Afford Anything - Ask Paula - When Should I NOT Use the One Percent Rule for a Rental Property?

Episode Date: January 4, 2019

#170: When should you NOT use the one percent rule for rental property investing? In today’s episode, I encourage two callers to violate the One Percent Rule for real estate that they already own. WHAAATTTT? Why would I say that? Especially given that I’ve gained a bit of a reputation as The World’s Most Staunch Advocate of the One Percent Rule? (Long title, I know, but someone’s gotta wear it.) And if you’re not going to use the One Percent Rule, how should you make decisions about your real estate investments instead? Find out in this podcast episode. Enjoy! For more information, visit the show notes at https://affordanything.com/episode170  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 energy, your focus, anything in your life that's a scarce or limited resource. You need to know how to allocate that in the way that fits with you, with what you want. And so how do you do that? How do you align your daily decisions in accordance with your priorities?

Answering this question requires a lifetime of practice. There's no simple answer. and this podcast is here to explore how to do that well. My name is Paula Pant. Happy New Year's. This is the Afford Anything podcast. And we are normally a weekly show we air every week on Monday, but on the first Friday of the month we air a first Friday bonus episode.

So welcome to 2019. This is our January 2019 first Friday bonus episode. If you are joining us for the first time because you've set a New Year's resolution to get better with your money and now you're downloading finance podcasts to figure out how you can do that. Welcome. Here's basically what you can expect. Every other week, we interview a guest. And these guest interviews could be anyone from millionaires and early retirees to entrepreneurs to psychologists.

They could be investors. They could be people who study the decision sciences. We interview a pretty wide range of people. Search back through our archives to dig up some of the great ones. And we do this on every other episode. And on the episodes in between, I answer questions that come from the listeners, the community. Of the episodes in which I answer audience questions, I divide these into two. Half of them, I answer general personal finance questions on anything from index fund investing to budgeting to debt pay off.

And on the other half, I specifically answer questions related to real estate investing. I tend to get a lot of those. In today's episode, this happens to be the one in four episode in which I answer real estate related questions. If you're interested in that topic, stick around and listen. If you're not, don't worry, three quarters of our episodes are about totally different topics. So check out some of our other episodes in which we cover a huge array of other stuff related to financial independence, money management, personal finance, investing, and really at a more broad level, how to be a best. better thinker and decision maker, how to be better at planning for your life. Now, with that said, let's go to our first question, which comes from an anonymous caller.

Hi, Paula. I'm a newer listener in Boston, but I've been binging and loving the podcast. I've searched the blog and podcast files, but not finding exactly what I need. I'm a newer investor, and also doing some house hacking, renting my house on Airbnb when I'm in London working a few weeks each month. I made a couple of rental property purchases before I read. I made a couple of rental property purchases before I really knew enough about how to do all this properly, before learning about the 1% rule and so forth. Luckily, my first few properties, while not the best rental options,

were in markets that cut fire, so I sold them for solid profits and reinvested. Right now, I still have a duplex in a great suburb of Boston that is revitalizing and is a magnet for younger people. I've only owned it for about a year and a half. I bought it for 500,000, and it currently rents for a total of 4,100. So it does cash flow,

but is obviously not getting an ideal ratio. I know I could find other properties that do hit the 1%, either triplexes in the same town or in another cheaper market. So I'm thinking of selling. I doubt it is appreciated much, and if the house would just get what I paid for it, is it worth it to sell to reinvest the equity for a better deal? Or given all the fees and closing costs, would it be better to sit tight and wait for the rents to rise? This year, rents already rose 5%. Thanks so much for all you do and looking forward to hearing from you. First of all, congratulations on buying multiple rental properties and on continuing to learn and make decisions about how to improve your performance as a rental investor.

You are totally on the right track and I'm very happy for everything that you're doing. I love your question. The short answer? No. If I were in your shoes, I would hold on to it. I would not sell it. Cutting to the chase, that's the short answer. But let me pull back a little bit and talk through that thinking process.

First of all, the reason that I love your question so much is because at its core, the question that you have asked is, if you already own a property and that property is performing suboptimally, when does it make sense to sell that property? And that inherently is a very different question than what property should I buy. We use the 1% rule as a litmus test for properties that were interested in buying. But that same litmus test does not necessarily apply to whether or not we should sell a property. And the reason for that, as you said, is all of the closing costs and the transaction fees associated with buying and selling. In the world of stock investing or in the world of index fund investing, it's very simple to say, well, if you wouldn't buy it now, then don't hold it. For something like an index fund or stock investment, that makes a lot of sense because you can trade stocks for free on a lot of platforms. Or at worst, your trading fee is going to be $10.

In that arena of investing, the adage, if you wouldn't buy it, don't hold it, absolutely make sense. Real estate is a much more illiquid asset. I mean, think about it. When you purchase a home, you know that when you sell, you're going to pay. About 6% in realtor fees alone, not even counting other closing costs, which means that after you buy a home, that home has to appreciate in value 6% above the rate of inflation for you to just break even at the time that you sell. And again, that's not even counting other closing costs. That's only agent commissions. As a side note, that's also one of the many reasons why I encourage a buy and hold strategy. There are a lot of people who are tempted by what appears on the surface to be the easy money of flipping houses.

And I'm not talking about you. I'm just making this broad statement for the sake of everyone listening. There are many people who might look at the numbers in a vacuum and say, hey, I bought this home for $300,000 and I sold it for $330,000. Doesn't that mean that I did really well? Not necessarily. After closing costs, after commissions, after taxes, after inflation, after the holding, costs of paying on that mortgage during the months in which that property was vacant. In that

example, there's a good chance that all the profits would be dwindled down to zero. That's why people who professionally flip homes are so adamant about purchasing homes for significantly less than fair market value, because they know that the spread needs to be much bigger than most people think for them to have a shot at net doing well after holding costs and other fees. That's a bit of an aside. But going back to your question, the reason that I like it so much is because, A, you recognize the huge transaction costs that are associated with selling a property. And B, you ask that key question of, I know I wouldn't buy it, but does that necessarily mean that I should sell it? The answer is no.

At least if I were in your shoes, I won't tell you what to do. but if I were in your shoes, I would hold that property. I wouldn't buy it, but I would hold it. You could absolutely refinance it. That would be a good way of pulling some of the equity out of it in order to use that for another home purchase. Assuming that you qualify, assuming that your debt-to-income ratios aren't knocking you out of the running,

then a lender might approve 70% of the equity in your home as a cash-out-refi amount. So if you wanted to tap the value of that home for your next real estate purchase, that's the route that I would take. But the reason that I wouldn't sell is because even though the property is not performing as well as a different one could, it's still passable. It's still cash flow positive.

And if you sold right now, there's a decent chance that you would break even at best. So there's no compelling reason to sell, especially given the fact that you have alternate options for tapping that equity. If selling that house were the only possible way that you could ever buy another property, that might be a different story. But there are alternatives. And if cash out refying that house doesn't work, then you could look for a property that offers seller financing or owner financing. You could look for private loans. There are a bunch of different avenues that you could take that would allow you to buy that next house that don't require selling a home that's performing passably.

So I would hold it until the price rises enough that it makes sense to sell. Among the beta testers in my course, I had a student ask a variation of this question. She said, I have a primary residence that I'll be moving out of. Should I sell it or should I turn it into a rental property? And the common thread between a year two questions is that base question of, if I already own a home, when does it make sense to sell? And the answer to that becomes a function of what's the cost, what's the benefit, and what's the alternative? In your case, Anonymous, the cost of selling is high, the benefit is marginal, and the alternatives are plentiful.

So that's how I would approach it. And congratulations on your success overall in terms of buying homes, selling them for a good profit, and identifying those pockets where you can buy properties that meet the 1% rule and that perform at a much better rate. You sound like you're well on your way to having a fantastic rental property empire. So congratulations. Our next question comes from Rose. Hello, Paula.

This is Rose. I have a dilemma and I need your help with. My husband and I have two properties in two different states. Right now, we go back and forth between the two. For simplicity's sake, eventually we'll have to decide to stay in one place only. One property was paid in cash. The other, we paid $300K for it two and a half years ago, and it has a mortgage of about $180K.

Estimated current market value is $400K. I love this property and don't really want to sell it. I thought in renting it in case I changed my mind. later and decided to move back. But my husband argues that it's not worth renting it. So now I'm all confused and that's why I'm here. Do I sell it or rent it? The problem is that the rent does not meet the 1% rule. The most I could rent it for is $2,000 a month, maybe $22 to $2,400 semi-farnished. If my numbers are correct, here is the cap rate that calculated. $2,000 a month. minus 5% estimated vacancy for an yearly income of 22800.

Utilities are electric, HOA, property taxes, and insurance for a total of 10K. Considering the paid price of 300k, the cap rate is 4.235. Not that great, and I'm not sure if it makes sense to rent it. Your opinion is greatly appreciated. podcast. Keep up the good work. Thank you. Rose, this is a fantastic question and I think my answer is going to surprise you. Don't calculate the cap rate on this. Don't look at this as an investment. This is a personal expense. You are offsetting the cost of the property by renting it, but this is a personal consumer purchase. You said so yourself in the voicemail. You want to keep this,

not because it's a good investment, but for personal reasons. And that's perfectly fine. There's a difference between renting out a property versus being a rental property investor. It's one thing to own a property and offset some of the cost of owning that property by renting it out. It's another thing to approach property acquisition and holding from the perspective of an investor. On the surface, they may look like the same thing, but they're completely two different frameworks, two different activities. And what you're doing, which is perfectly fine, is you're getting something for yourself. You're getting this home or holding onto this home for yourself because you want it, because you like it.

It's not an investment. So don't try to force it to be one. Now, I've talked about this with the beta testers recently, this whole notion that buying a rental property is different from being a rental property investor. And I find that sometimes people have a hard time grasping this idea. So let's take a look at this principle outside of the context of houses. As you may or may not know, there's a particular app called Turo in which a person, it's the Airbnb of car rentals. So it's this app that allows you to rent out your car.

when it's not in use. So let's say you've got two people, right? Person A and person B. You've got Jack and Jill. Person A, Jack, says, Hey, I have a car, and I only drive it two or three days a week. So I want to offset some of the cost of owning this car.

So I'm going to rent out my car when I'm not using it. That's perfectly fine. But that's not an investment. That's Jack owning a car and making some money off of it when he's not using it. On the other hand, you've got person B, Jill. And Jill says, you know what? I want to become a one-person car rental company.

I want to be a rental car investor. So I am going to bust out the spreadsheets, and I'm going to run a rigorous analysis, and I'm going to scrutinize precisely what car to buy or lease at what depreciation schedule, with what assumptions for time in use or time and service, and with what assumptions for repairs and maintenance, and with what additional overhead, like hiring an assistant to manage the operations, and based on all of those assumptions and all of those calculations, I'm going to derive an estimated return on investment from that.

And based on all of that, on those formulas, I will make an extremely strategic purchasing or leasing decision with the goal of making the scalable and continuing to grow and improving my return on investment and having this eventually grow to be big enough that it is my full-time occupation or that it can feed my family, right? So in that example, you have two people who on the surface are doing the same thing. They're both renting out cars, but Jill is an investor. Jack is just some guy who owns a car who's renting it out when he's not using it. In that example, you can see the clear difference between those two. So when you take this principle and you apply it outside of real estate, outside of housing, you can see the clear distinction. The same is true when it

comes to a rental property. That's the difference between renting out your home versus being a rental investor. So if you're going to rent out your home and you're going to hold on to that home because you love it because it's your home. Do that. Love it because it's your home and rent it out to offset some of those costs. There's absolutely nothing wrong with that. But just be clear, be conscious about the fact that this isn't an investment. And that's okay. Thank you, Rose, for asking that question.

We'll come back to this episode after this word from our sponsors. Happy New Year's. Are you looking for a side hustle in the new year? Here's a fun one. Become a pet sitter. You can get paid to walk dogs or to have dogs board in your home when their owners are out of town. And you set your own schedule, you set your own hours, your work is super flexible, and you even set your own rates. Generally, you can earn between $25 to $35 per night per dog who boards in your home, and they're pet sitters who make a grand a month or more for playing with dogs.

So how do you get this cool gig? You go to rover.com slash Paula, where you create a free account, and then click on Become a Sitter, and then you create a profile, and then you start hanging out with dogs. All of the bookings and payments and communication is handled through the Rover platform. If you're interested, check out Rover.com slash Paula to get started. You'll be snuggling dogs in no time. Become a sitter by visiting rover.com slash Paula. And from there, you can create your profile and get started watching dogs.

Check out Rover.com slash Paula to get started watching dogs today. Do you remember when you started your small business? It was no small feat. It took a lot of late nights, early mornings, weekends, and the occasional all-nighter. Bottom line, you've been insanely busy ever since. So why not make things a little bit easier? Our friends at FreshBooks have the solution. FreshBooks's Invoicing and Accounting Software is designed specifically for small business owners.

It's simple, it's intuitive, and it keeps you way more organized. to then a dusty shoebox full of crumpled receipts. Send and create professional-looking invoices in 30 seconds and get them paid two times faster with automated online payments, file expenses even quicker, and keep them perfectly organized for tax time. And the best part? Fresh books grows alongside your business,

so you'll always have the tools you need when you need them without ever having to learn the ins and outs of accounting. Join the 24 million people. who have used FreshBooks. Try it free for 30 days. No catch and no credit card required. Go to FreshBooks.com slash Paula and enter Afford Anything when they ask, how did you hear about us? Again, that's freshbooks.com slash Paula to try it for free for 30 days. That's freshbooks.com slash Paula, P-A-U-L-A. Our next question comes from Angie. Hi, Paula, this is Angie. I was wondering if you could talk a little bit about how you evaluate a

neighborhood when you're deciding to buy a rental property. I've heard you mention specific zip codes that you really like and find attractive. And I was wondering, you know, outside of the properties themselves, what sort of research you do on a neighborhood and, you know, I guess possibly even drilling that down to, you know, a specific block or couple of blocks. So any insight you you have on that would be much appreciated. I'm looking at doing my first rental property as a long distance landlord looking at Huntsville, Alabama, which is a place I've never actually been. So I'm very interested in how you research a place like that. So thank you for all of the great work you do. Really appreciate it. Angie, congratulations on searching for your first rental property and for

deciding to become an out-of-state landlord. There is so much opportunity with that. And I love the fact that you're looking at Huntsville, Alabama, Alabama is full of great rental properties. So let's talk about how to learn about a city and learn about a neighborhood and then drill that down to a street. Let's talk about all of that right now. Now, first of all, Angie, I'm sure you already know this, but for the sake of everybody who's listening, let's cover a basic foundational piece right here, which is that broadly speaking, neighborhoods tend to be divided into what's known in the real estate investing community. as Class A, Class B, Class C, and Class D. Class A neighborhoods are fancy places that you would love to live.

These are the places that have stainless steel appliances and granite countertops. Class B neighborhoods are like, you know the Simpsons, the cartoon? That's like basically where they would live. A reasonably safe working class, middle class kind of neighborhood. Class C neighborhoods are. are maybe a little bit on the edge, but you might be willing to live there. You wouldn't prefer it, but if you were trying to live super cheaply because you want to start your own business, or if you decide that maybe you want to go to grad school and you want somewhere to live,

you would be willing to live in a Class C neighborhood. You wouldn't prefer it, but you would do it. A Class D neighborhood is a place that some real estate investors refer to as a war zone. And when I first heard that I really didn't like that term because there are real war zones out there and I don't think that they should be compared. But there are some class D neighborhoods that even in broad daylight with a group of people, you still don't feel safe. The litmus test for whether or not a neighborhood is class D is, are you willing to go there alone in broad daylight in the middle of the And if the answer is no, then don't invest there. So let's look at class A, B, and C neighborhoods.

Now let's assume that you are out of state, as you are, Angie, and as many of you who are listening will be. How do you first identify looking at a new city that you've never visited what neighborhoods are Class A, B, or C? Well, here are some of the strategies that I use. First of all, the Class A neighborhoods are the easiest ones to figure out. Get on Google Maps and look for the location of Panera Bread, Lulu Lemon, Starbucks, Sephora, the Apple Store, Whole Foods, the Melting Pot, and Breyo Tuscan Grill. Wherever you see those, that's a Class A neighborhood.

Look for any business or subdivision or street in which the word point or grill or creek is spelled with an extra E-Sher neighborhood. on the end? Or look for anything labeled the blank at blank, such as the plaza at park villas, or the flats at Shoreline Avenue, or Stone Creek at Tully Springs, right? Those are all hallmarks of Class A neighborhoods. And if there's anything that's referred to as the village, game over. Like, that is so Class A, it's a caricature of itself. The other way that you can look for Class A neighborhoods is just get on Google Maps and search for the location of the cookie cutter developer subdivisions, right? Pulte homes, Riland homes, D.R. Horton homes.

What are the neighborhoods that they're building in? Those are the Class A neighborhoods. There's probably a Lulu Lemon nearby. These are super easy neighborhoods to find. Oh, the other thing you can do is run a search for the keywords, Best Preschools Huntsville, best doggy daycare, Huntsville. best sushi, Huntsville. Now you know where the nice neighborhoods are.

Now you know where people with money live. So that's how you find Class A neighborhoods. Now what do you do when you find it? Once you figure out where the Class A neighborhoods are, whether or not you're interested in investing in Class A neighborhoods yourself, in order to get a sense of what's happening in that city, once you figure out where the Class A neighborhoods are, look at the major apartment complexes that,

are in those neighborhoods. You'll see this on Google Maps. So I did this for Huntsville. And what I did was I got on Google Maps. I looked up the location of Panera Bread Huntsville and go figure it's right by the Apple Store. And then I found these major apartment complexes. I found Royal Pines Apartments, Madison Gardens Apartments and Research Park Apartments. They're all right by the Sephora. and every major apartment complex has a website. So the next thing that I did was I went to that website, and I looked at those apartments, and I looked at how nice are the finishes, and what's the rent? So, for example, Royal Pines Apartments has a website in which their photos look great,

but the finishes are actually kind of basic. There's cheap laminate countertops, cheap oak cabinets, a really old-looking stove. Like they clearly invested in high-end. photography. The photos are very, very well done, but the upgrades are kind of meh. And I can also see the price. I can see that at that apartment complex, you can rent a two-bedroom for between $806 to $876 per month. So what does that tell me? Right away, I have information about the expected level of finishes and the price in what would be, a relatively higher-end, secure area, a Class A area in Huntsville.

So now I can anchor at one end of the spectrum. And conversely, if I'm trying to figure out where the Class C neighborhoods are, then here's what I did. I went to Google Maps, and I googled Cash Advance Huntsville, Alabama, and then I Googled Payday Loan, Huntsville, Alabama, and then I googled Pawn Shop, Huntsville, Alabama. and I looked at where those are. What this does for me is it allows me to take a broad area, something as broad as an entire city, Huntsville, Alabama,

and start narrowing down to specific neighborhoods. And once I've narrowed to specific neighborhoods, depending on what I want, then once I'm in there, then I can drill down a little bit more closely and start looking block by block. Because, yeah, it's true. They're not going to put a Lulu Lemon next to a cash advance. center, but sometimes they're not that far away.

Sometimes it does get block by block. Maybe not to the degree of difference of a Lulu Lemon versus a payday loan center. You know, maybe it's not that extreme. But when you drill down into a neighborhood, sometimes you will see a cash advance center that's three or four blocks away from a Trader Joe's. And when you see that, that's when you know that you've got a real-advent center. really start paying attention to the nuances of each street. Because when businesses that cater to such a different clientele are located so close together, then you know that you're looking at a

neighborhood where every street or even the side of the street that you're on makes a difference. By contrast, if you're looking at a neighborhood where all of the businesses are fairly homogenous in terms of the income level of the client that they serve, then you know that the type of dwelling in that neighborhood is also going to be probably around the same price point. So this is the part of the search where you start narrowing not just to zip codes, but also to certain streets. Now, what I've just explained is how to look at the difference between Class A versus Class C. Class B neighborhoods can be a little bit harder to search for. That's the in-between zone.

The strategy that I've just outlined will give you a solid starting reference for Class A versus Class C. The other thing that you can do is you can look at the Trulia crime map. Now, unfortunately, this works well in some cities and it doesn't work well in others. If you were investing in Atlanta, Trulia has a really excellent crime map for Atlanta, where you can drill down and look at specific, not just neighborhoods, but you can look at a specific street and see that there's more crime on one side of a given intersection than there is on another side of that intersection. I looked at the Trulia crime map for Huntsville, Alabama, and when I looked it up, everything has the same level of crime threat.

And what that indicates to me is that there's not enough data that Trulia is pulling, because the city cannot possibly be that homogenous. So for many of you listening who are looking at other cities, the Trulia Crime Map could be a good resource. Unfortunately, Angie, for Huntsville, it's not. The other thing that you can do is search both Yelp and Reddit for the phrase, I'm moving to Huntsville, where should I live,

and see what locals say about different neighborhoods. Other search terms that you can use include places to avoid in Huntsville, most dangerous places in Huntsville, why I love Huntsville, and why I hate Huntsville. Search for all of those phrases and see what people say, but take that with a huge grain of salt because the way that a person evaluates a city is based on their own frame of reference. And if the person who is writing that online is somebody who is only familiar with neighborhoods, that feature a Starbucks and a macaroni grill, then their frame of reference may be one in which perfectly nice neighborhoods get discarded

because those neighborhoods don't reflect what that person is used to. So it can be helpful to look at what people online are saying about neighborhoods, but it could also be misleading. So take that with a grain of salt. I'll give you an example. My own neighborhood in Las Vegas, where I personally live, I think it's fantastic. I've lived here since 2015.

I love it. And relative to where I used to live in Atlanta, this neighborhood feels a lot safer. I'm a lot more comfortable here. In 2017, Thanksgiving 2017, my parents flew out to visit. I live in a condo, and we had Airbnb to a place in this same. building where they could stay for a month. And within two or three days of being here, my parents said, you know, we're not comfortable here. We think this place is too dangerous.

We're not going to stay here. Even if we cannot get any type of refund from Airbnb, even if we end up having to pay for the whole month and not using it, we're still not going to stay here. And we encourage you to move out as quickly as possible. That was their response to this neighborhood. and I live here. I still live here. I've never thought of my own neighborhood in those terms. So the fact that two different people can look at exactly the same neighborhood and have such wildly different interpretations of it underscores how contextual a person's impression of a neighborhood is. So that's what I mean when I say to be skeptical when you read online reviews about various neighborhoods in a given city. But to start your search, use businesses, the types of businesses that are in a given neighborhood are a fantastic barometer. That will tell you all you need to know about whether a neighborhood is class A, B, or C.

And once you've narrowed that down, then you can start drilling down more deeply, which essentially is a function of zoom, in on Google Maps, looking at all of the commercially available data for residential housing there, such as looking at apartment websites, and then once you've drilled down to a couple of blocks, then start searching those blocks from the perspective of a tenant. So once you've zoomed in on Google Maps enough that you're looking at an area of maybe six blocks, then put yourself into the shoes of a person who wants to rent there and see what you can find. What are the finishes in those houses? What's the square footage? What do they cost? Once you have that area drilled down, search as though you are a tenant who wants to live there

and see what the competition is. That's how you gain familiarity with an area. The final thing I'll say is after you put a property under contract, I strongly recommend flying out there to see that property. So you don't need to do this prior to making an offer on a property because you will most likely make many, many, many offers that do not go through before you make the offer that does and then you go under contract on that property. And once you go under contract, then if it's specified within your offer, which I hope it is, you will then be in a due diligence period in which you have a buyer's general right to terminate. And it's during that period of time when you have that buyer's general right to terminate that I highly encourage flying out there, even if you can only be there for 24 hours. Or heck, even if it's less than that, even if you fly out there at,

at seven in the morning and fly back at seven at night. Go there for 12 hours, but go there and see the property before you purchase it. A lot of real estate investors disagree with me about this, so what I have just said is controversial. There are plenty of investors who will say that's absolutely not necessary if the numbers work, they work. Heck, I even interviewed on this podcast, Rich Carey. He can't fly out there because he's stationed in Korea. He's in the military and stationed in Korea and he buys houses in Montgomery, Alabama. In his case, he's way too far away to fly out there. And he's absolutely made it work. He's managed renovations from Korea. So there are plenty of investors like Rich who don't go out there to see the property,

and they do just fine. He owns 20 homes. They cash flow very well. But if you have the ability to do it just for a day, I mean, it'll cost you what a few hundred. maybe three or $400. And I think that's absolutely worth it. So thank you, Angie, for asking that question, and good luck with buying your first rental property. We'll come back to this episode in just a minute. But first, if you're like me,

there's a long list of books that you want to read, and there's just not enough time to read them all. Blinkist has to solve that problem. Blinklist takes thousands of best-selling nonfiction books and distills them down to their most essential elements so that you can read them or listen to them on your phone in 15-minute increments. And you can listen anywhere. I like to do it when I'm running errands.

You know, if I'm driving, for example, it's a 15-minute drive, I can listen to a summary of a book during that drive. They have a huge library with classics like Think and Grow Rich and Modern Best Sellers like The Power of Habit. By the way, totally recommend the Power of Habit. It's a great book. And there are 5 million people using Blinkist to expand their knowledge in 15-minute increments. Blinkist is also constantly adding new titles to their library.

And right now, Blinkist has a special offer for my listeners. Go to Blinkist.com slash Paula to start your free trial or get three months off your yearly plan when you start today. That's Blinkist.com slash Paula, spelled B-L-I-N-K-I-S-T dot com slash Paula. Blinkist.com slash Paula to start your free trial or get three months off your yearly plan. Blinkist.com slash Paula. If you have a business or you know someone who does, you probably know that running a small business means that you have to wear a lot of hats. And some of those hats are, meh, not that great. Like filing taxes, running payroll.

You have to do it, but it's probably not what you love about running your own company. That's where Gusto comes in. Gusto makes payroll taxes and HR easy for small businesses. Fast, simple payroll processing, benefits, and. and expert HR support all in one place. Gusto automatically pays and files your federal, state, and local taxes, so you don't have to worry about it. Plus, they make it easy to add on health benefits and even 401Ks for the people on your team.

So those old-school clunky payroll providers, they weren't built for the way that modern small businesses work. Gusto is. So let them wear one of your many hats, because you've got better things to do. You run a company. Listeners get three months free when they run their first payroll. Try a demo and check it out for yourself at gusto.com slash Paula.

That's g-U-S-T-O-com slash Paula. Gusto.com slash Paula. Our next question comes from Ingrid. Hi, Paula. Here's my real estate-related question. I read your article back in 2014 about the big dilemma of paying down your current mortgages or investing in another rental property. I currently have two rental properties. They both have pretty big mortgages on them, but I do want to just keep investing in other properties.

I love that article, but I know it was back in 2014 and you kind of left it like you hadn't decided yourself. So I was just wondering if since then you've made any headway on that decision for yourself? Is there a certain amount of debt that you'll leave your rentals in before you buy another one? Or do you kind of just still see what's on the market? And if there's a good deal, you buy that. If there's not, you put the money towards one of your mortgages. And then lastly, is there a way to pick which mortgage that you pay down? Is it a higher interest rate? Is it a bigger mortgage? Is it the one that's making less cash each month? I'm kind of just asking for your opinion because I know there's not a definite answer on this. So I'm seeing if you have an opinion that you are doing currently with

your properties. Thanks so much. Ingrid, first of all, thank you for having read me for so long. If you've been reading my article since 2014, wow, thank you. Thank you for sticking around with me for so long. Thank you for being part of the Afford Anything community for five years now and counting. So yes, you're correct in 2014. So for the benefit of everyone listening who hasn't read that article, I was really deliberating between do I pay down my houses? Do I buy more? And by the way, that question never disappears. That's always a lingering question on the back of your mind. But here's how I approached it. First of all, I decided not to incrementally make payments towards a mortgage. Instead, I decided that what I would do is save up money into a savings account. And when that savings account grows to a particular,

threshold, like when that savings account grows to enough money that I could apply it as one big lump sum towards a mortgage, I could then at that point decide, all right, do I want to pay off this mortgage or do I want to use this big chunk of cash to make an ample down payment on another property or even buy a cheap property in cash? Right. So one of my mortgages has a balance of about $100,000. What I started doing, rather than putting an extra $2,000 a month for the next 50 months into it, instead of that, what I started doing was putting money into a specific savings account that would just accumulate with the idea that as this grows, it'll give me more options. And then when the balance of that account hits $100,000, then I can decide to either

make a giant lump sum payment and wipe the whole thing out all in one check or not. I could also decide to put all of that money towards buying another property. And so what ended up happening is, of course, I bought another house. We accumulated about 60 grand in cash. And in 2015, a year after I wrote that blog post that you referenced, we paid cash for a house. We paid cash for a house. We paid $46,000 in cash for a house and then put another $15,000 into renovating it also in cash. And then, wait, actually, I take that back. Did we buy that in 20? No, we bought that house in 2014 also.

That's right. And then in 2015, we made $100,000 down payment on the personal residence in Las Vegas. So, yeah, to answer your question, my history is that of accumulating cash in nothing. so that I have the option to do something big, whether that something big is a big mortgage wipeout or a big property purchase. I just let money accumulate until I can go big or get another home. Now, to the other part of your question, you had asked about how I decide how much debt I want to carry. I look at debt not on each individual house, but across my portfolio.

as a whole. So across my entire rental property portfolio as a whole, I hold about 50% equity and 50% debt. For me, personally, that's a ratio that I'm comfortable with. A lot of real estate investors find that too conservative. There are a lot of investors who want to borrow 90% and have equity of only 10%. In fact, there are many investors who feel like they're doing a subpar job if they have too much equity. because then, hey, how's your return on equity doing? How's your cash on cash return? Well, guess what? I can make both of those metrics improve by taking out more debt. That's what you'll hear in a lot of real estate investing circles. And that's one of the many reasons that I always tell people to be careful about what metrics you follow. Because if you are following a formula like cash on cash return or return on equity, if you're following that formula in a vacuum just because you think that's what you're supposed to do, without contextualizing that with regard to what does that formula actually mean and what does it represent? And do I want the output to be high? Well, then that's not really a holistic look at the investment. So my cash on cash return is quite low by a lot of real estate investor standards. My return on equity is quite low. But my equity to debt ratios are 50-50, and I'm very comfortable there. Again, that's just my own personal comfort level. Everyone has their own risk tolerance. So what's comfortable to me is not necessarily going to feel good for you or for

anybody listening. We've had Rich Carey on the podcast on a previous podcast episode. He buys his properties totally in cash. He likes the simplicity. He likes the lack of risk. But then you've got other people, like Brandon Turner from Bigger Pockets, he's comfortable with way more debt than I am. So it is a personal decision and it may adjust over time. But the one thing I would say is don't focus too much on the debt that any one property carries. Look at your entire portfolio and see what the aggregate debt to equity ratio is in terms of understanding how much risk exposure you have as a whole across all of your properties. Now, to the third part of your question with regard to deciding what we're going to, what property to pay off first, I would go at the property with the smallest balance.

And the reason for that, the reason I would do that is quite simply because of my payoff strategy, which is save up the entire repayment amount in cash first and then decide whether or not you're going to apply this. So following that strategy, it makes the most sense to pay off the smallest balance first because if you're doing it in one fell swoop with one check, then that's the first one you're going to reach. But I do remember one of my, I mean, regret is a strong word, but I remember many, many years ago, I think it might have been 2013 or 14, somewhere around there. I remember making an additional $8,000 payment towards the Triplex.

In hindsight, I wouldn't have done that. And I realize that makes me perhaps the first person in the history of podcasting to get on a microphone and say, oh yeah, remember that extra principal payment that I made towards a debt? I kind of regret that. But it's true. I do. And I think the reason why is because it wasn't strategic. I think I looked at the 30-year repayment schedule and saw how far into the future 30 years was. And I had a knee-jerk reaction. And I was like, okay, just pay it, pay it. You know, and then I took whatever cash I had at the moment and made it as an extra principal payment. And, you know, and I know that everybody on the internet says, you'll never regret being debt free, blah, blah, blah. But I just told you that I do. Specifically, the reason that I would not do that again is because when I made that extra payment, I did it in a way that was not strategic. It was not contextualized within a bigger framework of this is my plan, this is my strategy. It was an impulse decision. It was an emotional decision. And so that $8,000 extra payment that I made towards the triplex, I mean, that could have been the kernel of savings towards another house. Or it could have been part of the renovation budget of one of the properties. It could have done a million things. And as this podcast is themed around the concept of opportunity costs, right? Doing one thing always comes at the expense.

of doing something else. And so making an extra principal payment that was not sufficiently large enough to wipe out the entire mortgage balance, what did it really do? Sure, it lowered the lifetime interest that I will pay on that loan. Yes, that's true.

But it didn't improve my cash flow. It didn't build me a bigger emergency fund, thereby decreasing my liquidity risk. It didn't renovate a property thereby improving my occupancy and improving possibly also the rental rates. So even though it was an extra principal payment towards a debt, that specific payment was suboptimal. There were many better things that that $8,000 could have done. And it was after I made that payment that I then later thought more about it and came to the

philosophy of, all right, Paula, if you're really going to wipe out a debt, do it in one fell swoop or don't do it all. And to clarify for everybody who's listening, I'm talking specifically about mortgage debts on rental properties. So no part of my answer should be interpreted as a strategy for something like credit card debt or a car loan or anything like that. I'm speaking in this context specifically about rental property mortgages and that alone. Well, thank you so much for asking that question. That's a fantastic question. And good luck with whatever you decide for your own properties. Our final question today comes from Jackie. Hi, Paula. This is Jackie. I currently own three properties. Two are full rental units. One is a duplex.

I live in half of the duplex and Airbnb the other half. I have a down payment of $30,000 ready for my next rental property, but my debt to income ratio is too high to qualify for a traditional bank loan. I want to buy the next property for a long-term hold, and I'm more. wondering if you have any recommendations for other ways to secure financing. The only debt I carry is that on my properties. Thank you for your help. Jackie, congratulations on the properties that you have accumulated already. That's fantastic. And I love the house hacking that you're doing, living on one side of a duplex and Airbnb being the other side. If you cannot qualify for a loan from a financial institution like a bank or a credit union, here are some of your other options. In no particular order, number one, you could look for a property that is being

sold with seller financing, which is sometimes also referred to as owner financing. There are two common ways to find this. One is that some properties that are publicly listed on the MLS will specify within the listing description that that property is being offered with seller financing. then that's an easy find because it's written right there. Alternatively, you can suggest to the seller that the seller provides the financing, meaning that the two of you will come up with a loan agreement and your mortgage payments will go directly to the owner, directly to the seller. I mean, they shouldn't go direct.

They should go through escrow. But via escrow, they will go direct. Now, sometimes you can ask a seller who is listing their property publicly on the MLS for it, but oftentimes where this is found is when you are buying properties that are not publicly listed. So if you're driving for dollars, for example, or if you're sending out a postcard campaign or a direct mailer campaign, or if you're working with wholesalers, this is often where because you're approaching people who didn't have their house publicly for sale in the first place, there's more space to negotiate.

And there's also more space to have a direct conversation with the seller. So seller financing is a fantastic option. If this feels very new to you, one good starting point might be to get to know wholesalers in the area in which you're looking to invest. I would not recommend going to a major company that wholesales involve. I would recommend talking to local mom-and-pop investors who specialize in wholesaling. Many of them will have had plenty of experience in working with seller financing. And when you go to them and tell them that you're a buy-and-hold investor who is interested in purchasing a home with seller financing,

they'll oftentimes be able to show you the ropes or point you in the right direction or provide you with some of those properties. So that is absolutely one option. Another option, I know that you can't qualify for a conventional loan, and you also probably can't qualify for any type of federally backed loan, like an FHA loan. Talk to a banker to see if there's a possibility that you could qualify for a portfolio loan. You may or may not. I don't know the details about your finances. but ask a banker if getting a portfolio loan from an institution might be an option for you.

If there is a way for you to get institutional financing, that might be there out. So that's a second option. Finally, you could take out a private loan. Private loans are loans that are made by investors to investors. And one of the best ways to find people who issue private loans is to network in investor meetup groups because, I mean, by definition, if a private lender is in the business of lending to investors, then that person's occupation is to network with investors. So if you go to investor networking events, that's where the private lenders are going to be.

And you do have to definitely sort through a lot of duds. There are a lot of people at those things that are just trying to sell you something or There are a lot of people who are all talk, no action. There's a ton of that. So keep your guard up. But the bright side is oftentimes you just need to find that one person, that key person who is authentic and who's been in the game for a long time and who knows what they're doing and who knows the players. And even if that person is not a private lender, they'll know who to connect you to. So eventually it's a numbers game.

You meet enough people and eventually one of them is the person who introduces you to the person who is the right person that you need to talk to. Thank you for asking that question, Jackie. Good luck with growing your real estate empire. That is our show for today. If you have questions about real estate, head to Afford Anything.com slash voicemail to leave your question. That's afford anything.com slash voicemail. As a reminder, we have released a free e-book. It's called One Tweak a Week a Week, and it outlines 26 quick, easy, actionable steps that you can take to improve your finances this year in the first six months of this year. It's one tweak a week for 26 weeks. So it covers January through June. And if you follow this one per week, then within six months, you will have made plenty of improvements in your financial life. Now, all of these tweaks are designed to be quick and easy. Most of them are designed to be done in under an hour. Several of them can be done in five minutes or less. Obviously, more effort equals more reward, right? Some of the tweaks are longer and more time-consuming, but they make a bigger impact over the long term. Other tweaks are smaller, but all of these taken together accumulate.

bit by bit into an improvement in your overall financial picture. So you can download this for free at afford anything.com slash 2019. That's affordanything.com slash 2019. Thank you so much for tuning in. My name is Paula Pan. This is the Afford Anything podcast. I'll catch you on Monday. By the way, end of year, well, I guess technically beginning of new year, update on the

charity water campaign. long-time listener of this podcast. As you know, we spent 2018 running a big fundraising campaign for charity water with the goal of raising enough money that we, the Afford Anything community, could solely sponsor and build some type of a water project, such as digging a well or creating a rainwater catchment system in some community in the world where people get sick with diseases like cholera and typhoid from dirty drinking water. So that was our 2018 campaign. And at the beginning of 2018, my goal was to raise at least $12,000. Well, guess what? It is now the beginning of 2019. And I can say, officially, that last year we raised $21,978. What? We blew our goal out of the water.

No pun intended. So thank you so much to everybody who contributed to the campaign, who raised money, who bought a t-shirt with 100% of the proceeds going to this campaign. Thank you so much to everybody who came together as the Afford Anything community to create a water project somewhere in the world. This approximately 732 people are going to be able to drink clean water. Thanks to you and thanks to this community. So thank you all so much.