Afford Anything - Ask Paula - The Real Estate Episode

Episode Date: April 8, 2019

#187: Sarah needs $36,000 per year in rental income to reach FIRE (Financial Independence, Retire Early). She owns several rentals. When can she comfortably consider herself FIRE? AyV wants to rent out his primary residence. Should he renovate? Anonymous lives in a high-cost-of-living city, but she found a small city nearby with Class B and C+ multifamily properties. These properties need a little work. How can she estimate repair costs? Carly bought a property that underperformed the one percent rule. It’s appreciated in value. Should she sell? Erin is trying to decide if she should buy a $270,000 personal residence in northern Virginia, or a $50,000 rental property in Huntsville, Alabama. Nancy wants to buy rental properties from overseas, but she’s having a tough time finding real estate agents who take her seriously as a buyer. What should she do? I answer these six questions in today’s final Ask Paula - Real Estate episode. Enjoy! For more information, visit the show notes at https://affordanything.com/187  Learn more about your ad choices. Visit podcastchoices.com/adchoices

You can afford anything, but not everything. Every decision that you make is a trade-off against something else, and that doesn't just apply to your money. It applies to your time, your focus, your energy, your attention, anything in your life that's a limited resource. If you're directing it towards one thing, you are not directing it to something else. There's a trade-off always. And so the questions become twofold.

Number one, what are your highest priorities? Not what does society tell you that they should be, but what are actually the biggest priorities in your life? Where do you want to direct your time, money, attention, energy? And number two, how do you change your life so that the decisions that you make on a daily basis reflect that bigger vision? Answering these two questions is a lifetime practice. And that is what this podcast is here to explore. My name is Paula Pant. I'm the host of the Afford Anything podcast. And today is the final episode in which I will exclusively and only answer questions about real estate investing. Now, to be clear, I will continue to answer questions about real estate investing

in future episodes. Every other episode, I answer questions that come in from the audience. This is the last episode that I will dedicate solely to that topic. So in the future, those questions will be mixed in with the general grab bag of other questions that I get about index fund investing or budgeting or getting out of debt or everything else in the universe of personal development and personal finance. So let's get started. Our first question comes from Sarah. Hello, Paula. My name is Sarah, and I have a question for you on how to achieve fire through buy and hold real estate investing or through rental properties. So first, I want to thank you for being so inspiring and always covering all the math. I find that very valuable. And my question for you

is, how do you know if you achieved fire through real estate? So I really think the math behind traditional fire and things like index fund investing is very straightforward, but it really becomes less clear to me when you add rental properties. So for us, our scenario is that we need $3,000 a month to hit fire. And for each property, we have set aside six months of gross rent as an emergency fund. So once we hit our desired number of properties that we need, we plan to snowball each of these or kind of pay them off smallest to largest until we own each one. And then once he rental is paid for and no longer has a mortgage. We're trying to decide, you know, realistically how much of the income from that house could we then live off of,

versus how much should we be saving for every property once it no longer has a mortgage. So we've been trying to estimate exactly how many houses we're going to need to realistically hit our goal. I'd love any suggestions and insight on math that you might have to help us figure out our dilemma. Sarah, first of all, congratulations. I think that your plan is amazing. The fact that you have six months of gross rent in an emergency fund is rock star solid, and your plan to snowball the debt payment on your mortgages is awesome. So congrats to you. Now, to your question, I actually hear two questions in here. I hear the question of, when am I fire? And I also hear the question of, when can I live on $3,000 per month in rental income?

those could be teased out as separate questions and I want to answer each of them individually. Before we get started, though, for the sake of everybody who's listening, I know there are some listeners who are wondering what on earth we're talking about when we say the word fire. So for listeners who might be new or who aren't familiar with this topic, fire is an acronym for financial independence retire early. I define it as the point at which your passive income typically through investments is enough. And of course, that opens up the both practical and philosophical questions of how much is enough or enough for what. But in my own definition of it, and everybody kind of has their own definition of it because the more you deep dive into fire, the more you realize that it is a state of financial well-being that is highly subject to interpretation. But the way that I define fire is that your passive income is enough such that you can live from a place of abundance. You can make decisions from a place of security and stability rather than fear.

Of course, that's a very soft and fuzzy definition. So let's dive into the numbers. Sarah, to the portion of your question that says, when am I fire, the reason that I tease this out is because you might be fire before you can live on $3,000 per month in cash flow. And here's what I mean by that. Now, I don't know all of your numbers, so I'm going to run through some hypotheticals. You need $3,000 per month to live. That's $36,000 a year. At the 4% withdrawal rate, assuming all of your money was an index fund, at the 4% withdrawal rate, that means that you would need an investable portfolio of $900,000 to generate that $36,000 a year in passive income.

However, if all of your money, all of your net worth was invested in rental properties, then you would be operating off of what would be more analogous to a 6% withdrawal rate rather than a 4%. So you would need equity, free and clear equity, of $600,000 in order to generate that $36,000 a year. And here's how I calculated that. If you have $600,000 worth of free and clear equity, and that free and clear equity is invested in rental properties that produce gross rental income of 1% of the equity value, then that $600,000 worth of equity that you have translates to $6,000 per month of cost. gross rental income. So I guess I should add an asterisk here, to be clear, when I save $600,000 worth of equity, I'm basing that on your acquisition price and not on future equity gains that the properties may have produced that may or may not correspond to higher rental income. In other words, to make this simple, what I'm saying is if you have a check for $600,000 and you go out and

buy a $600,000 apartment complex at the 1% rule, you buy that tomorrow. You buy that tomorrow. that apartment complex, at the 1% rule, produces $6,000 per month in gross rental income. Now, since you bought that apartment complex with a $600,000 check, you have that apartment complex free and clear, you have no mortgage on it, which means that your only expenses are the operating expenses, and at the 50% rule, your operating expenses will consume over a long-term aggregate average around 50% of that gross rent, which means that you're operating expenses will cost about $3,000 a month, leaving you with the other $3,000 per month in cash flow. So what I'm illustrating here is that if your rental properties are at the 1% rule,

then $600,000 worth of rental property, as measured from the time at which you acquire it, will produce that $3,000 per month that you need. As compared with index funds in which you would need $900,000 in order to get that same $3,000 per month, 36 a year. And for that reason, you can conceptualize index funds and portfolio investing as a path towards a 4% withdrawal rate, and you can conceptualize rental property investing as a path towards what would be analogous to a 6% withdrawal rate. The reason for that is because these two investments may have the same total return, but the returns in rental properties biased towards the indexed.

income stream. So in rental properties, if you assume that the property keeps pace with inflation and nothing more, that means it'll have appreciation of around 3%. And the other 6% comes in the form of that income. And that allows you to take a bigger chunk of income, a bigger chunk of that cash flow from the rental property without drawing down on any of the principal, since the principle is locked up in the property itself. With index funds, the returns biased towards capital appreciation. So you might have the same total return, but such a small percentage of that comes in the form of an income stream. The bulk of it comes in the form of capital growth. And that's why you draw down at a 4% rate because you don't want to risk drawing down too much

of the principle. The benefit to rental properties is that you don't have that risk of too much principle drawdown, which allows you to pocket the entire income stream that it produces. So all of that is a bit of a lengthy way. to say index funds, 4% rule, rental properties, 6% rule. That being said, you need $36,000 per year in order to reach fire. Index funds, that means you need 900,000. Rental properties, that means you need 600,000. However, it is highly unlikely that 100% of your investments are in one or the other. Most people have a blend of both, and so I'm betting that you have a combination of rental properties as well as index funds that are probably inside of a 401k or a 403B or an HSA or an IRA.

So the reason that I say that there are two different questions in here, the question of when can I live on $3,000 a month in rental income, and also the question of when am I fire, is that you might be fire before you can live on that $3,000 a month in cash flow, rental income. For example, if you have $400,000 in equity, free and clear, then if that equity is producing gross returns at the 1% rule, and if that property is also having operating expenses at the 50% rule,

then that $400,000 worth of free and clear equity produces $2,000 per month of net cash flow. And if in your 401k or 403B, you also have another $300,000 worth of index funds, well, that $300,000 in index funds is enough to produce another $1,000 a month at the 4% rate. So in that example, you would have a total net worth of $700,000 split between rental properties and index funds. And so your rentals are not yet producing $3,000 a month. They're only producing $2,000 a month in this example. But you would still be fired because between your rental properties and your index funds combined, those investments total would allow you to draw down enough money to come.

your cost of living. Now, again, this is where fire becomes a bit of a subject to interpretation, because it might be the case that you have $300,000 in your 401k, but you don't want to draw it down. So this is where the question of whether or not your fire then becomes open to interpretation, because you could draw that down if you wanted to. There are certainly ways that you can tap your 401k prior to the age of 59.5. It's complicated. It's headachey, but you can do it. On one hand, you might be fire because you can. On the other hand, you might not think of yourself as fire because even though you can, you choose not to.

But on the other, other hand, fire is essentially a movement towards the ability to choose. So the very fact that you are choosing not to would, in many people's eyes, still mean that you are fire because you are choosing whether or not to withdraw that money. So do you know what I mean here? Like the question of when am I fire and the question of when can, I live on $3,000 a month from cash flow from rentals? I consider them two separate questions because so much of that depends on how you define the moment at which you reach fire.

So leaving that to the side, let's answer the second part of your question, since that's a much more direct and pragmatic answer. And that second part of your question is, when can I live on $3,000 per month in rental income? As I just outlined, when you have $600,000 in free and clear equity and that equity, you is producing returns at the 1% rule, meaning it's producing $6,000 per month in gross rental income, free and clear. Then at that point, you have enough gross income coming in that you can reasonably assume that you will be collecting $3,000 per month over a long-term aggregate average. And what I mean by that is that cash flow from a rental property or from a basket of rental properties,

is volatile. You're not going to get exactly $3,000 every month. You will perhaps get $36,000 over the span of the previous trailing 12 months. But during those trailing 12 months, in some months you'll be keeping 5,000 and in other months you'll be negative 5,000. So when you reach the point that you are grossing $6,000 a month free and clear, at that point, you definitely have the ability to live on $36,000 a year from that cash flow. But before you actually make the leap, before you quit a job or say goodbye to other income that you're earning, take a couple of additional steps to protect yourself from the volatility of that cash flow and from the risk that a major one-time cash outlay might knock you on your butt a little bit. You know, the advantage to rental

properties is that you can plan for fire at the 6% rule instead of at the 4% rule, and that's awesome. But the disadvantage to rental properties is that there are major cash outlays that you have to make from time to time. And that doesn't happen in the world of index funds. You're never going to get a phone call from the S&P 500 saying, hey, you need to throw down $6,000 this week for a new roof. And so before you quit your job, in order to plan for that, and in order to protect yourself from that, here's what I would do. Number one, you mentioned you have six months of gross rent in an emergency fund. I think that is awesome.

I certainly wouldn't prioritize pushing that up to eight or nine months right now. Right now, I would prioritize snowballing those mortgages. Once those mortgages are paid off, I think six months of gross. rent is totally cool and you can basically, if your properties are newer and they're in good condition, you can relax. But if your properties are older homes, if they have some deferred maintenance, so meaning they're in anything other than excellent condition, and or if you live in an area where there's a lot of moisture, a lot of rain or snow or ice, or specifically if your rental properties are located in an area with a lot of moisture.

In those situations, then, yeah, once the mortgages are snowballed and they're paid off, before you quit your job, just boost the emergency fund up to maybe eight months of gross rent, eight or nine months of gross rent per property. Just to give you some additional protection against those cash outlays and so that you'll be in a position in which if you do have to draw down from that emergency fund, which you will, for replacing the windows, replacing the roof, dealing with a broken water heater, when you tap that emergency fund, you'll still be left with a comfortable remaining reserve. The reason that I say the thing about if your properties are located

in a high moisture area is because there are two things that cause properties to deteriorate, time and water. So if your properties were built in the 1940s in South Carolina, I would have a bigger emergency fund than if they were built in the 1990s or the early 2000s in the Arizona desert. The one other thing that I would do before you quit your job is if you know that there's a major capital expense that you're going to have to pay for one of your properties, go ahead and make that expense before you quit your job before you take the leap. And so what I mean by that is oftentimes for properties, we can see the big things that are going to come up. Yeah, sure, sometimes a water heater unexpectedly breaks. That's true. But more times than not, we know what is coming down the pipeline in a few years. We know that the windows are 30 years old and that they're flimsy and they're not well sealed and they stick. And we can tell by looking at them that these windows are on their last legs and it's not urgent that we replace them now. But at some point in the next three to four years, we probably should. it would probably be a good idea, maybe at the next tenant turnover, right? Like, it's easy to do, I shouldn't say easy, but you know, you can do a walkthrough of your

properties and spot those things. And so before you quit your job, before you decide to live on your cash flow alone, do a walkthrough of your properties and look for those things. Look for the fascia boards that are rotting out and the gutters that look like they were installed in the 1960s and should probably be torn down. Look for those things and just go ahead and even though they're not urgent and even though you could probably wait for a few more years to do them, just go ahead and get those things done so that that way after you quit your job, you don't have to worry about it. A lot of real estate investors hate making those big cash outweighs

because they have this mindset of that wiped out my profits for the year. I think that's a bad way to look at it. The better way to look at it is I'm paying up front for the next 30 years of service that these windows are going to give me. I'm paying up front for the next 20 years of service that this flooring is going to give me, assuming it's not carpet. Then it's only like four years. So while you are in a position of strength, while you're in that position where you've got cash flow coming in, your properties are paid off free and clear, and you still have your jobs. So you've got multiple sources of income, which means that you have additional flexibility. While you're in that position, just go ahead and pay up front for those things that your properties are going to

need for the next decade to come. That plus a strong emergency fund, the combination of those two things will totally give you the ability to live on that three grand a month in cash flow when your properties are grossing $6,000 free and clear. Cool. Thank you so much, Sarah, for asking that question. And congratulations on everything that you're doing. I think you have a solid plan. Our next question comes from Avey. Hey, Paula. This is Avey from Palsam, California. Thank you for answering my question last October 21st, 2018. I do have another question regarding real estate. When I bought my property last September 2014, I bought it for around $285,000. At the time of close, it was valued for $290,000. I am planning to

move out of the house, but not anytime soon. I do not plan to sell the property. I just want converted to a rental property down the road when I'm ready to move out and buy another home. Where do I start if I want to convert my house into a rental property? Do I talk to a licensed contractor first? And my number two question is, how much should I be spending when it comes to renovating my house? And what should I renovate first to make it more appropriate for a rental property without overspending or over budgeting with a property? With Hazillo Redfin, they said that my property is around $370,000 to $380,000. Prices around my neighborhood probably got sold around 350, somewhere around that range.

It's a three-bedroom, two-and-a-half-bath, a two-story property with an HOA. And that's it. Thank you for taking time to answer my question. Avey, I think that's great that you want to convert your primary residence into a rental property, my question to you is, why do you need a contractor? Why do you need to do any work to it whatsoever? The impression that I get from the message that you've left is that you are currently living in this house, which means that this house is fine for somebody to live in. You're living there. It's good enough for you. So if it's good enough for you, why wouldn't it be good enough for a renter?

I mean, certainly if there's something that needs to be done, do it. Like if you've got a termite infestation, deal with it. If you've got a rodent infestation, deal with it. But that's not specific to turning a property into a rental property. You would do that yourself even for you living there, right? So as long as you maintain the home in the way that you would normally maintain it for yourself, then you don't need to go above and beyond and do anything special to turn it into a rental. Unless you have some plan of converting it, you mentioned it's a three-two, two-story, I'm assuming single-family home. Unless you have some major plan of converting the single family home into a duplex or adding a partition wall that turns part of the living room into a fourth bedroom so that then it becomes a four bedroom, those would be the instances in which you would need to do some type of renovation.

But it doesn't sound like that's in the game plan. And certainly if there are any safety issues, get those fixed. Beyond that, make sure that the smoke detectors are working properly and that there's a smoke detector in every bedroom plus the kitchen, plus. Plus, every hallway. Install a carbon monoxide detector. That's pretty cheap. You can go to Home Depot and grab one for almost nothing. Actually, I'm looking on Amazon right now.

You can pick one up for $20. But yeah, you don't need to do anything special. Just rent it out. The only other things that come to mind are check with your city or town that you live in to see whether or not you need a license as a landlord. Some municipalities require that. Others don't. So just check the laws in your local area.

I would also open up a separate bank account so that you can have a business checking and business saving account from which you deposit your rental income and pay for rental related expenses and then link those to bookkeeping software. That way it's much easier for you to track your income and expenses when it comes to tax time. And that's it. Oh, and get an umbrella liability insurance policy. So, congrats on deciding to move out of your home and convert your home into your first rental. By the way, I did want to make a note for the sake of everybody who's listening. Did you notice how Avey said that he bought the home for $285,000? And at the time of closing, it was worth $290,000.

So by virtue of being a good negotiator, he was able to buy this home for less than the fair market value at the time of closing. which means he gained instant equity at the closing table. He gained $5,000 worth of equity at the closing table. And that is what's so cool about real estate is that you can do that. You can gain instant equity right away, especially if you are willing to make multiple offers and you're willing to be patient throughout your search. Avey, you also mentioned that your property is worth between 370 to 380 today. You know what's funny?

I'm saying this for the sake of everyone listening. I am less impressed by that than I am impressed by that 5,000 that you gained an instant equity at the closing table. And the reason for that is because the property valuation going from $290 back then to $3.80 today, that was the broad general market. There's nothing that we can do about it. That's just the circumstances of the overall market that we live in. That's market appreciation. that's cool. It's icing on the cake, but I think what's a lot cooler is when you do such a good job of finding a property that you make an offer for 285 that gets accepted, but then when you close that property is worth $290. Because in that circumstance, that $5,000 equity gain, that's not the market. That's you. That's something you've done. That's something you've done.

That's something you've created. That is, that's forced appreciation, essentially. That's appreciation that is done by actions that you have taken, by negotiating well and choosing well and picking the undervalued property. So I am far more impressed by the $5,000 of instant equity at the closing table than I am by the $90,000 that you made through circumstances outside of your control. What I think is the power of real estate is when we do things, when we negotiate well, when we plan renovations wisely, when we put up a listing for a rental property that's really well written and well photographed, and we optimize those properties and we make them more valuable than how we found them. We add value. When people have asked about turnkey companies in the past, somebody posted this question in the Facebook group, the Afford Anything Facebook group, where they said, I don't understand what value can I add. How would I execute judgment? How would I add value to the deal?

This is a perfect example. In purchasing the property, you bought something for $5,000 less than it was worth. And I get that like, okay, $5,000 might be a rounding error. There are many different opinions of what a property is worth. So if you're doing a comparative market analysis versus getting a broker price opinion versus getting an appraisal, sure, yeah, you can get three different professional opinions and they're going to say three things. I get that. But the broader point is that this is a perfect example of how you can use your judgment to create value where there was not value before, where you can use your talents and your skills to bring value to a property. That's the reason that I don't like turnkey investing is you're not using your talent or skill. You're just throwing some money at it and that's it, which means that it's going to do as well as the market does and no better. So anyway, great

job, Avey, on choosing that home and enjoy turning it into your first rental. We'll come back to this episode after this word from our sponsors. Are you tired of getting nickel and dined by your bank? And are you also tired of not earning very much interest on the money that's in your checking account? Check out Radius Bank. They have this thing that's called Radius Hybrid Checking, which is a free high interest checking account. It's called hybrid checking because it combines the high interest of a savings account with the flexibility of a checking account. Now, here is the situation.

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rental property investment. The city where I live has a high cost of living and not much that meets the 1% rule that would work for me. But I found another small city nearby that I like because it has proximity to big city, access to trains, diversified employer base, including three colleges, two hospitals and one well-known vocational school, and lots of reasonably priced multifamily homes. I found a few that seem like they might pass the 1% rule, but most need a little bit of work. They're probably mostly class B or C plus type properties. And that brings me to my challenge. I understand that the 1% rule should account for the purchase price plus the cost of repairs needed to be rent ready, but how do you know how much repairs will cost? I've seen enough

HDTV to know that there's a really wide range of what can be done and what can be spent. In some properties, there's photos, in others you don't see what the inside looks like. So it's hard to tell. I know you've mentioned out-of-state properties you'd have a team to help repairs. But if you don't own in the area yet and you don't have a team in place yet, how can you get an estimate to know, is there a baseline rental amount that should be built into a budget? What's the best way to think about the cost of repairs to be rentable part of the 1% equation when it's your first time? Thanks so much. Appreciate your help. Anonymous, first of all, I think that that small city that you described, the one that's

close to but just outside of where you live, sounds awesome from the way that you've described it, the fact that it has many industries, diversified employment, multiple higher education institutions, access to a major city, public transportation, it sounds awesome. And class B to C plus properties, multifamily properties that need a little bit of renovations, that is really a golden sweet spot for prime rental property investing. That's often where you can create value, where you can find and create value. So to your direct question, which is, how do you estimate renovation costs? If you think about a flow chart of how you buy a rental property, you're not at the stage currently in which you estimate renovation costs. That comes later. So right now, it sounds like you're at the stage

where you're looking at listings and you're trying to decide which properties you want to make an offer on. So what comes next is that you get a real estate agent and you have your real estate agent do a walkthrough of the properties and FaceTime you as he or she is doing a walkthrough of the properties. That way, you get to see a lot more of the properties than what any listing photos will show. So that right away is going to give you a lot more information. Then you make an offer on the property and if the offer gets accepted and you go under contract, that is when you send in a general contractor who will give you a renovation estimate on the property. So trying to get an accurate renovation estimate right now, this is just not the right time for it. It's too early in the game.

After that property is under contract while you are in your due diligence period, that's when you're going to send in two people, number one, an inspector, and number two, a licensed general contractor. The inspector will clue you in as to everything that needs to be fixed, and the inspection is going to be scary. That's how they're designed to be. But the license general contractor is going to give you actual estimates, actual numbers for how much this renovation is going to cost. And when you send him or her in, what you would want to ask them is to give you two estimates, one of all of the renovations that would need to be done in, say, the next four or five years. So clue you in on major capital expenses that don't need to be tackled immediately, but that

you'll want to have in the back of your mind or have on your time horizon, your five-year time horizon. But you'll also want that general contractor to give you an estimate of the minimum viable renovations that are absolutely necessary to get it rent ready for that first tenant, because that is the number from which you'll be making the 1% judgment call. So if the roof needs to be replaced sometime in the next five years, that's fine. I would not let that dissuade you from purchasing a home, because that's not, strictly speaking, the minimum viable necessary to get it rent ready for that first tenant. But if the property is in such disrepair

that it cannot get a certificate of occupancy and there are certain things that you need to do just to make it habitable for that first tenant, then that is the estimate that you would receive from your general contractor that would play into your assessment of whether or not that property meets the 1% rule. But again, that estimate from the general contractor

comes after you get the property under contract. So right now, if you look at a rental property, if you look at a multifamily, and it seems to be within reasonable striking distance of meeting the 1% rule, and it doesn't have to be accurate, it just needs to be in the right ballpark. If you find a property that's in the right ballpark and you feel as though that property merits further, deeper consideration, that is when you send your agent in there, have the agent facetime you with a walkthrough, have the agent take a bunch of photos and text you or email you those photos. And that step right away is going to clue you in at least at a broad level as to whether

or not the place is habitable. And if there are people living there, it's probably habitable. There are some people who are living in places that are beyond the pale. But for the most part, if there are people who are living in there, then you know that people can live there. but if the place is vacant, then you want to have that walk through just so you know, hey, is it okay to put somebody in here right now, or am I going to have to take some drastic measures before I can safely have somebody live here? So when the agent walks through the property and FaceTime's you, that's when you'll get that basic information. And again, that's still too early to calculate renovation costs.

Once you get that basic information, you'll have a better sense of what the property looks like on the inside. then you make an offer on the property. When it comes to estimating the costs on a property, the real work begins after you go under contract. Because here's the thing. You are going to, or I shouldn't say you, but many, many real estate investors will make offers on 20 properties. And one or two of those offers will actually get accepted. One or two of those offers will go under contract. So you don't want to waste a whole bunch of your time trying to decipher the operating expenses on a property if it's not under contract yet.

Your due diligence begins when your due diligence period begins. And that due diligence period is not going to begin until the offer is accepted and you guys go under contract first. So really at this stage, the question is not how do I estimate renovation costs? Really at this stage the question is, or the action item is let's get those three people on my team. get the agent, let's get an inspector, and let's get a general contractor, because those are the people who I will be interacting with most at this stage while I'm submitting offers and then on day one of going under contract. So, best of luck and congratulations on finding a good location with great properties. That's fantastic. Our next question comes from Carly. Hi, Paula. My name's Carly,

and I'm calling from Seattle. I have a question about your 1% rule on property. What What about appreciation? I'm just wondering if we bought a property that is, you know, the return is instead of 1% is a 0.5%. But the growth in that property has doubled in terms of its value. Is that a good property to hang on to or is that something that's worth selling at this point? Thanks for your thoughts. Carly, so the 1% rule is a rule around when to purchase a property.

It is not a rule around whether or not to hold a property. So the 1% rule applies only to making a purchasing decision and not to making a holding or selling decision. And the reason for that is that when we talk about a stock investment, like a share of Coca-Cola or Nike or Tesla, it's very easy to say, if you wouldn't buy it now, then don't hold it. So on any given day, because the ease and the transaction costs of selling a stock on the stock market are so low, it's very easy to. say, would you buy it now? If yes, then hold. If no, then sell. Houses are different in that once you purchase a property, A, there are huge transaction costs associated with selling it. You need to get the tenant out of there. You need to clean it up. You need to stage it. You need to pay for the holding costs while it's vacant. Then you need to pay the transaction costs on the real estate

agent commission, as well as other closing costs. There are massive, massive costs associated with selling it that you don't face in other situations that need to be baked into the should I hold or not formula. In addition to that, you have an intimate level of knowledge about a home that you have owned for a while. You have a much more clear understanding of its current condition. You know what major capital expenses you can anticipate. I mean, once you've owned a home for a few years, you've got a pretty good idea of what's going to happen in the next five years with regard to that home. Are you going to have to replace the windows? Are you going to have to put more insulation in the attic? You have a history with this home, and so you know what to expect better,

and there is a certain value to that. And so for those reasons, as well as many more, the question of whether or not you should hold a home, should I hold or sell, is intrinsically different from the question of should I buy? And the 1% rule applies to buying. Specifically, it applies to buying and buying alone. So it should not be used for an application for which it was not intended. So to apply the 1% rule to the question of should I hold or sell is to use the wrong tool for the wrong job, right? It's using the wrong formula, applying the wrong formula or the wrong question. Now let's take a step back and at a conceptual level, understand the why behind the 1% rule. So the 1% rule states that at the time that you purchase a property, the property should collect gross rent

of 1% of its total acquisition price. And I define total acquisition as purchase price plus upfront repairs, minimum viable upfront repairs necessary to make it habitable for that first tenant. So for example, if you buy a home for $150,000, but it is unsafe for a human being to live there, and you need to put another $75,000 into making it just a place where somebody could live, then you've purchased that home for $2.25. Now, the reason that I say that is because there are some people who optionally want to make a place better, you know, like, oh, the kitchen looks really ugly, it looks outdated, I'd like to fix it up. That's cool. You can choose to do so. But that's not, strictly speaking, required.

Like, that's an optional upgrade that you're doing for the sake of maybe raising the rent or attracting a nicer tenant. So that doesn't go into the equation. The equation is purely, what do you buy it for? And what's the minimum that you need to put into it in order to make it ready for the first tenant? That's your total acquisition cost. And if you can gross 1% of that per month, so $1,000 for every $100,000 that you put in, So in this example, you buy a house for 150, you put 75 into it, you've bought it for 225. If you can gross 2250 per month, well, then that means that you are grossing, if you're

grossing 1% a month, you're grossing 12% a year. And if you're grossing 12% a year and 50% of that goes to operating expenses, then the other 50% is what's left over as your net operating income. And what that means is that this, if you think of a house kind of like a stock, it is yielding a dividend, an unleveraged dividend, of 6% of the value of that asset. Its net operating income is 6% of your acquisition price of that asset. And so that is the reason why I advocate the 1% rule as a buying formula. Because if the home is yielding an unleverage dividend of 6%, and then it continues to keep pace with inflation, now you're getting a total return of 9%. So that's the reasoning

behind the 1% rule. But then once you own a house, I mean, holding is a whole lot of factors there. What would you do if you sold that property? How much would it cost? How much would you get in equity if you were to sell it? Like how much, you know, what would be the amount of cash to you after selling, after paying all of the transaction costs associated with selling? What would you do with that money? Would you 1031 it into a different rental property? Right. What opportunity costs are you foregoing by holding that property versus, you know, what else would you do? what is the value to you of knowing that property and knowing what to anticipate because there's a certain certainty value that it has as compared with the uncertainty of a property that you're less familiar with. I mean, those are all of the factors that go into holding.

So thank you so much for asking that question. Best of luck with whatever you decide to do with your property. We'll return to the show in just a moment. Do you run a business? If so, then as you know, you are juggling a lot of balls. You're spinning a lot of plates when you're running a small business. There's a lot of stuff that you're handling, and some of that stuff is fun, and it helps you grow your business, and others is, you know, necessary, but it's not the reason that you went into business. And so stuff like filing taxes, running payroll, you have to do it, but it's not probably the thing that ignites you.

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If I'm going from point A to point B and it's going to take me 15 minutes, that's not enough time to get into a podcast episode or to really get into an audio book. So that's a perfect time for me to listen to a blink. Some of the ones that I like that I recommend you check out are Seven Habits of Highly effective people by Stephen Covey and Rich Dad Poor Dad by Robert Kiyosaki. Right now for a limited time, Blinkist has a special offer just for our audience. Go to blinkist.com slash Paula to start your free seven-day trial. That's Blinkist, spelled B-L-I-N-K-S-T.

Blinkist.com slash Paula to start your free seven-day trial. Blinkist.com slash Paula. Our next question comes from Erin. Hi, Paula. My name is Erin, and I'd like to ask if you would ever buy a first rental property before owning your own home. I'm trying to decide if I should put my savings toward a down payment on my first home in my expensive Northern Virginia area, or put the money toward a real estate residential investment property in Huntsville, Alabama, where I have work connections but haven't visited myself yet. I have $15,000 earmarked for one of these options, $8,000 in my TSP after just one year of working, and $36,000 in more grass.

of Vanguard funds. I've just received a $12,000 raise and I'm guaranteed a $28,000 raise next fall. As a single person, I'm squeamish about the idea of buying a forever home if that might not work out when I do eventually find a partner to share a home with. That said, I do hate renting and miss the quiet of more land and not sharing walls with neighbors, though I could do it for another two or three years if it means getting some passive income from owning a rental. If I invest in Huntsville, I want to hire a property manager so it'll be totally passive income. What should I consider and whether I should put my pot of money toward a large down payment in Alabama or a paltry down payment here in very expensive Northern Virginia?

A mortgage officer just ran numbers for me and said I'd very comfortably afford a $50,000 property in Alabama at 20% down for $360 total per month or a maximum price of $270,000 in northern Virginia, which buys absolutely nothing here, not even a shoe buy. for 150% times my current rent. Thank you so much. Erin, first of all, as you know if you've listened to this podcast for a while, I generally don't like to tell people what to do. I generally like to give people things to think about, factors that they should consider, and then leave people to make their own decision. But I have to just be honest, when I heard your question, the first thought that popped into

my mind is that I have never heard more of a slam dunk case for buying a property in Huntsville, Alabama, as I hear when I listen to your question. So here's what I'm going to do, for the sake of being fair. I'm going to talk through why I think that, and then I am going to make the devil's advocate argument for the other side and voice the dissenting opinion to myself, to the best of my ability to do so so that we can explore how to look at this from a few different perspectives. So here we go. First of all, let's set the stage a little bit here with what we're comparing because in this question we're comparing purchasing a personal residence, a primary personal residence, with purchasing a rental property. Oh, and to answer your initial question,

which is, would you buy a rental before you'd ever buy a property for yourself? Hell yeah. And so let's frame what we're comparing here, which is buying a property. personal residence, which is not a cash-producing investment. It is not something that sticks cash in your pocket every month. It is not something that pays you a dividend or an income stream. It is something that costs you money. It removes money from your pocket every month. You hope that maybe, maybe, maybe, if the market does well, it might go up in value. And historically, that has been the case. But when you buy a personal residence who are fundamentally making a consumer purchase. And I know I'm going to get some angry letters from people who say,

yeah, but you're just throwing your money away on rent. For those people, let's talk about the difference between what is an investment and what is a personal purchase. If you are not calculating the present value of future dollars, if you are not calculating the cap rate, if you are not calculating the cash on cash return, if you are not calculating the internal rate of return, guess what, the thing that you're buying is not an investment. So, yes, buying a personal residence for many people has ultimately ended up being a wealth-building move, but that is not the same thing as something being an investment. So, moving away from generalities and towards specifics, let's talk about your potential personal residence versus this opportunity that you have in Huntsville.

Now, you can put down a 25% down payment on this $50,000 property in Huntsville and still have a few thousand left over for closing costs, other miscellaneous things. I'd want you to beef up your cash reserves just a little bit more before you go ahead with this, because after you buy the property, there might be some unforeseen expenses, renovations, maybe a vacancy for the first month or two after you buy it. So have some cash on hand so that you can get through those initial first few months. months because oftentimes there are just a lot of unanticipated expenses that come up at the very beginning and you don't want to be thrown off course, particularly right at that point when you're new to investing and extra sensitive to everything that is going on, right? Like you don't have the big portfolio built up yet. So have additional cash reserves on hand before you do it, but it sounds amazing. You've got a 25% down payment on an investment property that I am, I don't know the

rental income or any of the numbers on it, but I'm sure it will probably have a very strong cap rate, good returns. Huntsville, Alabama is a fantastic place to be a rental investor. I mean, you've got this concentration of well-paid government jobs in a low cost of living area. That's the best of both worlds. And as this property starts generating cash flow, you can use that cash flow to number one, save an even larger emergency fund for the property, save larger cash reserves for it. Number two, once you're done doing that, then that cash flow can become the basis for your next down payment on either your next rental property or on a personal residence for yourself. So you put yourself in a stronger position by virtue of using this money in a way in which

it's generating additional cash in your pocket. it. Compare that to buying a personal residence for yourself, which you mentioned would be you could borrow for a $270,000 personal residence, which, as you said, isn't going to buy you very much. It certainly doesn't sound like it's going to buy you something that you would be happy with. So it sounds like you would end up buying something that you would want to sell in a few years anyway, thus probably wiping out any of the equity gains that you built in it through principal pay down or through market appreciation due to the high cost of the transaction fees when it comes to selling. So you'd probably be selling it soon enough that you would wipe out any of

the potential gains. And in addition to that, while you're living there, you'd be paying 150% of what you are currently paying. So this property, if you were to buy a personal residence, would cost you more money out of pocket and you wouldn't like it that much. And you would probably end up wiping out most of your gains in a few years anyway. So that's why, when I heard your question, I was like, whoa, this is the biggest slam dunk I've ever heard. All right. But for the sake of playing devil's advocate, let's make the counterargument just because I don't want to tell you what to do. I want you to make your own opinion. So I am going to give the dissenting voice to myself. Here we go. The arguments in favor of buying a personal residence include,

you mentioned that you might not want to live where you are currently living. You might not want to share walls with your neighbors. And you like the idea of having a single family home with a yard and with some space. And there is a value to enjoying where you live. It is not an investment, but there is certainly psychological and emotional value that comes with enjoying the place where you live. And if loving your home, I mean, This is stretching a little bit, but I suppose you could argue that if enjoying your home makes you more productive or happier than indirectly, it might have some monetary benefits to your life. That's kind of a stretch, but I can imagine some people saying it. But in any event, regardless of that, there is absolutely value to the psychological benefit of the enjoyment of owning your home and the enjoyment of having some space. An additional argument might be that a $50,000 property is most likely going to be a Class C property. I haven't specifically looked at properties in Huntsville, but based on that price point, there's going to be a higher risk profile of what you might deal with in a property at the $50,000 price point. And so depending on your risk comfort level, you may or may not want to purchase a property at that price point.

And if that's the case, if that is not a rental property that aligns with your rental risk profile, then you could ultimately end up doing more harm to yourself than good by buying a property that is misaligned with your own risk profile. And what I mean by that is that sometimes when people get into rental properties, they purchase a property that's out of step with their own risk tolerance and they have a bad experience and then they give up on rental properties entirely when in fact it's not that the entire universe of rental properties are unsuitable for them it's just that they were not in the appropriate investment for their own investing style and so i don't know what your investing style is and

frankly neither do you because you've never done it before and that's the type of thing that you really learned through experience but so if i were to form the dissenting opinion to myself and make another argument for buying a personal residence with this money, it might be that there is some logic to starting your rental investing journey with a slightly higher-end property, a Class A or Class B property, so that you can get comfortable with rental investing at a more comfortable threshold of the spectrum. And then once you've achieved that comfort with rental investing in general, then you can move on to including a Class C portion of rental properties in your portfolio. Right. So the analogy might be, if somebody's really nervous about market investing, the analogy might be start with bonds and then add stocks.

It's kind of like that. Finally, in terms of resources, the New York Times has a fantastic rent versus buy calculator. I would encourage you to go there. We'll put a link to it in the show notes. I would definitely encourage you to go there and run your numbers for renting your current place as compared with buying this $270,000 personal residence. Run your numbers through that and see how it pans out. Now, you're going to have to make assumptions about how long you would live there, what the opportunity cost of tying up the down payment is as compared to the returns that you would get in an alternate investment. You're going to have to make some assumptions about the relative

difference between utility costs, whether or not there's an HOA, et cetera, et cetera. But because of the fact that they ask you to make all of those assumptions, you can really play with these variables and see what the difference between renting versus buying, what that difference looks like, and how long you would need to live in a property before you reach that crossover point at which buying makes more sense. So again, I'll link to that calculator in the show notes, which those are available at afford anything.com slash episode 187. But run your numbers through there.

That's the final somewhat pro-you-buying-personal investment argument that I'll make for the sake of exploring that avenue. That being said, I have always been a fan of renting in a high-cost area and buying in low-cost areas. And in your case, it sounds as though you can rent for a few more years while accumulating investments in places where the returns are. Oh, final thing, you mentioned that you would have to hire a property manager. Well, those numbers are going to be the same anyway, because regardless of whether you're buying locally versus out of state, when you are analyzing a property, math must be identity agnostic in order for it to be math. And what that means is that you cannot value your own time at zero, somebody else's time at greater than zero, and refer to that as an apples to apples comparison. And so regardless of whether you're investing locally or out of state, you run the numbers as though you're outsourcing everything, including the property management, And if you choose to do some of the work yourself, that's fine.

But that's not baked into the analysis because you're not buying a job. You're buying an investment. And so you want to create a distinction between owner you and worker you. If you buy locally and you choose to do some of the work yourself, then worker you is getting compensated for the work that you are doing. That's different than owner you receiving a return on investment. And so for math to be math, it must be. Identity agnostic. It must not depend on the identity of the individual performing the task. So when you're analyzing a property, always run the numbers as though you're outsourcing property

management, regardless of whether or not you intend to actually do so. Thank you so much, Erin, for asking that question. Our final question today comes from Nancy. Hey, Paula, it's Nancy calling. I called you back in episode 159 and asked some questions about TSP for federal government workers. We are still living abroad and plan to for the rest of my career, which will probably be another 15 years or so. We're looking to buy multi-unit properties in the U.S., but while we live abroad. And I wonder if you have any advice for that. We found it really hard to find agents that are interested in working with us. Maybe they don't think we're serious because we're not

physically in the U.S. And also, we've struggled to find people who are willing to do video tours for us or do any of that kind of legwork. As of now, we're looking at the Baltimore area, the New York, New Jersey area, and in New Orleans and that area around Louisiana. Also, using sort of Zillow or open source information about searching for property seems to not really come up with much for multi-units or duplexes and triplexes. So we're kind of running into a brick wall, and we'd like to have some advice about how best to navigate that world. Thank you so much. Nancy, thank you for calling back.

Now, first of all, if you are working with real estate agents who are familiar with working with rental property investors, and that's the key, then those agents should not be putting up roadblocks to FaceTiming you as they walk through properties. I mean, that's super common. Agents do that all the time for investors who are out of state and out of the country. So broadly speaking, agents I found tend to either have most of their experience as people who work with owner occupants or they do most of their experience with people who are investors. And generally, if you try to work with an agent who is accustomed to working primarily with owner occupants or retail homebuyers, and you start asking them the questions that an investor asks, they are a fish out of water. So if you're working with or talking to agents who aren't used to working with investors,

then I guess, sure, maybe they'll be weirded out by doing the things the agents who work with investors commonly do. Like, it is super, super, super common for agents who work with investors to FaceTime you as they walk through a property, to take pictures of a property with their phone. We're not talking about crazy professional photos here. We're just talking, take out their iPhone, snap a whole bunch of photos, upload it to a shared Dropbox folder, or upload it to a Google Drive folder, or just email it to you or text it to you. Any agent worth their salt who works with investors would be happy to do that. So what I would recommend for you is to make sure that you are working specifically with

agents who specialize in working with rental property investors. Now, how do you find them? The number one way is by asking other investors for recommendations or referrals. Find a forum with other real estate investors. Ask them who they use. Find out who they use. In fact, head to the Afford Anything Facebook group. Pop a question in there to see if there are any real estate investors

there who work with agents who they can recommend. Now, the fact that you're looking specifically at Baltimore, the New York, New Jersey area, and the New Orleans area, perfect. Just say that in the Facebook group and see who they'll talk to. In my course, your first rental property, we have a forum there where people can trade referrals and information, bigger pockets has forums. I'm sure there are probably some Reddit threads that would also have that information. And then the other thing to do is in each of those cities that you named, Baltimore, New York, New Jersey, and New Orleans. So Google the name of those cities, and then Google either R-E-I-A, which is Real Estate Investors Association, or Google R-E-N-C, Real Estate Networking Club,

Google the names of those cities, plus either of those two acronyms, and then find the Real Estate Investors Association or the Real Estate Networking Club that is local to those areas, get on their email lists, because oftentimes they'll have an email list serve, basically, where everybody can talk to one another, you know, in the form of a Yahoo group. People still use Yahoo groups, apparently. So join those email lists and then chat with the other investors who are part of that. Another thing you can do, go to meetup.com, look for real estate investors in those three areas, Baltimore, New York, New Jersey, New Orleans.

And again, ask for specifically real estate agents who work with. with investors. Now, the other other thing you can do is a lot of ideas here. All right, there is a designation that's awarded by the National Association of Realtors. The designation is called SFR, which stands for short sale and foreclosure resource. Now, as a word of warning, SFR is also the acronym that stands for single-family residents. So it's a little bit confusing because the same acronym SFR is used by real estate investors in multiple contexts. So in this context, SFR is a designation awarded by the National Association of Realtors for agents who are short sale and foreclosure specialists. They're resources in specifically those

fields. Now, even if you are not looking specifically for a short sale or a foreclosure, If you want to find an agent who specializes in working with investors, well, guess what? Who are the people who look for short sales and foreclosures? They're not retail homebuyers. They're not owner occupants. They're the investors, right? So by virtue of going to an SFR specialist, a real estate agent who has the SFR designation, you are necessarily screening for agents who work with investors.

In our show notes at Afford Anything.com slash episode 187, I will include a link to the page on NAR's website where you can find SFR specialists in a given geographic area. Speaking of the show notes, I'm just going to throw this out here. There are a lot of people who listen to this podcast with experience in the real estate field. If any of you know of an agent in Baltimore, New York, New Jersey, or New Orleans, who specializes in working with investors, drop a comment in the show notes. Drop a comment in the comments on the show notes. All right. Now, to the second part of your question, which is how do you search for multi-unit properties, there is a website called R-O-I-Signal.com that is a search tool that is specifically optimized

for looking for multifamily properties. So we're talking duplexes, triplexes, four-plexes, all the way up to 100 units. I, again, not to plug my own course, but to plug my own course for a minute. So this search tool is $20 a month, so $240 a year. I include one year of access to this for free to anybody who joins my course. So if you, I mean, you can just go to ROI signal and pay for access to this tool. You're certainly welcome and everybody is welcome to do that. But I liked the tool so much that I emailed the developer and said, hey, I want to chat.

And then we got on the phone and we talked for a long time. and I said, tell you what, will you give me a bulk discount? And he said yes. And so I'm paying out of pocket at a discounted rate for every single student who signs up for my rental property investing course. So you can pay for the search tool. You can join my course, whichever one you want to do. But that's a great search tool for multi-units. There's another search tool called LoopNet, but it's not as targeted towards multifamily residential. I mean, you can find multifamily on there, but it's really optimized for offices, warehouse, like other forms of commercial investing. And some investors, well, you know, different investors have different

opinions of it. We'll just say that. The final thing I would say is that we did a podcast episode with Rich Carey. That was episode 136. We will link to that episode in the show notes as well. In that episode, Rich talks about how he has purchased 20 single family homes from overseas. He's in the military. He's stationed in South Korea. And he owns 20 single family homes all in Montgomery, Alabama. He talks about it in that episode. Fantastic episode. So tune into that if you haven't already. He also has a great blog. It's called Rich on Money.com. I'll link to that in the show notes as well. So if you want to hear the story of somebody who's done it from overseas, he is a fantastic example. So thank you for asking that question and best of luck with your multifamily search. I want to close. out with this great question from Troy, here we go. Hi, Paula. My name's Troy. I'm calling from Baltimore, Maryland. I'm just wondering when you're going to start your online real estate investing course. Thank you very much. Well, Troy, thank you for asking. So my course, which is called Your First

Rental Property, opens for enrollment today, Monday, April 8th, 2019. It is officially open for enrollment as of today. And the enrollment window is only one week long. So if you want to sign up for the course, you can enroll this week. You can enroll from Monday, April 8th through Friday, April 12th at 1159 p.m. Pacific. At that point, enrollment is cut off. You can no longer join. And the reason for that is because the course is 10 weeks long. And we all go through it together as a group. I mean, you get instant immediate access to the course when you sign up. And if you want to self-paced through it, you can. Group pacing is an option, not a requirement. But it's designed so that we all go through it together as a group so that that way I can be very directly

involved, I can be around, I can answer questions. You as the students can talk to each other. So every day, there will be a forum thread where you can discuss the lesson that we went over that day and you can like roundtable it and mastermind it with one another. There's a lot of value to that. And so we keep the enrollment open for one week, April 8th through 12th, and then we close enrollment on Friday, April 12th. And then the first day of class is Monday, April 15th. And the class runs 10 weeks long. Graduation is Friday, June 21st. After those 10 weeks, you will have a lot of really solid information and readiness and confidence to find and finance and renovate and put a tenant in your first rental property.

It's a ton of information. It's worksheets and quizzes and handouts and checklists and word-for-word scripts that you can use when you're making phone calls to property managers or agents or contractors. We have canned responses that you can just copy-paste and save in Gmail for when you need to interface with a tenant. So we've got loads of information in there from the A to Z of how to analyze, find finance, renovate, negotiate,

for purchase, advertise, and sign a lease with and manage a tenant. It's a lot of stuff to cover. That's why it's 10 weeks long. Plus a one-year subscription to ROI Signal, which is the multifamily search tool, is included for free for all of the students in the course. You can sign up by going to afford anything.com slash enroll. That's afford anything.com slash enroll. And again, enrollment is this week only, April.

8th through 12th. After that, we are closing our doors so that I can focus all of my attention on the students who are inside of the course. I don't know when we're going to offer it again. I'm thinking maybe October, but I'm not totally certain. And everybody who's in there gets lifetime access to the course. In fact, many of our beta testers are going to go through it again because there's so much information in there that they find that it's going to be helpful to to go through it a few times and to go through it with a new cohort of people so that you've got more people in the forums and more life and more energy and more people to bounce ideas off of. You've got a community in there that are all doing the same thing that you are.

So Troy, thank you so much for asking. For everyone who's listening, I hope to see you inside the course. And thank you again. I did want to answer one question that several people emailed to me. So a few people asked, isn't it weird? that you say that you don't want to be pigeonholed as a real estate investor. Like you want to be known for more than just that, but you're launching a rental property course at the same time. Like, why is that? As I mentioned a few episodes ago, I do think it's important for people to

understand that I made my money by running an online business and I invested that money into rental properties. I think that rentals are a fantastic way to invest the money that you are making from your day job or from a business that you are running, from whatever it is that you do full time during your nine to five, I think rentals are a fantastic way to invest that money. But that is different from rentals being the thing that you do from nine to five or rentals being that primary source of income, right? So I want to make sure that that distinction is clear, especially for the students who enroll in the course. Thank you so much for tuning in.

My name is Paula Pant. This is the Afford Anything podcast. And if you're interested in rental properties, come check out the course, affordanything.com slash enroll. This week only. By the way, next week, Daniel Pink, bestselling author, comes on the show to talk about the scientific secrets to perfect timing. Thank you again for tuning in. My name is Paula Pant. I'll catch you next week.