it's great. And I'm certainly, certainly not a technophobe as the host of a podcast and the owner of a blog. I'm definitely not like a technophobe in any way. I'm not a ludite. Ooh, fancy word, ludite. But it doesn't replace human judgment. So if you go to a website like Rentometer to try to estimate the rent, don't use that to to plant your own thinking. Arrive at your own conclusions and then check those AI sites to see if they corroborate and or challenge what you yourself have concluded. In other words, use them as backup verification.

Use them as a second opinion, not as a first. So that's how you estimate, wow, this is a big question, big answer. I don't know. That's how you estimate income. And all right, so let's go back to your first half of your second question, which is, How do you calculate cap rate? What you're going to do is first you're going to calculate your potential gross rent. And potential gross rent is the amount of money that you could rent a property for at full occupancy.

So for property rents for $1,000 a month times 12 months a year, potential gross rent is $12,000, right? Then you're going to subtract for vacancies. So let's say that you estimate that this property is going to be vacant for one month a year. So you subtract $1,000. now less vacancies is minus 1,000. And so the number that's left over is your effective gross rent. That is now 11,000. So your effective gross rent is the maximum potential minus vacancies equals your effective gross rent.

And by the way, in the show notes, which is available at afford anything.com, in the show notes, I'm going to link to an article that's going to walk you exactly through how to calculate cap rate. So that's how you arrive at the effective gross rent. And then after that point, what you're going to do is you're going to start subtracting operating expenses. And now operating expenses include just as though you are running any other type of business, any expense that you have that relates to the normal operation and functioning of your rental business. It does not include debt servicing because you want to first assess whether or not this property is a good deal. and if it is, then you look at financing, you don't want to conflate the two. So it's not going to take into account the principal and the interest on your loan,

but it will look at property taxes and homeowners insurance because both of those are part of your normal and ongoing and permanent operating costs. And it'll also include any utilities that you as the landlord pay. It'll include repairs, maintenance, management fees. And wow, this is turning into a really big, answer. I'm going to link to this article, which will have more detail on how to kind of go through this, but the short, the very, very short answer, and this is really not doing this justice, because this is a extremely big question. And by the way, this is what's taking me so darn

long to complete building this course. It's like these questions are actually, they have really long answers. This course, I'm building this course on rental property investing. It's not even remotely done yet. But if you're interested in learning more, if you go to afford anything.com slash VIP list, I'll put a link to that in the show notes. You can sign up to get updates on finding out when I will finally be done with this thing. I'm, trust me, I am kicking myself super hard. I am more frustrated with myself than anybody else is with me. And I'm sure there's a lot of people frustrated with me for how slow I'm being. But I am super frustrated myself for how slow I'm being because I just want this to be good and I want it to be comprehensive and I want it to

really, truly answer these questions. So you can sign up for the VIP list if you want to know more about the course. But that being said, the short, short, short answer to your question so that I can keep this podcast to a reasonable length of time is that you can ballpark, if it's a 12-month lease, ballpark estimate that about 10% is going to go to property management, estimate that about 1% of the value of the property per year is going to go into repairs and maintenance. So, in other words, $1,000 per every $100,000 of house, or $83 per month, if you want to look at it that way, per every $100,000 of house, will go towards repairs and maintenance. And then in order to get information about the utilities, go to the local utility providers,

the electric company, the gas company, the water sewer company, If this house has already been used as a rental, the former landlord's profit and law statements will have that. And the former landlord's tax records will have that. So you can always ask the former landlord for that information. So yeah, so that's the bigger answer to the question. I'm not going to go super into depth because, again, this is turning into a very long answer. But that's how you get that information about what the expenses are going to be. And then, now that you've either looked at the former landlord's P&L statements or caution.

contacted the utility providers directly, as well as made some rough estimates as to repairs and maintenance. And by the way, property taxes, that's public records. So you can just look at the county records and know what the property taxes are. So that's easy enough. Insurance, you can call an agent. Just get a ballpark quote. So that's how you estimate the expenses on a property. And then once you do that, you subtract those estimated operating expenses from your effective gross rent. and that leads you to your net operating income. And that net operating income proportional to the value of the property, that is how you calculate the cap rate. Woo!

Okay. Man, wow. That was a long answer. Way longer than I intended. Steve is my editor is going to kill me. So I'm going to cut myself off here. Thank you so much for all of you who have made it this far into the podcast. I really appreciate you being here.

you're clearly interested in real estate because you've listened this long, so please head to Afford Anything.com forward slash VIP dash list. I'm going to put a link to that in the show notes. Head to that URL to sign up for the email list that will clue you in on when I will finally, finally, finally freaking release this rental property investing course. It's called your first rental property. Hopefully I would do it at some point before the sun turns into a red giant and swallows up the earth. That's the goal. Thank you again for listening. Super appreciate it. You can find the show notes at Affordainthing.com slash episode 69. That's slash episode 69. And again, there will be links in those show notes to a lot of the stuff that we've talked

about in today's episode. Thank you so much for listening. My name is Paula Pant, host of the afford anything podcast. I'll catch you next week.